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The Lasting Effects of Choosing Bailouts

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Whether you think they're good or bad, they will happen again.

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Our government had two choices last year and in 2008: bail out the major banks or don't. Either choice had massive ramifications, some of which haven't been felt yet.

I was perusing the Web yesterday and went onto the site of Billy Long, candidate for US Congress, 7th District of Missouri, my home state.

Long has a card on his site that shows what he's for and against. As you can guess, he has check marks in the "for" box for term limits and fair taxes. In the "against" box he has marked earmarks and bailouts. Oh, Billy, if it were only that simple.

Let's start with a brief history of what happened in the banking industry.

In the early 1990s, Bill Clinton had the noble idea to expand home loans to the middle class by allowing Fannie Mae (FNM) and Freddie Mac (FRE) to buy bank loans. The stipulations were that people only had to put down 3% as opposed to 20% like in the past.

The Glass-Steagall Act was repealed, which allowed insurance companies, banks, and investment banks to merge and have much more in assets than they had compared to equity as in the past.

The laws of supply and demand took over and drove up the price of real estate.

A typical community bank might have $1 in equity for every $5 in assets it holds. If it loses more than $1 in assets, the net equity is $0 and the bank is insolvent. The big investment banks, like Lehman Brothers and Bear Stearns, had $1 in equity for every $30 in assets. It doesn't take much of a movement in assets to wipe out the entire corporation with that kind of leverage.

The Bush administration didn't believe that the government should involve itself with overseeing businesses. The SEC commissioner, Federal Reserve Chairman, and Secretary of the Treasury took a hands-off approach and had ample opportunity to get involved.

These banks were riding the real-estate wave and holding copious amounts of these bonds on their balance sheets as inventory to be sold to investors. This is similar to a grocery store that has food in inventory, only that these bonds dropped in price when people became worried that the housing market was overheated.

Meanwhile, the Federal Reserve had been creating money from thin air and loaning it to these banks. Until 1971, the US was on the Gold Standard and couldn't create money in this manner. This ended under Richard Nixon to fund the Vietnam War.

In addition, the Fed kept interest rates extremely low, allowing people to afford loans, only predicated upon interest rates staying low.

When it was realized that these banks had liabilities that exceeded their assets, hundreds of banks were technically insolvent. Not only did these banks do home loans, they also offered credit cards, business loans, stocks, bonds, derivatives, currencies, and thousands of other products.

So let's stop right there. The government could have allowed the Citigroups of the world to implode. Had it done that, the banks couldn't have lent any more credit card debt, car loans, home loans, etc., meaning anyone relying on credit cards would be cut off.

Simple math says that one-quarter of all real-estate agents, car salesmen, stock brokers, and bankers would have been out of business. So if unemployment is 10% right now, let's just say unemployment would be about 20% with no bailouts.

The Dow Jones wouldn't have rebounded from the 6,000 range to the 10,500 range. It would have hit 4,000 and maybe rebounded to 6,000.

But that didn't happen. We did have bailouts. The average person knows that something is afoul, but what is it? The money to bail out these banks is created from thin air. Forget that the fat cats on Wall Street made huge bonuses and are still in business. The real harm is what it does to the dollar.

Everyone says that the taxpayer is going to have to pay for this -- partially true. Anyone who holds one American dollar is going to suffer. The dollar will continue to depreciate, oil will soar, commodities will rise, and higher interest rates will hamper borrowing and induce investors to put their money in bank CDs.

This is what has happened in the past and will happen in the future. Keep this article and remind me of it in five years. I hope I'm wrong, but probably won't be.

Politicians running for office love to blame the other side. The minute someone starts pointing fingers, I know that they don't know what they're talking about.

If they knew this was coming, why didn't they wear a sign and get on a soap box in town square. It was quite simple. A person only needed to be verse in monetary policy, fiscal policy, accounting, knowing Wall Street, understanding the American consumer, banking, the lobbying process, and a brief history of the US economy since the American Revolution.

Sounds like Billy should have spotted this. Trust me, we're all in this together.
No positions in stocks mentioned.

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