We’re all familiar with the proverbial ship that has a leak.  What’s the quickest and easiest way to address that leak?  Patch up the hole.  That usually “fixes” the problem, or at least hides it for a while.  But then the hole becomes larger and other holes pop up all around the rest of the ship.  Before you know it, you’re farther out at sea, and the safety of land is a long, scary swim away.  Had the boat’s crew addressed the problem with care and diligence at the first sign of trouble, this problem might have been cut short or avoided all together.  But with quick fixes comes hefty consequences down the road.

I’m sure you’ve figured out what I’m hinting at by now.  The proverbial boat is our economy and the crew is the mortgage industry, credit markets, Wall Street, and the government.  What started with a small hole known as the subprime debacle, turned into a larger hole known as the credit crisis.  Now there are various other holes and leaks in the financial sectors which have resulted in a sinking economy.  Each day brings about a new disaster and the government’s response is to “invest” in 700 billion dollars in failed assets and hope the patch sticks for good this time.  Well guess what folks, my prediction is this will only get us further out to sea and still falling short of our destination.  In my opinion, the confidence and clean slate we need for this troubled economy cannot be achieved with a quick fix like buying sour assets.  The problem is too deep rooted and beyond a simple government “plan” that is loosely defined and poorly thought out at this point.

We got to where we are because we were overleveraged, greedy, gluttonous, and too naïve to realize that the United States is not invincible.  And now the Treasury and Fed are going to bail us out for our bad behavior.  From merger to buy-out to bail-out, where will the government draw the line?  Which companies will they deny relief?  What about the auto manufacturers?  The airlines?  How about those defaulting auto loans and credit cards that we haven’t even concentrated on yet?    At this point, what incentive does the average American have to pay their debts?  Not much if they can just use a crisis like this as an excuse to walk away from their obligations.

America’s problem is that we’re too accustomed to a free lunch, and each and every bailout is only reducing accountability and increasing the expectation that someone else will handle the consequences.  Throwing money at the problem, lowering rates, and all other typical emergency procedures have not worked thus far, they have only extended and exaggerated the problem.  In my opinion, this $700bil bailout will be no different.

My two biggest concerns with their bailout proposal are how it affects the taxpayer and how successful it can possibly be in the long-run.  The Treasury and Fed are finally convinced that the government needs to step in and do something drastic.  Better late than never I guess, but I disagree with their plan.  I believe that taking all of the contaminated items off of these institutions’ balance sheets will only delay the inevitable.  The sale here to Joe Shmoe Taxpayer is that we can benefit down the road by acquiring these various asset classes at severely discounted values now, yet the Fed and Treasury can’t even come up with a concrete way of valuating the assets to begin with.  Herein lies the problem.  This strategy will not trigger lenders to start lending again, and the freeze in capital is a major problem.  Yes, a bailout plan must happen, but one of the things that is troubling me most about the plan is that it’s relieving the symptoms but not the ailment.  The biggest issue is not that the banks don’t want to lend, but more that after they make a loan, they don’t have anyone to sell it to. It’s economics 101.  The seizing up of the credit markets is from a lack of buyers and not a lack of sellers.  It is ridiculous to assume that the vacuum in the system will heal itself unless you recreate the credit markets in a way that provides more realistic and accountable valuations, which in turn will bring back the buyers of these securities.  Do that first and then maybe think about the clearing of bank balance sheets.

Instead of trying to build off of and repair a failed system, we need to create a new system (definitely not overnight) that is free of the inadequacies and contamination that haunt these large, cash-starved institutions today; one that can be tracked and ensures a clear method of valuation not only for large and complex securities, but simply for the dollar as well.  If money doesn’t begin flowing again, the problem will only get worse.  Let me qualify that statement though.

We need a healthy respect for money in this country.  We need to learn to save, increase liquidity, not over-leverage, spend responsibly, and have some foresight on the consequences of our actions.  We need small business to have the opportunity to innovate and grow.  We need qualified buyers to be able to buy homes again (of course, making sure they are actually credit worthy AND have substantial skin in the game).  We need successful businesses with good track records and well thought-out business plans to get the capital they need to move forward.  Most importantly, we need jobs to be a result of all the aforementioned and for people to go back to work.  We need to throw out the faulty financial mechanisms that were created during the boom and return to fundamentals.  Ultimately, this new and improved economy can be the end result of the current catastrophe if we create new opportunities instead of bailing out failed investments.  Those bailout dollars are better spent by creating a new structure that supports healthy lending and investing.  Lending and investing that uses sound, time-tested fundamentals.  We don’t have enough government and tax payer dollars to buy our way out of this one, because it doesn’t stop at Bear Stearns, Lehman Brothers, Washington Mutual, or AIG.  Intervention needs to take place, but a quick fix is not realistic.  We need a solution that doesn’t just patch holes, but instead builds from the ground up and promotes new opportunities; opportunities that stem directly from these distressed assets, and opportunities that are completely independent as well.  This “bailout” plan needs to be more than just window dressing to calm the masses.  Only a new platform that stimulates the credit markets will be able to recreate our economy.  The United States has some of the greatest financial minds in the world that brought this financial nightmare to our door steps, and I believe these same minds can bring about the dawn.

Copyright: Michael Facchini, Regent Global Funds 2008