Posted by
Philip D. Nathanson on Thursday, October 23, 2008 4:08:29 PM
Nearly every time Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson talk, especially when they suggest a new program, the stock market collapses. Perhaps their hodge-podge of government spending solutions should be called "The Wealth Destruction Act of 2008." Since they began to brew their solution in September, total stock market capitalization in the United States has plunged by approximately 30% or $4 trillion. With stunning speed, this has decimated a wide range of investors from individuals to public and private pension funds and college endowments.
Inflammatory rhetoric full of dire forecasts by Paulson and Bernanke to sell their $700 billion bailout triggered a global panic and rapid de-leveraging. Now it has killed consumer and business psychology. No doubt some of the stock market's decline stems from the recessionary implications of this recent plunge in sentiment. But clearly the market is voting thmbs down on a seemingly endless progression of government spending programs and bailouts of poorly-run businesses.
The Bernanke Paulson remedies do little to address the root problem which is that widely-owned mortgage-backed securities that have fallen significantly in value. See http://www.freerepublic.com/focus/f-news/2103816/posts for a discussion of the subject. Until these assets are sold or enough market transactions occur so that they can be properly valued, the problem will not be resolved. If these securities have fallen so much that they render the firms owning them insolvent, these companies should go out of business and their assets and operations should be sold to others. The free market has always resolved difficulties of this nature. If it had been allowed to function, Bear Stearns would have filed for bankruptcy, followed by Lehman and then AIG. Others who made poor decisions would have soon been revealed. The role for government is to provide stability while assets are re-allocated from poor decision-makers to better managements. Instead, Federal officials have chosen to mask the problem and delay its resolution by loaning capital to the weakest firms.
Paulson and Bernanke want nothing to do with a free-market solution. Instead they have set forth a hopelessly-complex and continually-evolving plan, with crucial details to be decided later. We are told that the "taxpayers" will make a profit on the government's purchase of bank stocks. But this ignores the economic costs of mis-allocating scarce capital to the weak and away from the strong, to say nothing of the inevitable strings that will be attached to the money. Bernanke has suggested that the government could profit from its purchase of toxic mortgage-backed securities at fire-sale prices. But government officials are consistently undermining the value of the collateral for these securities by pushing for reductions in mortgage principal and monthly payments.
A loss of $4 trillion in equity value is serious stuff. The stock market is telling us the Bernanke and Paulson plan will be ineffective and inefficient. It will distort and weaken the economy. The government may be able to print money fast enough to fund the bailout, but it will also sow the seeds of an inevitable climb in inflation and interest rates.