As the Treasury and Federal Reserve bail out proposal of the whole US (and possibly even global) banking sector gets approval via congress. It has to be kept in mind that the approval for such a broad institutionalization, or protection of banks and the finance sector, is no way a broader effort to bail out the indebted/poor American citizen. Who, as it has been discussed will be footing the bill of such bizarre and in someways desperate measure to stop the rich from going into recession.
The dangers are immense in this ‘bail out’ scheme, obvious at this point with a Trillion plus money pledge to buy banks distressed assets, it’s effect on inflation and devaluation of the US dollar. Traders will be now trying to bet at which way the US economy will go, whether a deflation recession, or stagflation recession. With the new bank bail out proposal it appears to be a stagflation ‘severe’ recession looming; just as the commodity markets were adjusting to a US slowdown, the USD strengthening. Then Federal Reserve (under Ben Benanke) and US Treasury (under Henry Paulson) whack this badly thought out plan of propping up badly run banks and their losses. The commodity markets, being relatively good safe havens to inflation, may start to rally again.
The market will of course tear this plan apart with due skepticism, more notably the problems with asset valuation and the buying of distressed debt at discount from banks. In other words, to what extend should the bailout cover the toxic assets of bank, which in some cases could equal the value of the bank itself, say 100% (remember AIG insurance was 80% junk). Which would essentially qualify as a complete takeover from the US government. Otherwise the bank with it’s ‘junk’ bought at a discount, may find it hard to function – after selling it’s distressed assets at a cheap rate to the US government. Hence they might as well close up shop anyway.
With broader consumer markets in recession, it has to asked how a bank which has had it’s toxic waste disposed of return to profit? Or, do they scale down, horde cash and sit it out – likely scenario. If this is the case banking stocks will still come under pressure with no real recovery occurring (in the bank sector).
The Foreign Exchange markets may be good indication of the soon to be worries of the USD under a lot of pressure.
Politicians who should be looking after the interest of the electorate have now helped distinguished the two separate economies in markets, the banks, Wall Street and main street. This plan will essentially shut off main street from the finance markets; insulting the banking world from further losses (but as discussed this plan may still not stop the banks running at a loss – even if they do disengage from the broader economy and it’s ills. The banks may just become corpses kept alive with government money).
Of course main street will go further into recession. A dreadful distortion of free markets, as the powers at be are now reshaping and protecting the gamblers who caused their own markets to meltdown.