Bailout a Done Deal -- So What Happens Now?

By Henry Blodget, Huffington Post. Posted October 7, 2008.

Now that the government has been terrified into rubber-stamping the Wall Street bailout, what happens now?

I wish the news were better, but in my opinion, here's the most likely scenario:

* Hank Paulson & Co. survey the banking industry and decide who will stay and who will go. JP Morgan, Citi, Wells Fargo, and Bank of America will stay. Goldman will probably stay. Morgan Stanley might stay. Everyone else in trouble could go. The government doesn't need to save all banks. It just needs to save some.

* Within a month or two, Paulson buys $250 billion of crap assets. He pays more than market value, but not an egregious amount more (because the public will be watching these early rounds). Over the next six months, he buys $700 billion of assets ... and then he -- or his successor -- asks Congress for more money.

* Confidence improves modestly, but banks continue to hoard capital and credit markets stay tight. Loans stay expensive and hard to get. This keeps pressure on the economy.

* The credit crunch filters through to consumers: Credit cards, home equity loans, mortgages, car loans, etc., get more expensive, putting more pressure on consumers and forcing them to cut back further.

* The economic news continues to get worse: American consumers continue to pull back, housing continues to fall (as of July, the year over year declines were still accelerating), companies begin to cut back, which leads to layoffs -- which puts more pressure on consumers.

* The global economy continues to weaken: Europe, Asia, and, eventually, emerging markets. This has already happened, and everyone else is later in the cycle than we are.

* The stock market continues to fall, as corporate earnings come under increasing pressure and hope for an early 2009 recovery fades. Analysts are still expecting huge growth in S&P 500 earnings for next year. These estimates will get cut by at least a third.

* The government enacts further measures to try to stop the fall in asset prices (stocks, houses) -- including an expansion of the bailout plan -- but these don't work. Governments always try to do this. They never succeed. All they do is delay the inevitable.

* A new round of white-collar prosecutions send a new posse of corporate villains to jail. Some will be guilty. Some won't. All will be hated.

* The government announces a new New Deal, finally investing in the country's infrastructure, in the hopes that this will stimulate the economy (which it will). Investments include broadband, green tech, wireless, physical infrastructure, et al.

* Eventually, asset prices will bottom: Housing down 40% in real terms, the stock market down at least 50%. With luck, this will happen by early 2010, so the recovery can begin. Warren Buffett loads the boat with stocks, but by that time, most people are too depressed (and poor) to follow him.

* Unlike Japan, we finally force our banks to write down assets as far as they need to be written down ... and then recapitalize them. This is what we should have done in the current bailout, but we'll get it right next time (we hope).

* We gradually begin a long-term economic recovery, one in which consumers save a greater percentage of income, thrift and saving again become admirable qualities, we gradually begin to wean ourselves off international oil, and the bacchanalian decades of the 1990s and 2000s become an embarrassing memory.

* The stock market finally begins a new, long-term bull market, in which stocks once again return 10%+ per year. Unfortunately, most Americans will be so sickened by the stock losses they've sustained since 2000 that they'll miss many years of it.

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Henry Blodget writes and speaks frequently about the Internet, investing, and the financial markets.