Wall Street Bailout: Making a Deal With the Devil

Henry Paulson's "bailout" bill, with only a few anti-Wall Street, pro-Main Street fig leaves slapped on by Democrats, appeared ready to sail through Congress on a bi-partisan tide. But something funny happened on the way to the printing press. It appears as if some conservative House Republicans are reluctant to sell their souls and ditch any remaining pretense towards American-style capitalism.

What's left of the Barry Goldwater wing of the Republican Party, which maintains its natural tendency to trust the markets and not government, has dug in its heels. But, Bush, Paulson and the Democrats have argued that our problems are so dire that free enterprise principles must go out the window. The struggle is historic, but the Congressmen are fighting a losing battle. Sadly, Americans now appear willing to abandon their economic heritage at the first sting of financial pain.

Although passage does seem inevitable, it is nevertheless the wrong thing to do. Central government planning did not work in the Soviet Union and it will not work here. Only free market forces are capable of sorting through the mess. Political meddling will make the problems worse.

In selling the bill to Americans, many are pointing to the Resolution Trust Corporation as an example of similar intervention that worked in the past. However, there is no proof that RTC actually helped as we have no way of knowing what might have happened had the government stayed out.

Missing in this discussion is that the Savings & Loan crisis of the 1980's, much like the current crisis, was a byproduct of government interference in the free market. By insuring bank deposits through the FDIC, the government created a moral hazard that resulted in extreme risk taking among member banks, whose depositors sought only high yields, without any regard for the risks that the banks were incurring. Banks that refused to take big risks lost deposits to those banks that did. Absent FDIC insurance, depositors would have considered risks as well as rewards, and the S & L crisis never would have happened in the first place!

The urgency for passing this bailout bill is based on the claim that the American economy will collapse if nothing is done. If the government were to stay out, and allow the market to function, there will certainly be a great deal of economic pain. Companies will go bankrupt, banks will fail, real estate and stock prices will keep falling, and many people will lose their jobs. However, government action will not prevent any of this. At best, it will merely delay the inevitable, but only at the cost of increasing the severity of the underlying problems, thus making their ultimate resolution that much more painful to endure.

The bottom line is that there is no way to resolve our economic problems without a severe recession, and our politicians need to level with the public. As a nation, we gambled on the alluring riches of real estate and we lost. The price must be paid. Contrary to the Bush Administration rhetoric, the fundamentals of our economy are not sound. If they were, we would not be in this mess. Recessions are meant to restore balance, purge excess, and liquidate mal-investments. On that score we have a lot of work to do.

We are being told that this plan will help the economy by keeping the spigots of consumer credit flowing. However, to really address the fundamental problems, those spigots must be tightened. Since we have already borrowed and spent ourselves into bankruptcy, the last thing we need is for consumers to borrow more.

Our leaders maintain that without this bailout consumers will not be able to borrow money to buy cars. So what is wrong with that? We already have plenty of cars, and if we are broke, why do we need to buy more? Instead, we need drive our old cars longer, pay off our underwater auto loans, and produce more cars for export. It is also argued that without access to credit parents will not be able to borrow money to send their kids to school. That's fine by me as it will force Universities to reduce tuitions to levels families can actually afford. They will either have to cut out all of that bureaucratic fat, or go out of business for lack of customers.

In the end it is impossible for the American economy to be rebuilt on a sounder foundation of savings and production without a lot of economic pain. Government efforts to reinforce the shaky foundation of borrowing and consuming will result in the entire structure falling down around us.

For a more in depth analysis of our financial problems and the inherent dangers they pose for the U.S. economy and U.S. dollar denominated investments, read my new book Crash Proof: How to Profit from the Coming Economic Collapse.

Comments

[WEBISKING:]

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2008 Sep 28 09:07 AM

[Metzenbaum ...:]

Sigh.

You are correct. The economy won't collapse. The horrid financial architecture on Manhattan Island will collapse, and 300 million American ought to say bye-bye, not buy-buy.

The government aided in the creation of this wealth generating machine and now they want another transfer of wealth.

Poor, poor America.

2008 Sep 28 09:07 AM

[Buffalo B:]

They are scaring us with Warnings of Mass Devastation (WMD's) if we don't give them more power. This from the people who created this problem. I'm not sure which is worse, their fiscal bankruptcy or their moral bankruptcy, but I will no longer support their tyranny.

2008 Sep 28 09:08 AM

[investor88:]

Agree this mega bailout is no magic solution and skirting the underlying problems of over leverage and over consumption. The problems will fester instead of being solved through a normal recession or depression of creative destruction.

2008 Sep 28 09:30 AM

[HiThere:]

Kudos to all involved who have tried to slow it down.
Too many are focused on current position and immediate gain-
Mark to Market is showing something, not causing it.
We are being sold a bill of goods-we have been stagflating or there would have been no need to borrow. Boom fed by credit expansion and the answer is to extend more credit? With wages and fixed income flat or declining and credit tightening... We are missing an opportunity to really shake this thing out.

2008 Sep 28 12:02 PM

[oldgoldbug:]

Well said.

2008 Sep 28 12:47 PM

[Al-USA:]

Ok well, nothing to do but throw the bums out of office come November. Out with the old, in with the new...

2008 Sep 28 05:49 PM

[DavyJ:]

Peter, though I agree with the overall gist of your article, you said: "Absent FDIC insurance, depositors would have considered risks as well as rewards, and the S & L crisis never would have happened in the first place!"

So you believe that mom and pop and DavyJ can analyze a bank and make a reasonable decision as to whether it's a safe place to bank? Even A. M. Best didn't downgrade AIG until late last June.

What do you propose next? Do we all have to evaluate all the drugs on the market and decide whether they are safe for us and our children? Sometimes we do need a central government.

You might want to choose a better example in the future.

2008 Sep 28 08:53 PM

[johnchen12:]

This is a great article. It pointed out the problem of the current financial system of America. We American people need to save more instead of borrow more under current enconomic. Unfortunately, all politicians such as Henry Paulson did not see this. By given away more money and credit to people may not be useful at current time. The problem is the afforability. There are not many people who can affort the current housing price due to the high housing price. The housing price is still too high which compare with the incoming and saving of people having. For example, the average income of an well-known city Irvine of Orange county/California is about $85,000 familiy income, but the housing price for a 2000 SF house is still $700,000 which is down from $900,000. But $700,000 is still too high. The price is still two times of 2001's price. An average person still cann't affort the price. By giving people more credit to buy the house to stop price to go down will creat more problem. The goverment did not realize the root of the problem.

2008 Sep 28 08:54 PM