Thursday, September 25, 2008

Is the Bailout DOA?

At 3pm the bailout seemed to be a done deal. By 5pm, the deal was waivering and by 8pm some insiders are saying that the massive Wall Street bailout is dead in it's current form. Wow, what a day.

As is the case most nights, there is news breaking late into the night and I'll update the stories as news flows in.

1) The Fate of the Bailout - I think it's become increasingly clear to Congress that this bailout's popularity is on par with a Cowboys fan in the Meadowlands. Calls to some Congressmen have been running 100 to 1 against this bill. My concerns with the bill remain that while it may grease the gears of capitalism it does nothing to address the underlying problems - home prices nationwide will continue to fall due to the weak economic backdrop.

There is talk of a new proposal from House Republicans, but there are a couple of scenarios that I see as viable:

a) The bailout fails and Congress delays any action. The markets are in for a really bumpy ride if this happens, but remember Goldman and Morgan Stanley took on this risk of their own accord. No one forced them to play in these markets.

b) A new bailout package is passed. The markets can explode upward but as the fundamentals of our economy are slowly revealed the markets can and will likely bleed lower.

2) Leading Economists on the Bailout - Economists in general are a dry, unexcitable lot. They are not prone to statements in black and white, they see the world in many shades of gray. However, it is for this reason that I find the following letter sent by 190 leading economists to the leaders of Congress particularly compelling:

"To the Speaker of the House of Representatives and the President pro tempore of the Senate:

As economists, we want to express to Congress our great concern for the plan proposed by Treasury Secretary Paulson to deal with the financial crisis. We are well aware of the difficulty of the current financial situation and we agree with the need for bold action to ensure that the financial system continues to function.

We see three fatal pitfalls in the currently proposed plan:

1) Its fairness. The plan is a subsidy to investors at taxpayers’ expense. Investors who took risks to earn profits must also bear the losses. Not every business failure carries systemic risk. The government can ensure a well-functioning financial industry, able to make new loans to creditworthy borrowers, without bailing out particular investors and institutions whose choices proved unwise.

2) Its ambiguity. Neither the mission of the new agency nor its oversight are clear. If taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions, and methods of such purchases must be crystal clear ahead of time and carefully monitored afterwards.

3) Its long-term effects. If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America's dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted. For these reasons we ask Congress not to rush, to hold appropriate hearings, and to carefully consider the right course of action, and to wisely determine the future of the financial industry and the U.S. economy for years to come." - emphasis mine.

We certainly live in interesting times.

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