Ten Reasons Why the Fed's Bailout Won't Work

It has been heralded as the answer to the world financial crisis, I have my doubts, when you consider these ten reasons why the US bailout won't work, it becomes very clear why the majority of serious economic commentators share my scepticism....

1.Buying toxic assets will do nothing to restore the balance sheets of troubled firms, says John Hussman, the portfolio manager of the Hussman Strategic Growth Fund and the Hussman Strategic Total Return Fund, and chairman of Hussman Econometrics Advisors . Such action would improve the balance sheet, he said, but it doesn't add capital to stressed firms, which is what they need.

2.Edmund Phelps, the winner of the 2006 Nobel Prize in economics and director of the Center on Capitalism and Society at Columbia University in New York, made parallel arguments in an opinion piece in a recent Wall Street Journal. Mr. Phelps said the main prong of a rescue plan must include “cash transfusions in return for warrants,” as with the Federal Deposit Insurance Corp.’s rescue of Wachovia Corp. of Charlotte, North Carolina.

3.LIBOR, the rate at which banks lend to each other, since the bailout was passed is in fact higher. The 3-month Treasury yield has dropped again. And the DOW dropped 300+ points.So the Bailout news hasn't done it (and if the market thought the bailout would work, the markets would have reflected that.) This suggests that the US government will have to do even more. Which it has already started to do. Fed and 9 other central banks responded by announcing another MASSIVE liquidity injection. The market rallied modestly on this news, but not much.

4.Part of the problem is that the crisis has now spread to Europe (Fortis, etc.). The economies of UK, Germany, etc., were already following the same path as the USA. More bank failures won't help.

5.Paul Krugman Professor of Economics and International affairs at Princeton University,says “For the fact is that the plan on offer is a stinker — and inexcusably so. The financial system has been under severe stress for more than a year, and there should have been carefully thought-out contingency plans ready to roll out in case the markets melted down. Obviously, there weren’t: the Paulson plan was clearly drawn up in haste and confusion. And Treasury officials have yet to offer any clear explanation of how the plan is supposed to work, probably because they themselves have no idea what they’re doing."

6.The much vaunted bailout does not address the prices/valuation of US property, stocks and risky bonds; all of which will continue plummeting; further compromising the asset side of the US balance sheet while the liability side remains – and drives hundreds of billions more in net loan losses. The asset side will be further undermined by the collapse of commodity prices in the face of plunging global demand.

7.It stratospherically increases US government liability at a time of plunging tax revenue from all sources, destruction of loanable capital, and growing liability to fund unemployment claims and the like. This liability can only be met by borrowing, taxing or fiat money creation – each of which has major negative consequences.

8.Kenneth Rogoff Professor of Economics and Public Policy at Harvard University believes that “The plan’s central conceit is that government ingenuity can disentangle the trillion-dollar “subprime” mortgage loan market, even though Wall Street’s own rocket scientists...(who shared more than $36bn dollars in bonuses last year, thanks to the huge profits these institutions “earned” on their risky and aggressive business strategies)….have utterly failed to do so. Let’s ponder this. Investment bankers have been losing their cushy jobs because they could not figure out any convincing way to price distressed mortgage debt. Otherwise, their firms would have been able to tap the trillions of dollars now sitting on the sidelines, held by sovereign wealth funds, private equity groups, hedge funds, and others. Now, working for the taxpayer, these same investment bankers will suddenly come up with the magic pricing formula that has eluded them until now.”

9.It costs $700 billion dollars, which is as much money as the combined annual budgets of the Departments of Defense, Education and Health and Human Services. It amounts to $2,300 for every man, woman, and child in America. This $700 billion will all be borrowed money. The plan raises the national debt ceiling to $11.3 trillion. That is $11,300,000,000,000.

10.It gives Sec. Henry Paulson, formerly the head of Goldman Sachs, the power to buy assets from his former firm with no court or administrative oversight. Goldman Sachs, like many Wall Street firms, gave its CEO a $67.9 million bonus last year. That is more than 1,400 times what the average American earns. Yet the plan has no provision to cap salaries or reduce bonuses at Wall Street banks that take taxpayer money.