Bail-outs

At the cost of making my page look like another dissertation column or a who-is-responsible-for-the-mess forum, here comes a post on the bailout saga.

We live in unprecedented times might sound too much of a cliché, but let me explain that with some numbers to get us off on the right footing. Stock markets around the globe have wiped out $ 23 trillion wealth, excluding the derivatives (which are a zero sum game). What number pops into your mind, when you hear bailout? Imagine how much value that holds for you, for a minute. Now let us correct ourselves. The bailout touted at $ 700 billion is much more. A random total of announced packages exceed $ 16 trillion, more than the US GDP ($ 13 trillion). (Bloomberg says bailout is $ 7 trillion)

Bailout	Amount
Most glamorous of the bailout package	$ 700 billion
Latest bailout to reduce blockades on credit cards, auto loans, mortgages and other borrowing	$ 800 billion
Fed program to buy all Companies commercial paper	$ 2,400 billion
FDIC guarantee for inter bank loans	$ 1,400 billion
FDIC guarantee for Consumer loans increased to $ 250,000 per account	$ 10,608 billion *
Individual commitments outside $ 700 billion package
Bear Stearns	$ 29 billion
AIG	$ 123 billion
Citigroup (Inc. $20 billion as cash infusion)	$ 326 billion
Automobile sector for alternative fuel development	$ 25 billion
Automobile bailout (expected in December)	$ 25 billion

*- Calculated from marginal impact of $ 250,000 instead of $ 100,000 insured

This gives a running total of $ 16.4 trillion. And it is for sure, that this is not all the kitty, given the non disclosure policies of Fed. So where will the Fed conjure up all the money from? One argument could be, all of this would not require funding, but in a worst case scenario (as if it is not now?), this would be the amount that Fed will have to cough up. We will address this later.

FDIC had a reserve ratio of 1.25% previously under the $ 100,000 of consumers deposits insured meaning it has $ 1.25 for every $ 100 insured, but now under the new legislation, it would fall to an abysmal 0.5%. This suggests that they should have new risk mitigating mechanism which drastically reduces bank failures. But given the conditions, the FDIC is just bracing itself for the surprise of its life.

Historically other big bailouts in the US have been,

Bailout	Amount adjusted for inflation
1933 Public Works Administration Created to reduce unemployment (25% then)	$ 3.3 billion (unadjusted)
1938 Spending program to provide stimulus	$ 5 billion (unadjusted)
1979 bailout of Chrysler	$ 4.2 billion
1990 Savings & Loans bailout	$ 210 billion

For all the bailout money, Fed is buying toxic assets, which are not disclosed. The crisis has been created by the run ups of the prices of these assets, which by their nature, is illiquid, high risk and inflated. Now the Government is not addressing their problem of being over priced. It is gleefully accepting these at the sky high prices, thus trying to sustain the bubble. But the free market ideology suggests that we allow these asset prices to correct themselves till they become an attractive buy to someone. This sounds like just another American parent trying to give his kid some dough to kick the bucket on his doping addiction.

Another challenge that the administration faces is the high unemployment rate, now at 6.5% and could not take long to reach 8%, a high in the last quarter century. The worrying situation is that of the 6.5% unemployed, less than 22% are able to find new jobs (Thomas Lam, economist). A higher portion of skilled employees getting the pink slip will also hurt the wage levels badly. And all of this is in the face of all the massive bailouts announced by the Government. Fed’s actions just seems like they are telling folks, ‘It is all a nightmare. Please wake up now, get over it and give all your pains to us.’

Now that all the promises of infinite lines of credit have been made, it is time to produce all the money without hiking up inflation. Debt could be a way out. Then it will just be a simple transfer of corporate debt to Government debt in one big swoop, without touching the leveraging issues, as the underlying assets remain the same. And under the burden of so much debt, the Government would be forced to raise taxes, impose trade restrictions, cut down on unemployment subsidies and cut down on infrastructure spending naturally putting into jeopardy Obama’s second term, even before getting off the mark.