Good news: The 'bailout' has crashed

Good news this morning: it looks as if America's trillion-dollar nationalisation of bad assets won't be going ahead. As readers of my earlier posts on this should realise, this is good news. Investor Jim Rogers encapsulated last week the bad news at the heart of the now-dead bailout plan:  "This is madness, this is insanity, they [want to] more than double the American national debt in one weekend for a bunch of crooks and incompetents."  Ain't that the whole truth.

Quite aside from the absolute irresponsibility of printing $700 billion of bailout cash to further inflate the money supply -- more of the same rocket fuel that caused the problem in the first place -- the plan to keep prices high is precisely the opposite of what's needed in a depression. 

Herbert Hoover's plans to keep prices high after the 1929 stock market crash was an object lesson in what not to do after a crash -- as Fed Chairman Ben Bernanke conceded last week to House Republican Ron Paul (see the video here). Hoover's plans, continued by Roosevelt in 1932, did precisely the opposite of what he intended: instead of protecting failing businesses and providing the funds necessary for recovery as he hoped, the failure to let the market contract and flush out the dead wood and malinvestments as is necessary for recovery merely prolonged the pain.

Today's American bailout plan made the same mistake, and would simply have prolonged the pain (and with that cash injection, even enhanced it).  Allowing the market to cut its losses and cut out the dead wood -- which is what a contraction consists of -- is painful for a year or two, but prolonging the contraction only ensures it's going to be painful for a whole decade (just as it was for Japan when it applied the same medicine in the early nineties, ensuring their necessary recovery was delayed for a decade, a point made on Morning Report this morning by Jim Rogers) with good money being poured after bad long after the time to cut the losses is over. 

How long must the necessary contraction take?  "Until," says Ludwig von Mises, "the illusions of the boom have been dispelled and economic activity has readjusted to the realities of the existing conditions. Attempts to interfere with free and flexible prices, wage and interest rates prevent recovery and prolong the depression period."

Let's repeat: you can't fake reality.  The contraction and both recovery need to happen; they can't be avoided.  The only choice is whether that takes a year or two, or whether the process is prolonged for a decade. 

Which of the two would you prefer?

And, too, by bailing out the assets of incompetent banks, it would have punished the shareholders and directors of competent banks and businesses.  As John Allison of North Carolina's BB&T Bank said late last week, the Paulson Plan is aimed at helping poorly run banks -- it has nothing at all for competently run banks:

    U.S. Treasury Secretary Henry Paulson's proposed $700 billion bank rescue aims to help ``poorly run'' companies and the primary beneficiaries would be Goldman Sachs Group Inc. and Morgan Stanley, said BB&T Corp. Chief Executive Officer John Allison in a critique of the plan.
    Treasury ``is totally dominated by Wall Street investment bankers'' and ``cannot be relied on to objectively assess'' the impact of government policy on the financial industry...
    ``There is no panic on Main Street and in sound financial institutions,'' Allison wrote. ``The problems are in high-risk financial institutions and on Wall Street'' ... 
    The market should be allowed to eliminate ``irrational competitors,'' he said. ``There were a number of poorly managed institutions and poorly made financial decisions during the real estate boom,'' Allison wrote. ``It is important that any rules post-`rescue' punish the poorly run institutions and not punish the well-run companies.'

You can read the full statement from John Allison here.

UPDATE 1:  The always astute Frank Shostak affirms the argument: "The Rescue Package Will Delay Recovery," he says.

UPDATE 2:  In An Open Letter to My Friends on the Left, Steven Horwitz answers the many critics who say this is a crisis of free markets; people like the two US presidential candidates who say erroneously it's a result of "shredding regulations" (as if!) and a "lack of regulatory oversight"; or local Marxist Matt McCarten, who says "the US example puts paid to the free market idea":

In the last week or two, I have heard frequently from you that the current financial mess has been caused by the failures of free markets and deregulation. I have heard from you that the lust after profits, any profits, that is central to free markets is at the core of our problems. And I have heard from you that only significant government intervention into financial markets can cure these problems, perhaps once and for all. I ask of you for the next few minutes to, in the words of Oliver Cromwell, consider that you may be mistaken. Consider that both the diagnosis and the cure might be equally mistaken.

Consider instead that the problems of this mess were caused by the very kinds of government regulation that [were] now proposed...

And in an older article Frank Shostak, again, points out how regulations allowing banks to inflate their own money supply (what's known as "fractional reserve" banking) accelerates both booms and busts, and how under fractional reserve banking (in which all banks are inherently bankrupt) , the various means by which their "reserves" are met are inherently flawed, and when the ineveitable crisis does come "the collective attempt of banks to improve their solvency actually runs the risk of making them less solvent, thereby deepening the liquidity crisis."

In every sense then, we're now paying for the bad decisions of regulators and the government's central bankers.

UPDATE 3:  On the question of this being a "failure of free markets," it's worth re-reading this article by George Reisman, in which he points out  both the ack of a free market, and the reason for there being "very little, if any, rise in real wages" in the recent booms:

    In contrast to the experience of the 1920s, in the two great recent credit expansions, i.e., the dot.com bubble of 1995-2001 and its successor the presently collapsing housing bubble that began not long thereafter, there has been very little, if any, rise in real wages. Most commentators appear to attribute this to nothing more than the unrestrained greed of businessmen and capitalists. They apparently go on the theory that if there is anything in the economic system that breathes or moves other than at the command of the government, or other than with the active supervision and control of the government, it is proof that we live in an era of “laissez-faire"...
    This alleged laissez-faire environment, such writers pretend, has enabled businessmen and capitalists shamelessly to enrich themselves at the expense of increasingly impoverished wage earners, to whom nothing any longer even “trickles down.” {Are you listening, Barack Obama?]  Increased free trade and “globalization,” of course, are attacked as part of the process and as greatly contributing to the stagnation or outright decline in real wages.
    In sharpest contrast to such blather, in the real world there are innumerable rules and regulations enacted by the Federal Government to control virtually every aspect of economic activity. They are contained in the more than 70,000 pages of The Federal Register. The overwhelming mass of government interference described therein, and in its counterparts at the state and local level, is a glaring refutation of claims about the existence of any kind of laissez faire in the present-day world. The very description of such interference, in tens of thousands of pages of official text, is a refutation of such size and literal weight as to render any claims about laissez faire or insufficient government controls or regulations utterly nonsensical.
    This truly massive body of material also suggests that the actual explanation of the stagnation in real wages is precisely an ever growing burden of government intervention in the economic system. The intervention is in the form of policies that undermine genuine saving and in numerous other ways undermine capital accumulation and the rise in the productivity of labor. Personal and corporate income taxes, the inheritance tax, the capital gains tax, and government budget deficits—all entail the taking away of funds that if left in the hands of their owners would have been heavily spent, indeed, overwhelmingly spent, in the purchase of capital goods and labor services. Instead, those funds are diverted into financing the consumption of the government and those to whom the government gives money.
    Inflation and credit expansion greatly exacerbate this diversion of funds, because their effect is artificially to increase the incomes subject to these taxes and to thus to deprive business firms of the funds required to replace assets at prices made higher by the same process that increases their taxable incomes. The progressive aspect of income and inheritance taxes also worsens their effects, because incomes tend to be saved and invested the more heavily the larger they are; at the same time, substantial inheritances are more likely to be retained in the form of accumulated savings and capital than are modest inheritances.
    Because of the reduced demand for labor that results from the taxation of funds that would otherwise have been used in employing labor and in buying capital goods, wages are substantially less than they otherwise would have been. At the same time, the buying power of those reduced wages is also sharply reduced in comparison with what it would otherwise have been.

UPDATE 4:  From Noodle Food:

Reading that NY Times article in full, I'm impressed by the seemingly principled opposition to the bailout. See these descriptions and quotes:

Jeb Hensarling, Republican of Texas, said he intended to vote against the package, which he said would put the nation on "the slippery slope to socialism." He said that he was afraid that it ultimately would not work, leaving the taxpayers responsible for "the mother of all debt."

Another Texas Republican, John Culberson, spoke scathingly about the unbridled power he said the bill would hand over to the Treasury secretary, Henry M. Paulson Jr., whom he called "King Henry."

A third Texan, Lloyd Doggett, a Democrat, said the negotiators had "never seriously considered any alternative" to the administration's plan, and had only barely modified what they were given. He criticized the plan for handing over sweeping new powers to an administration that he said was to blame for allowing the crisis to develop in the first place.

In contrast, consider what the supporters of the bailout are saying:

When it comes to America's economy, [Representative Steny Hoyer of Maryland, Democratic Majority Leader] said, "none of us is an island."

Representative Maxine Waters, a Democrat, said the measure was vital to help financial institutions survive and keep people in their homes. "There's plenty of blame to go around," she said, and attaching blame should come later.

UPDATE 5:  Jeffrey Tucker at the Mises Institute is cock-a-hoop!

House rejects the bill. This is a magnificent repudiation of the Fed, the Treasury, Bush, Wall Street welfarists, inflationists, and stabilizers of all sorts. The costs of what the Fed has already done are going to be massive and felt for many years. But at least Congress has so far, and this time only, not participated in the evil.

It's a great birthday gift for Ludwig von Mises.

Whatever the case with stock markets--and we can be confident that whatever prices emerge are truer than they would be with a bailout--it is fantastic that oil prices have retreated so dramatically. Drivers cheer. May all commodities follow. How this can be spun as dreadful news is beyond me.