Bail In or Bail Out?

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As I write this, the DowJones is down 600 points, largely in reaction to the House defeating the federal bailout of the credit industry.

What should we think and do about this?

If you've got no money and no debt, then just go about your business normally. I think the smartest long-term positioning is to begin looking at the goods and services you can provide to other people in your community without involving long distance transport or complex supply chains involving multiple creditors and borrowers. In other words, try to make what you do as real as possible.

If you do have money, well, either sit tight through the "capitulation" or do some bottom feeding of favorite underpriced stocks in industries that provide real goods or services to real people, and that don't need to borrow lots of money to do it. If you've got more than 100k in a single bank account, you might spread it out.

The reality of the (failed) bailout plan is so very different from the way people are thinking about it, though, that I thought I might offer some clarity. (I'm sure some of you will interpret this as additional obscurity, so ymmv.)

The main point of the original plan was for the federal government to buy distressed assets - like mortgages - from banks and other institutions. "Distressed" doesn't necessarily mean these are bad assets, or that the mortgages won't be paid back. It simply means these are debts that are selling way way below their longterm value. No one wants to pick up anyone's mortgages because housing prices are going down, foreclosures are going up, and shareholders of banks don't want them on the books.

So a package of mortgages that might be worth a million bucks in the long term if they're all paid back is only getting, say, $200,000 on the market. That's what's shrinking the credit markets. So the Federal government wanted to buy all this credit at a higher rate, bail out the creditors, and take on the mortgages. In the best of worlds, the Treasury would have made money off all this. They'd be using what government has over business (time) to purchase depressed investments and wait out the decades it takes for them to earn out.

The deal almost went through until McCain made his highly publicized drop in to DC, accidentally highlighted the leftist underpinnings of any government intervention, and polarized the parties involved. He left, but the damage was done. (It may have failed without McCain's help, but I enjoy blaming him.) America now saw the bill as an anti-populist bail out of banks. Call it socialism if you like but it was really just business. Democrats compromised by turning the investments into loan guarantees, but conservatives saw the whole plan as much too much like the way FDR got America out of the Depression last time: namely, socialism.

The bigger fact, though, is that even with a short-term bailout, the underlying mega-economy is in the dumps. Government can help lubricate the gears of the economy by utilizing its capacity to engage in longterm investing, as with the failed bailout bill. But this entire effort was really just a balance sheet adjustment. Unless we are also investing our time, energy, and remaining money in productive industries, education, and renewable resources, we will not have changed the real economy at all.