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Will the Bailout Work?, Part 1


A curve in the road ahead.

Will the bailout plan work?

The answer depends on the definition of "work." If you mean no more government intervention, no further costly programs and a functioning market, then the answer is no. But there are things the bailout will do. This week I try to help you see what might lie ahead around the Curve In the Road.

The Curve In the Road

When you're out driving on a strange new road, you can't see around the curve ahead. But you can read the warning signs to get an idea of what might be coming.

First, let's look at the "rescue plan" as passed by Congress. As I pointed out last week, this is a bad bill. But it was necessary to pass something, and soon. Earlier this week, I sent out a report that reviewed a study of 42 major baking crises. The conclusion: Navigating them successfully depended upon quick action.

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The credit markets are almost completely frozen. The LIBOR is bid only, no offers. Commercial paper markets are imploding. And what is trading is often at rates that are much higher than they were a few months ago. Corporations are being strangled on high rates. Corporations have little or no access to normal credit markets, and they will face massive problems when it comes time for them to roll over short-term debt.

The LIBOR has gone crazy. This is not an orderly market.

Click to enlarge.

Look at the following chart from friend Greg Weldon. For most readers, the commercial paper market is something you don't think about. But it's the lifeblood of business. We have seen this market drop by almost 30% in a year and by 10% in just the last three weeks! I simply cannot overstate how serious this is. Left unchecked, business activity in the US would soon slow enough to bring thoughts of the Great Depression. It will not be left unchecked.

Click to enlarge.

The credit crisis is not simply a Wall Street issue. It has fast become a Main Street issue. And Main Street is where jobs are created and maintained.

As I've said for months, the problem is that financial institutions are having to deleverage. They have massive losses and simply have to raise capital in order to survive. If you can't raise equity capital (and most can't), one of the ways you do that is to make fewer loans and to take less risk. You also charge more for the loans you do make.
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No positions in stocks mentioned.

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