Will the Bail-Out Help?

Bureau of Economics

Today some of the questions many people wonder are precisely what has gone wrong, what is going wrong, and what will a bailout fix.  What has gone wrong is that the credit default swapping market was not sufficiently capitalized to account for a heavy rate of defaults.  Normally banks are required to meet a reserve ratio as part of their regulation.  However, when debt is sold to non-bank entities, like Merrill Lynch, they no longer have to meet a particular reserve.  One of the requirements for Goldman, now that they are a bank, will be to meet this reserve.  This is why they needed to find a sugar daddy, like Warren Buffet.

What is going wrong still is that now that banks have been burned they have become increasingly more conservative, and have refused to loan not only home owners money, but also businesses money.  Businesses, in turn, are being increasingly conservative with their precious dollars, for fear that they won’t be able to get more of them.  Because of this the U.S. is likely to suffer a recession, and no place will suffer worse than the entrepeneurial capital, Silicon Valley.

There is also the matter of all the failed loans.  We don’t know where all the debt is, because banks can take their sweet old time deciding when a loan has failed, and hence reporting it to their stockholders.  The bailout will give creditors incentives to get rid of debt that is likely bad.

What the bailout may not fix is the confidence problem that creditors now have.  Creditors may, however, be of two minds, one being that they could fail by taking on too much debt, and the other being that the U.S. government will provide a backstop to any serious failure.  If the latter is true, even if unwsie, then those companies will make capital available.

Who wins in the current climate?  Large companies that are their own banks can take advantage of their position, because there will be fewer smaller disruptive competitors.  Venture capitalists will win because they will be able to drive better deals with startups.  Employers on the whole will win because the job market will slacken.

The consumer, however, may not win.  The cost of imported goods and services remains high in this environment, and is unlikely to change for some time, until capital markets open up again.  This is because the dollar remains near all time lows.  Worse, because other economies are beginning to faulter, we will not be able to export our way out of the hole (we’ve been doing that for some time).

Put another way, everyone is still in for a rough ride.

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