Diary

Bailout Passes - Economy Still Plummets?

When the inevitable finally happens and The Bailout passes the Congress later this week, the next question on everyone’s mind will be: what happens next?

I have no doubt that this bailout could provide some short-term relief to the credit crisis, liquidity and recapitalization in the banking system, perhaps even serve as a sort of catharsis to the stress afflicting the credit markets.

I also have no doubt that not only will this be short-lived, but that the long-term damage of this legislation will prove to actually make the problem far worse in the coming months. The politicians who have risked their reputations on this bill are going to lose a lot of credibility with their constituents if/when the economy and the stock market keeps dropping and unemployment rate continues to climb.

The most dangerous part about this bailout is that after putting the nation through a collective panic attack about our financial future, after making the most dire predictions about impending doom if we do nothing, and after admitting that this is not the best way to handle the crisis, but –it’s our only option, and we have to do something – if, after all of that, we find the markets and our economy back in the death spiral mode in a few more weeks or months, then the entire United States government will have lost all credibility.

Especially the U.S. Treasury.

This is dangerous for many reasons. Mostly because unquestioned belief by the world in the “Full Faith and Credit of the United States” is what seperates our nation, its finances, and consequently our high standard of living from the less desirable places to live on this planet. It is what keeps our interest rates low, our lifestyle high, and provides our government with the financial resources to preserve freedom, property rights, and the rule of law.

Without this credibility, a draconian reassessment of our national priorities would have to occur, and we would undoubtedly be forced into an age of austerity that few among our population have ever endured.

I tell you honestly, this will not be the only bailout. There will be more, likely many more. Each one claiming to be the last, and each one larger than the one before.

When the perception of the world’s capital is that the U.S. government is incapable of affecting a positive outcome to this crisis, the Treasury will find itself in a similar position to Lehman Brothers several months ago – in desperate need of more capital, but no confidence in the plans that a solution is near.

The simple fact is that there are $14 trillion worth of mortgage backed securities out there. That is several trillion dollars larger than our entire “official” national debt. To think that $700 billion to $1.3 trillion of Treasury financed debt will be able to solve the underlying problems of price discovery, an illiquid market, and an estimated $3 trillion of deleveraging of the banking system is foolish and naive.

The most dangerous part of all is the notion that a government who created this mess with Fannie Mae and Freddie Mac could run a similar government portfolio of mortgage securities any better – let alone the rhetorical folly of “the taxpayers may actually end up making a profit”.

The only way this thing doesn’t end up cost the taxpayers dearly is if the securities are bought at such a discount to face value that serious solvency issues come into play for the rest of the system. Any premium at all over this will put the taxpayers in the red, even over time.

The housing market has structural and fundamental reasons why it will not be able to reflate to bubble pricing without dramatic inflation and devaluing of the currency. There will not be any more 100%+ financing of mortgages in the future. There will not be sub-prime mortgages. There will be dramatically less jumbo mortgages. There will be very few, if any at all, option ARMs, interest-only, and other adjustable rate mortgages that allow borrowers to obtain low introductory payments without amortization. The future will be 20% down payments, high FICO scores, and very stable employment/income history.

When you factor in such things as a slowdown in the real economy, an increase in unemployment, the supply of unsold homes on the market, and impending bulk of underwater ARMs-reset related foreclosures from the 2005/2006 peak, it becomes hard to envision a day when McMansions in the Las Vegas suburbs or the Inland Empire in Southern California are going to be worth anywhere close to where they were 3-4 years ago. Without that, literally trillions of dollars of capital will be wiped out completely.

The scariest part of all is the thought of an Obama Administration filled with his Chicago Democrat Machine Cronies presiding over, mismanaging, and having fiduciary responsibility over this Paulson Hedge Fund.

This monstrosity will end up being a blank check for Executive Branch corruption that will be the envy of Third World despots.