Can A Bailout Succeed?

Not without these elements and possibly not with them

For the first time in recent
memory Congress listened to the American people and
blocked Paulson`s bailout of his

rich buddies by US taxpayers. The same Congress
that refuses the public`s demand that the Bush
regime be held accountable and its gratuitous wars
halted

refused to hand over $700 billion to the
financial institutions whose

irresponsibility has brought the US to its worst
economic crisis since the

Great Depression.

We must be thankful for this
sign that American democracy is not completely dead
and supplanted by executive branch authority. 
However, whatever bailout package that emerges will
fail unless it takes into account the following.

Any package that maintains the
mark-to-market rule and permits the resumption
of short-selling will undermine itself. In panic
conditions without the existence of a market, the
mark-to-market rule results in asset prices being
driven below their values, thus eroding balance
sheets and producing insolvencies. 
Short-selling permits short-sellers to profit by
destroying the share prices of institutions
suffering balance sheet problems, thus eliminating
their ability to borrow and driving them into
failure.  

A bailout, however large, that
maintains the

mark-to-market rule and permits short-selling
will pour money into a black hole.

A bailout that is treated as a
mere addition to the US government`s already massive
indebtedness will disconcert foreign creditors. 
There is a limit to the amount of debt for which the
US Treasury can assume responsibility without
undermining its own credit rating.  The
bailout, especially if the $700 billion proves
insufficient and more is needed, could impair the
Treasury`s credit standing.

In this event, foreign
creditors might not provide the funds needed for the
bailout or would provide them only at higher
interest rates, which would themselves undermine the
bailout`s success.  

According to a September 29
report in the
Washington Post: 

"Twenty of the nation`s largest financial institutions owned a combined
total of $2.3 trillion in mortgages as of June 30.
They owned another $1.2 trillion of mortgage-backed
securities. And they reported selling another $1.2
trillion in mortgage-related investments on which
they retained hundreds of billions of dollars in
potential liability, according to filings the firms
made with regulatory agencies. The numbers do not
include investments derived from mortgages in more
complicated ways, such as collateralized debt
obligations."[Broad
Authority, Lots of Money And Uncertainty ]

Leaving aside the
collateralized debt obligations, adding the three
mortgage-related instruments of the 20 financial
institutions comes to $4.7 trillion of which $700
billion is 15 percent.  If more than 15% of
just these troubled instruments are bad, the bailout
would require more money.  At what point would
foreign creditors see an endless pit?

If foreign creditors are to
finance the bailout, it must be credible.  The
best way to achieve credibility is to combine the
bailout with a reduction in other forms of US
foreign borrowing, specifically the US government`s
budget deficit and the US trade deficit.

Based on assumptions that do
not allow for recession and, perhaps, the full
amount of the wars` cost, the US budget deficit is
estimated to be in excess of $400 billion. 
Considering the urgency of the bailout, the $700
billion would also be near-term borrowing. 
This means a minimum of $1.1 trillion in new US
borrowing over the course of the year, a sum that
could cause foreign creditors to blink.

The bailout would gain
credibility if the US budget and trade deficits were
addressed as part of the package.  The US
government needs to choose between its financial
system and its wars.  As the wars serve no US
interest except for those of a few powerful interest
groups, the government should declare an immediate
end to the wars, thus reducing the budget deficit by
at least $200 billion annually.

The government should then turn
to the military budget, which at about $700 billion
is larger than the combined military spending of the
rest of the world combined.  The only
justification for such an enormous amount of
military spending is a policy of US world hegemony,
a policy that financial collapse makes nonsensical. 
The defense budget needs to be cut sufficiently to
bring the US budget into balance or, better still,
into $100 billion surplus.  

Such action would demonstrate
to foreign creditors a responsible approach to the
economic crisis.  Instead of more than doubling
the demands for new credit from foreign creditors,
the US government could keep the current level of
borrowing constant by eliminating the budget
deficit.  This would signal a new seriousness
to foreign lenders.

The trade deficit also must be
addressed.  The US is dependent on the
willingness of foreigners to finance its annual
consumption of $800 billion annually more than it
produces.  This ongoing financing floods
foreign creditors with dollar assets in such large
quantities as to raise questions about the worth of
the US dollar.  

The

offshored production of goods and services for
US markets has added significantly to the US trade
deficit as these ffshored goods and services count
as imports when US corporations bring them to the US
to be marketed.  Offshoring activity must be
curtailed either with taxes, quotas, or tariffs.  
It would be difficult to impose tariffs or quotas on
goods made by companies of our foreign creditors. 
But US firms that are producing offshore for US
markets could be curtailed.   Eventually
steps will have to be taken to bring the US trade
deficit into balance, but this could await the end
of the financial crisis.

Over the last 20 years the US
has made a collection of serious mistakes that may
yet prove fatal.  With the collapse of the

Soviet Union, the US government launched a
policy of world hegemony for which it lacked the
means.  The US government permitted much of its
manufacturing base to be located offshore to the
point of even being dependent on imports for its
military capability.  The US government
deregulated the financial sector and permitted the
rise of new highly leveraged financial instruments
whose failures currently threaten the US with
economic collapse.  

University of Maryland
economist

Herman E. Daly points out that the current
crisis is really one of the
"overgrowth
of financial assets relative to growth of real
wealth."  Daly believes that
"financial
assets have grown by a large multiple of the real
economy" and that
"paper exchanging for paper is now 20 times greater than exchanges of
paper for real commodities." Exploding debt
liens have simply outgrown the wealth.

The problem, in other words,
cannot be bailed out.  Historically, debt that
cannot be redeemed has been repealed by inflation. 
The same inflation that wipes out debt will wipe out
savings.

A failed bailout is the worst
possible outcome.  The chance of failure rises
if the US government tries to turn bad private debt
into good public debt without regard to the
expansion of the public debt