5 Reasons Why Wall Street's Bailout Won't Work

Most Americans know the phrase, “if it ain’t broke don’t fix it.” In the good times, when the economy boomed and Wall Street prospered, it looked like nothing was broke. The free market, we were told, was working like magic insuring prosperity and progress.

But then it happened, out of sight and out of mind, an upward trajectory turned in the other direction. In what was for many an unbelievable chain of events, markets started melting down, banks began writing down portfolios clogged with asset-backed securities that had no assets behind them. Confidence shattered. Suddenly, believers in unregulated transactions realized something was very, very wrong.

Alan Greenspan was “shocked” and said he was wrong to support deregulation of financial markets. As headlines conjured up breadlines and recession, with “something worse” threatening, the government was pressed to act.

Over a year later, after eight interest rate cuts, with one more promised, and the injection of trillions into credit markets and banks worldwide, little has changed. Markets are volatile and trending down while banks are still not lending despite frequent projections of massive unemployment and stagflation.

At the same time, we live in a country that believes that whenever there are problems, there must be solutions. And in the case of the financial crisis, there is no shortage of proposals especially because the whole system—if not capitalism itself—seems at risk. (Even the NY Times ran an editorial on “Rescuing Capitalism.”) This is not a situation that inspires confidence in token reforms and minor adjustments. There seems to be a consensus that this crisis is systemic and structural even as the candidates reduce it all to tax policy.

That hasn’t stopped the government from dipping into its tool bag and throwing everything it has at the problem---bailouts on an unprecedented scale, including, now, of insurance companies and auto lenders There have been pro-business rule changes even partial nationalizations of banks, mortgage companies, and insurance combines.

Together, the Treasury Department and the Federal Reserve Bank seem to be fighting on every front. They appear to be giving away money. Is it working?

“Scarcely a day goes by with out some dramatic new initiative,“ writes The New Yorker’s financial columnist James Suriwieki, “even as market chaos makes each new idea soon seem like ancient history.”

Why is that? Surely the people in command are smart, savvy and know the system well. What are they missing? They now know its broke (and many of them are broke too) but they can’t seem to fix it.

Here are five views on what they are getting wrong.

l. THE SYSTEM NEEDS TO COLLAPSE

That’s the view of a perennial bear investor Marc Fabor who “thinks the market was primed for a technical rally” but is not keen on the long-term prospects for the US economy:

“The governments in this world have no other option but to print money. That will lead down the road to inflation,'' Faber said. “You don't need to be an economist graduated from Harvard to know we're already in a recession. They will just put white paint on a crumbling building....

“To rebuild economic health in the United States, you need a serious recession that will last several years,'' he said. “The patient that got drunk on credit growth needs to go into rehabilitation. To give him more alcohol, the way the Fed and the Treasury propose to do, is the wrong medicine.''

2. CONSUMERS ARE NOT SPENDING

Bloomberg reports:

The big concern is that households, spooked by the turmoil in financial markets, will cut back rapidly and sharply, plunging companies into bankruptcy and deepening a recession that many economists say has already begun.

“If we did have a quick cut in spending, it could turn a pretty nasty recession into possibly the worst downturn we've seen in the postwar period,'' says Michael Feroli, a former Federal Reserve official now at JPMorgan Chase & Co.

3. MORAL HAZARD: THEY ARE BAILING OUT THE WRONG PEOPLE