Bonehead here may live to regret saying this just two posts back: The US can try to bail out the whole damn banking system if it wants. The real question, though, is the above: But who will bail out America? If you want further proof of the unlimited amount of fear attending to the markets at the current time, an as-yet undeveloped plan to mop up toxic securities from the US financial system caused the DJIA to jump 400+ points yesterday and perhaps the same amount today. Berpaulosi (see picture) to the rescue, eh? You'd think that most commentators would have learned their lesson by now, but this latest Jah comes down from the mountain story is not fooling me. Why? Let us count the ways:
(1) In Paulson's most recent statement, this latest initiative involves Fannie Mae and Freddie Mac purchasing boatloads more mortgage-backed securities. Wasn't it a bloated portfolio which helped lead to them getting into such a mess in the first place? With private sources of housing finance drying up, making the US even more of a monopoly-like provider is not likely to help. Of course, I am assuming that home prices have further to sink--no stretch of the imagination is required there. Tell me: how does guaranteeing even more depreciating assets help Fannie and Freddie? Said Paulson: The underlying weakness in our financial system today is the illiquid mortgage assets that have lost value as the housing correction has proceeded. That's really great and everything, but isn't Paulson setting them up to buy more illiquid mortgage assets (MBS, anyone?) that WILL lose value as the housing correction proceeds?
(2) Subprime mortgages gone bad are just the tip of the iceberg. When the whole iceberg reeks, ring-fencing the tip won't do you any good when all else is also going awry. For convenience's sake, Paulson seems to suggest that this problem is confined to subprime Although subprime borrowers were the first to feel the pain since they were most vulnerable to a housing-led slump, increasingly insolvent, bankrupt and/or foreclosed American households will ensure the cascading of troubles into other forms of debt. You name it: credit card, automobile, student loans, etc. Thus, mopping up subprime-related securities alone will not do the trick. Unless the US government can miraculously (a) resurrect home price values, (b) wipe clear trillions worth of American household debt and (c) increase stagnant incomes which have been flat since the start of the millennium, call me unconvinced.
(3) Why would making Uncle Sam more indebted than he is now improve matters for the US? Not only will doing so not change the fundamental picture in (2), but it will also do little to shore up the confidence of America's increasingly wary creditors. I initially thought estimates that this mess would cost the US government up to $2 trillion rather high, but it appears my view needs revision. The dollar will get a long, hard beating in years to come, "special FX" notwithstanding.
Bottom line: If you think the US government is your knight in shining armour, you are losing your mind. The magnitude of America's problems will not be solved by an entity that has so far demonstrated little ability in helping avert a crisis partly of its own making. Garbage in, garbage out.