(Washington, D.C.: Right Commentary): As the “Dow” (Dow Jones Industrial Average - DJIA)  plummets over 500 points today (up from the collapse of -705 that occurred within the half an hour after the vote), House members are running for political cover - each blaming the other party for the failure of HR 3997, the Emergency Economic Stabilization Act of 2008. The largely partisan vote (with House Republicans holding the line on their principles, upset by the deal that was cut over the weekend) - scuttled the bill, which failed to get the 217 required to pass (with 133 Republicans and 95 Democrats voting to defeat the bill 205 to 228).

It appears that there will not be a vote again today. Which is probably a good thing - seeing as it is unlikely that there would be a different result given the ire of House Republicans over Nancy Pelosi’s statements earlier in the day (blaming the Administration for the current crisis), as well as their general ideological disagreement with the basic strategy of the bill in buying assets and intervening in the capital markets.  

I believed when I first started writing about this issue that intervention by the Government was absolutely necessary to avoid significant deterioration in the confidence of the US financial system and to maintain the power and financial standing of the United States. I was one of the few conservatives who sided with the President in calling for an intervention and believed that injecting liquidity and confidence into the markets - while removing what was certain to be mostly zero-ed out loans - was the only way to solve the problem that Government itself had caused by encouraging Fannie Mae and Freddie Mac to buy risky paper while not caring to regulate it (or even pass rules that would make the market more transparent).

While I believe that Secretary Paulson’s plan was ambitious, and could have succeeded in stopping the hemmoraging of confidence and capital from the US markets, I also fundamentally agreed with and appreciated the position of House Republicans that the taxpayer should not be asked to underwrite bad debts and bail out failed institutions. The only time as a conservative I believe one can even consider government intervention is during market failure. During the Great Depression - Keynes successfully demonstrated that when markets fail to clear, only the Government has the tools necessary to get them functioning again. While antithetical to Conservative Values to intervene in markets - it is also antithetical to Conservatism to erode national power and weaken the Country’s ability to govern international affairs. Given the choice between financial collapse and intervention - I chose to support intervention in a time of market failure. I admire House Republicans who voted against the Bill - I understand that was their conscience. However, the reality of the situation is, we are teetering on economic collapse. Just as the Government’s first steps in the Great Depression made it worse - so too am I concerned that today’s actions will be the spark that eventually causes the explosion that causes economic meltdown.

Without question - this is the greatest financial crisis in the history. We are teetering on a collapse of modern economics.

What if we do nothing - some ask. The answer is simple - recession and possibly worse. And when I say recession, I’m not talking about the nonsense people have been complaining about in the newpaper the last two years. We have not had a recession - regardless of how bad Democrats complain the economy is under Bush. However, I believe now that the economy will fall into a true GDP contraction over the next six months, and may contract as much as 5% before turning itself around. A GDP recession of -5% doesn’t sound all that bad… right? In current GDP terms, that means the economy will shrink by $600B, or roughly 85% the cost of the bailout bill.

The reality is that in the last two weeks, the US markets have deflated by over 7%. The $700B package proposed was on top of the almost trillion dollars of government spending (the AIG bailout, Fannie Mae, Freddie Mac conservatorshpi, plus the Fed lending windows). Financial markets around the world are roiling at the idea of having a continued disorderly unwinding of this debt, however, the reality is, HR 3997 would not have solved the problem. As Secretary Paulson stated, the root of this problem was home mortages. I agree with that assessment. HR 3997 did nothing to address the root of that problem. Moroever, it provided such a hodge podge of measures, it is doubtful that the bill would have inspired enough confidence in the financial markets to bolster them sufficiently. In this regard, I am neither surprised nor all that upset the bill failed. However, it remains that something needs to be done.

All of that said, I don’t expect the bailout to drive the stock market. What drives stock value is profits. If companies are making profits, then stock values rise. No country is as effective as the United States in making profits. No one. As such, although it is grim now, I have confidence that the market will ultimately recover. It could take as long as two years for that to happen - something that would be politically painful for many incumbants on Capitol Hill. However, how low stock values it may go before ultimately rebounding, and for how long a Bear market would persist - who knows… I could easily predict a Dow at 9000 by the end of this week. The reality remains, however, that that profits, and not politics, drive the stock markets.

In contrast, the financial markets are driven by the availability of capital. That market has effectively stopped. Banks are unwilling to lend to one another at the moment in large measure because they are unsure of their own capital needs. In addition to what we might call “the liquidity crisis,” occuring, there is a very real threat of a national run on all depositor banks in the United States. Panic mentalty has set in minds of many, and the FDIC has asked member banks to set aside billions of dollars more than normal to ensure depositor liquidity. As more and more money is set aside to assauge the fears of depostiors, that money cannot be invested, and it cannot be place in the capital market. This makes an already impossible situation worse. 

Economic activity requires functioning capital markets. Capital will need to be able to come into the market and be applied to worthwhile endeavors. Since no one knows what the credit markets will look like (or if they will even function) - no investment activity is occuring in signficant amounts. No money - no expansion of business. Profitability will eventually return to the US economy, however, for now, there is no money for expansion, thus, growth is not possible. Recession is assured, and deep recession, or dare I say Depression, is not out of the question.

In addition to a recession, I predict the following will happen unless the United States figures out how to stop what could be the most vicious downward spiral of devaluations in assets since the Great Depression:

The dollar could fall say 30-40 percent over the next few weeks; there could be payments system gridlock, margin calls at the clearinghouses fail and trading implodes; the NYSE and DOW go into a free fall and only a trading shutdown would stop the Dow from shedding half its value.

Quite frankly - we may not be able to avoid that… and we got a taste of it today.

On the international scene, world markets could abandon the US dollar as a unit of valuation, and thus require the US to obtain other currencies, at higher premiums, in order to pay its debts internationally and to engage in international trade. This could cost US consumers billions of dollars and could effectively end US hegemony of international finance.

At home, we are teetering on the U.S. banking system would be insolvent, brought about by massive defaults in credit paper and the inabiliy of banks to borrow money from other lending institutions internationally. Depositors are already panicked and have been withdrawing cash from US banks. While the nation’s largest banks have been moving quickly to shore up the holes, eventually reserves will deplete. Emergency Fed/Treasury action would recapitalize the FDIC, but the Fed would lose all credibility as a central bank and monetary policy would at best be speculative.

Inflation would likely rise in the United States - further destroying wealth of the average American.

As capital dries up, all economic growth stops, the rate of unemployment would climb into double digits and stay there. Many Americans would not have access to their savings, or would liquidate their savings (in the form of 401k’s and other investments) at substantial losses - thereby limiting the money available in retirement. Meanwhile, inflation would eat at the savings they do have, and drive the situation to perilious levels.

The future supply of foreign investment would be noticeably lower, further exacerbating growth.

The Federal government could lose its AAA rating and we would pay much more in borrowing costs.

And of course finally, the deficit would skyrocket, as tax reciepts would fall in response to unemployment, lower profits, lower wages, and lower payrolls.

The $700B bailout sucks. It probably isn’t even 700B but double that. But so does financial collapse, and a loss of US leadership in the financial world.

Possibly Related Posts:

• Being Rod Blagojevich
• Eve of Destruction: Are we headed for a Global Recession?
• Treasury Bills “crack the floor” and deflation becomes a greater risk.
• Ford decides it doesn’t need a US bailout…
• The next “bubble” to burst - US Government debt?