Spiraling into the Abyss

The government’s bailout spiral continued yesterday, with Bank of America getting it’s own special bailout deal, Congress allowing the second $300 billion of the TARP to be released, and Congress unveiling the Obama $825 billion stimulus package.

The circumstances behind the Bank of America deal was remarkable.  CEO Ken Lewis said the company was fine and didn’t need any TARP money.  Then they met in secret in mid-December with the Treasury and basically told the government that they needed their own bailout, or else they would not be able to complete the Merrill Lynch deal.  Then, almost a month later, they announce that they got their deal.  As a publicly traded company, I have no idea how they got away with this.  That is material information, that directly effects their share price.  Millions of investors were duped into thinking their company was safe, when behind closed doors, they were clamoring for taxpayer money.  Can you say, “lawsuit?”

The terms of the B of A bailout are crazy as well.  They get a $20 billion direct infusion, and they are only responsible for the first 10 percent of the Merrill losses.  The government will shield the company from the rest of the losses, which could amount to over $100 billion!  This is all on top of the TARP money they have already received.

When are all the bailouts going to stop?  The problem with all these direct infusions is that it is like a dog chasing it’s tail.  As more losses mount from the banks’ bad bets, the more money they need.  It’s an endless cycle.  I’ve been reading a lot of articles about deflation, and they all call it the “death spiral,” but I think the current direction of the Federal Government is the real death spiral.

In retrospect, the original TARP plan looks much better than the one Paulson single-handedly enacted.  The TARP was meant to buy the troubled assets off of the banks’ books, allowing them to basically clear themselves of all the bad debt they are still strapped with.  By directly putting money into banks, it allowed them to pad their balance sheets, but didn’t rid them of bad assets.  Now, as the assets cause more and more losses, we are having to give out more and more money.  It could take trillions to finally get it to balance out, and it looks like our government will do anything and everything to save the banking industry.

The government and the big banks have us believing that our economy and banking industry are one in the same.  They aren’t.  If the banks fail, our economy won’t stop.  There would be some pain as a new system emerges, but eventually a new model would have arisen.  Maybe this is showing us that fractional reserve banking isn’t the best idea, and that a Central Bank, like the Federal Reserve, can cause huge booms and bigger busts.  At what point do we look at the system and realize that it is too broken to fix?

Instead, our government is willing to pump trillions of taxpayer dollars into these banks, trying to prop up the failed model.  Also, with all these bailouts and backstops (like the FDIC), we are inviting banks to make bad investments because they know the Federal Government will be there to save them.

At what point is enough enough?  There are already signs that a private lending industry could be forming.  The Carlisle Group supposedly has over $40 billion in cash they are waiting to put to use.  If big banks won’t lend, high-net worth individuals and private firms will eventually fill the void.  They will lend at interest rates that will allow them to account for the risk they are taking, not one that is artificially set by the Federal Reserve.  Instead of encouarging this kind of competition, the government instead is focusing it’s efforts and our money trying to bring a corpse back to life.


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