Main Street Trumps Wall Street: Bailout Fails…
In a stunning and unexpected vote, the Wall Street bailout bill (with no ultimate price tag attached, and hastily put before the House of Representatives within a week of its conception) was defeated by a vote of 228 to 205.
It appears a majority of Congress listened to the pleas of their constituents, who were overwhelmingly opposed to the bailout – in some cases the phone calls against the oddly-named bill (“To amend the Internal Revenue Code of 1986 to provide earnings assistance and tax relief to members of the uniformed services, volunteer firefighters, and Peace Corps volunteers, and for other purposes”) outnumbered the calls in favor of the bill 200 – 1.
What happens now? Well, for starters, the US markets reacted as expected: the Dow Jones dropped 6.98%; the S&P 500 fell 8.79% and NASDAQ plummeted 9.14%. The hyperbole was in full force all day: the market had its “biggest point drop in history” read one news service’s headline, cleverly avoiding expressing the concept in more meaningful percentage terms (in which case Black Monday – October 28, 1929 – trumps today’s losses: the market fell 13% on that one day. Today’s drop, in percentage terms, does not even make the top 10 worst percentage drops of all time).
What’s more, it’s almost certain additional banks will fail, credit will get even tighter and the economy will contract.
And that’s not a bad thing at all. In fact, it’s necessary, far more necessary than the artificial supply of credit the US government sought to create via the bailout bill.
As we previously wrote, the government-created surplus of credit, dating back to the 1938 creation of Fannie Mae, caused the problem in the first place. We’re not alone in that assertion: in fact, 166 academic economists signed a letter protesting the bailout – you can read Harvard’s Senior Economist Jeffrey A. Miron’s reasoning here. In order for the economy to correct itself, that artificially created excess credit needs to disappear. Who provides credit? Banks, for one. Banks closing down is part of the solution, not the problem.
What about consumer spending, you ask? Well, consider this: it’s often said that consumer spending is the “driver” of the US economy. The only problem with that statement is that it’s completely backwards: a healthy economy drives consumer spending, not the other way around. Think of it this way: it’s not until businesses flourish that more people get paid more salaries and therefore have more money to spend. The populace does not suddenly get more money from nowhere.
Only that’s exactly what happened: starting with the creation of Fannie, then Freddie, and exacerbated by Alan Greenspan’s monetary policy, people suddenly did get money from nowhere. Well, almost nowhere: in fact, it was the artificial guaranteeing of substandard mortgages by Fannie and Freddie that sealed the otherwise impossible (in a free market) deal. If the economy is only growing because people are spending more, there’s something fundamentally wrong with the economy – the entire flow of money is inverted.
To correct that inversion, consumer spending has to become re-tethered to income, rather than being a function of artificially inflated equity increases in real estate, against which people borrow to provide for their spending.
Expect all things which fall into the “optional” category of spending to be very hard hit. These include luxury items, entertainment, dining out, gambling, vacations, perfumes, novelty items, etc. Obviously stocks in companies which provide such things will also be particularly hard hit.
Expect oil prices to drop, as the people of the world’s largest oil consuming country tighten their belts.
Expect vehicle sales, in particular, to plummet under a triple whammy of high fuel prices, a cash (and credit) strapped consumer base and an inability of automakers to secure necessary credit when they need to invest in building smaller autos.
Expect this to last for a while.
But also expect that it will not last nearly as long as it would have, had the politicians gotten away with pouring gasoline on the fire by manipulating the supply of credit via the bailout bill. There’s at least $700 billion dollars out there to be invested which would otherwise have gone to buy the Treasury bills sold to finance the bailout.
And the people on Main Street are off the hook for at least $5,000 (but probably much more) in future tax obligations, which would have made recovery all the more difficult.
And a giant bureaucracy attempting to arrive at a “fair price” for assets which the market says are near worthless didn’t spring up to further confuse a market place already uncertain of the underlying value of assets.
And that means there’s a light at the end of the tunnel after all…