Bailout or Train Wreck?

By Mike Myatt, Chief Strategy Officer, N2growth

Will today’s meetings in Congress produce a Bailout, or will the end result be just another cobbled together train wreck in the making? Is the Bailout a prudent step forward for our nation, or is it just another band-aid solution forestalling the inevitable? So, will Congress agree to a deal today? If so, will it be the right deal? Will it work? If not, what will be the market ramifications? In today’s post I’ll provide you with my thoughts on the aforementioned questions, as well as put forth some economic observations and alternatives for your consideration…

Call me a die-hard free market capitalist, but I’m not in favor of a bailout. From my perspective nationalizing Wall St. simply rewards the wrong behavior, provides no assurance of an acceptable outcome, and unilaterally transfers all the financial risk to the taxpayers.  The following thoughts and observations will provide you with the underlying reasoning behind my thoughts:

• Will Congress agree to a deal in the near term? I think so; and if not today, likely by the time the Asian markets open on Monday. There is tremendous pressure for Congress to make a move to stabilize the markets, and I believe they will do so in the near term. Even though the current polls show that only 25% of American’s are in favor of the bailout, I believe most Americans anxiously await some form of swift resolution. Since we all know that polls are a key driver of decisioning in Washington, it is likely that some spin will enter the equation with the bailout being sold as something that it is not. The truth is that most of the really bright financial minds that I talk with see the bailout as a bad move. There is still a possibility that Republicans will dig in their heels in opposition, but this will likely only result in short-term delays rather than killing the bailout.
• What will happen if Congress doesn’t agree to a bailout in the near term? The market thinks the bailout is a done deal and has already factored in a price gain reflecting this. As mentioned above, I think the odds of Congress not stepping-in are unlikely. That being said, if they don’t, the capital and credit markets will have a severe negative reaction, and a bit of main street panic will ensue. There is a strong likelihood that a recession or worse could follow.  However, this is where I differ from the politicians…my contention is that the aforementioned scenario is not necessarily a bad thing. Markets need to correct themselves in order to purge themselves of corruption, bleed out inefficiencies, regain their balance, and move forward in a healthy fashion again. Would there be pain and suffering that follows letting the markets correct themselves? Absolutely, but this is the natural order of things. Markets and economies ebb and flow. They do not just run in an upward direction in perpetuity. To think that they should is fantasy. To think that the government should step-in and bail them out when they don’t is socialism. Both positions constitute flawed thinking.   
• What will the bailout look like? I don’t think it will differ greatly from the original plan submitted. While the plan will most likely call for a $700 Billion dollar bailout, it is highly probable that it will mushroom up to $1.5 Trillion dollars with near term adjustments that will most certainly follow the initial adoption. Sizing aside, there simply isn’t time to get consensus on sweeping changes and still meet the markets expected timing for a resolution. It will likely contain a few watered down oversight provisions, and a few points of clarification, which will in turn give Congress a few sound bites to leverage about how they’re looking out for taxpayer interests. However, from a meaningful perspective, it will still be woefully inadequate in terms of managing the risk associated with a bailout. 
• Will a bailout work? There is an argument to be made that previous bailouts (i.e. Roosevelt’s New Deal, the 1979 bailout of Chrysler, and the Resolution Trust Corporation) have had prior success. This gives hope that the bailout being currently contemplated may work as well. While this sounds good in theory, times have changed, and the stakes are much higher in our current situation. While I think the proposed bailout may provide some temporary market relief, at the end of the day, my belief is that all we will have done is to compound the problem and forestall the inevitable. The Government is framing this as an investment with upside, but it is actually a mandate with tremendous downside risk. There are absolutely no assurances this will work. I believe that assumption that capital and credit markets will ease post bailout is a flawed assumption. I think lenders and investors will still remain on the sidelines, more banks will fail, the stock market will remain highly volatile, and the collapse we’re trying so hard to avoid will still occur. We’re just buying time…
• Are there better alternatives? I think so…In principle, I’m much more of a believer in workouts than I am bailouts. The difference between the two are substantial. In a workout, the parties directly involved solve their own problems…some successfully, and others not successfully. In a bailout, third parties (that’s you) step in and underwrite the mistakes of others. Bailouts transfer risk, and workouts mitigate risk. The other point of distinction is that the end game isn’t simply to implement a bailout. What is truly needed is a comprehensive economic reform. The systems, regulations, and oversight (or lack thereof) that allowed this to happen must be reformed. In the absence of true economic reform, I again submit that we are just forestalling the inevitable. 
• Do you have any examples of other alternative solutions to the bailout that would make a real difference? Here a just two examples of alternate mechanisms that would more than sufficiently increase liquidity without taxpayer involvement: Impose a small percentage fee to be levied against the exchanges on all securities trades. This would raise hundreds of billions of dollars in the near term. This solution has been successfully implemented in a number of other exchanges around the world. It would allow Wall St. to pay for their own mistakes. My second suggestion is to eliminate the capital gains tax. If we coupled the implementation of exchange fees with the elimination capital gains taxes we would generate more liquidity into the system than the bailout, all without transferring risk to the taxpayer. If the bailout were to move forward, and the taxpayers become a conscripted class of investors, I would at least like to see a tighter bailout plan that actually treats us like investors. What is the exit plan, and how will the capital be returned? What type of return on ivestment will we receive, and over what period of time? Surely we should expect some form of return to augment the risk we are assuming.

All the pontificating aside, batten down the hatches. Things are going to get worse before they get better. More banks will fail, more business will fold, more mortgages will be foreclosed on, and more bankruptcies will be filed. The good news is that this too shall pass. The economic problems will eventually correct themselves and we will regain our course. In the meantime, while others are panicking, failing, and making the wrong decisions, you don’t have to. Cut out waste, hire good talent (there is more of it wandering around these days), keep investing in your marketing and sales initiatives, and don’t allow yourself to get caught-up in the chaos.