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Monday, October 6, 2008

Bailout Addiction

If you have been following the major equity markets over the last few days, it is clear that in the short term the bailout did little to subside the fear. Almost all major markets have continued to tank after the bailout passed. On one level, it would have been entirely too optimistic to have expected the bailout to settle the markets down. On the other hand, the sell off continued in part because the bailout does nothing to firm up a growing list of European banks that are now getting close being obliterated.

Now, we have the unintended consequences of the bailout. The Europeans had better be careful what they wish for. Folks like Chancellor Merkel were imploring the U.S. Congress to quickly pass the bailout. One of her own looks like it will be in need of its own bailout. Both on a policy and political level, Merkel will soon have no choice. The dominos will begin to fall. The Europeans are now attempting to work on a coordinated bailout. So, after we have forked over $700 billion, look for the Europeans to drop a similar figure.

We won't be done. Banks in China, Japan, South Korea, and Australia to name just a few all have significant capital in these bonds. Soon, they will all need a bailout and the governments will have no choice but to give them one. For one, the worldwide markets will demand it. The worldwide market may even continue to drop precipitously until they all get one. They may even at some point realize all these bailouts are worthless. They might reach a bottoming out after we are through with the bailouts. Two things appear clear. First, there is no end in sight in how much governments will need to borrow to bailout their financial institutions. There is also no end in sight for how far world markets will go until we get them.

Of course, this rash of bailouts has opened the flood gates. We all barely raised an eyebrow when the big three autos got a $25 billion "loan". (I say "loan" because they have something like 20 years to pay it back) California has asked for a $7 billion bailout. We are just getting started. The atmosphere is primed for any populist politician to run against anyone that voted for this bailout promising a Main Street bailout. It is only a matter of time before someone suggests a credit card bailout. What is any business owner or consumer to think about any risky behavior? Everyone will soon expect a bailout for any risky behavior. The proverbial genie is now out of the bottle, and we can't put it back in.

There is a saying in's not the crime but the coverup. In this case, we will likely one day say it's not the crisis but the response. No matter what the short term consequences would have been of withholding the bailout, I think we will regret the long term consequences of this bailout much more. First, the precedent has been set, and any risky behavior by anyone will demand the same bailout. It will be difficult for any government anywhere, worldwide, to justify not suppling after the multiple trillions that will be spent on this one. Second, the massive increase in government spending worldwide will lead to massive inflation worldwide. Third, it is unlikely that any of these bailouts will have the desired effect. Bailout or no bailout, it appears we are running headlong into a recession and even a depression. Fourth, the massive amount of new power each and every government will consolidate as a result of these bailouts will be felt for generations. The worldwide nanny state has now just multiplied exponentially.

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