Saturday, October 4, 2008

Light at the end of the tunnel?

The bailout bill finally passed in Congress, and its basic structure remains the same. It will still authorize up to $700 billion that the Treasury can use to purchase troubled assets from financial firms and banks to enable them to start lending and borrowing again, which will once again get the economy rolling, or so the theory goes.

There were some extra porky provisions put in (like $100 billion worth of tax breaks, including some for companies that manufacture wooden arrows), and a popular measure to temporarily increase federal deposit insurance from $100,000 to $250,000, which should reassure people for the time being.

There are also holdovers from the earlier bill, like the incremental nature of the purchases and some ways for the government to protect itself against losses.

But what will those losses be? It's important for people to understand that this $700 billion is not just going to disappear down the rabbit hole and be written off onto the national debt. Some of it may be. Perhaps even most of it. But there is no way this is going to cost the full $700 billion (since the assets will be resold at some price), and although few people really believe this, it's even possible it will be profitable in the end, if the real estate market recovers and these mortgages actually reflect some real value again.

It may still be a lousy bill, but it's better than it could have been, and with any luck, it will stem the bleeding, and inject some much needed confidence into the financial sector.

The problem is that despite the passage of the bailout, the markets fell again yesterday. Krugman is pessimistic. It goes without saying that Nouriel Roubini is pessimistic, but this is just terrifying:

It is now clear that the US financial system - and now even the system of financing of the corporate sector - is now in cardiac arrest and at a risk of a systemic financial meltdown. I don’t use these words lightly but at this point we have reached the final 12th step of my February paper on “The Risk of a Systemic Financial Meltdown: 12 Steps to a Financial Disaster” (Step 9 or the collapse of the major broker dealers has already widely occurred).

After running through the symptoms, he says this:

This is indeed a cardiac arrest for the shadow and non-shadow banking system and for the system of financing of the corporate sector. The shutdown of financing for the corporate system is particularly scary: solvent but illiquid corporations that cannot roll over their maturing debt may now face massive defaults due to this illiquidity. And if the financing of the corporate sectors shuts down and remains shut down the risk of an economic collapse similar to the Great Depression becomes highly likely.

Many have ridiculed Roubini during the past few years as nothing but a doomsayer, but to his credit, he accurately predicted this crisis as early as 2004. Remember, there are overly optimistic economists, like the ones who wrote Dow 36,000, and then there are those like Roubini. I think there are more profits in the former than the latter. Everyone wants to hear that they're going to make millions in the stock market. No one wants to hear about the collapse around the corner.

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