Dion Money Management Blog   Money Management for Retirees and Their Families

1.    The plan will help restore confidence in the economy. Confidence is the connective tissue of all modern economies, the reason farmers in Iowa grow corn, small businesses in New England run bed and breakfasts, metal fabrication companies in Pennsylvania bend steel, and, yes, banks lend money. In recent weeks, that confidence evaporated, freezing the credit markets. The bailout plan marks the start of the thawing process that will allow money to flow more freely again.
2.    It will remove a disincentive for capital to enter the financial sector. Ever since the government helped save Bear Stearns largely by wiping out equity holders while accommodating a sale to JP Morgan Chase, investors inclined to invest new equity in the U.S. banking system were forced to weigh whether they thought the government would step in if their choices went sour. This quandary likely caused many to choose to stay away altogether. By eliminating uncertainty, the bailout plan should lure this capital back.
3.    It buys time for an orderly disposition of assets.  The price the government may pay for these sick mortgage assets is far less important than the ability to take time to dispose of them. The Treasury has up to two years to buy the assets, some of which have real value that can’t be realized in a market where there isn’t a market for any assets. The bailout plan helps us get out from under this dilemma.
4.    It also buys time for the financial system to heal itself. This plan prevents financial Armageddon and starts the healing process for banks. As time progresses, they will be able to re-capitalize themselves from the quarterly earnings flowing out of their core lending businesses, along with new investments from outside investors.
5.    It is a one-time investment, not a recurring expense, and it may lower the federal budget deficit over time. Directly, the plan has the potential to generate returns — maybe not enough to offset the one-time outlays, but enough to get a lot of the money back, putting the final price tag well below the $700 billion upfront price-tag. Even more important, by likely lessening the downturn’s severity and speeding the ultimate economic recovery, the bailout will reduce the federal deficit from what it otherwise would have been by improving tax receipts and other inflows that increase when the economy is growing.
6.    It will lower what we ultimately will pay for this crisis. We can argue about how much the government should pay for some of the bad assets that will be taken off the banks’ books, or whether the upfront costs may reach $1 trillion as some have suggested. But the bottom line is this: If we don’t pay for it now, we likely will have to pay a lot more later as our financial system implodes, with ramifications that extend far beyond Wall Street to Main Street, through lost tax revenue, lost jobs, lost retirement savings, etc. This plan is cheap by comparison.
7.    Besides, $1 trillion is not that big.  Even if the overall upfront outlays do reach $1 trillion, compared to the size of our economy (roughly $14 trillion), that’s still only about 7 percent of GDP. That’s significantly smaller than most other bailouts that had to be done in financial crises that have confronted other countries in recent years. The $50 billion bailout of Mexico in the mid-1990s, for example, was in the magnitude of 19 percent of that country’s GDP.
8.    It is positive, not negative, for the dollar. The currency markets seem to think that Chairman Bernanke is going to fund this bailout by printing dollars. There’s simply no indication whatsoever for this – in fact, his refusal to lower the target federal funds rate last month in the face of overwhelming odds that he would was a clear signal of his intentions. Even if the Fed changes course and lowers rates, the move would be made because of rapidly deteriorating economic conditions, not to finance the bailout. Other pro-dollar ramifications: the improved stability to the U.S. financial system; slower global economic growth; and falling oil prices.
9.    It will lessen the economic pain. The tsunami spawned by this financial crisis is just starting to hit Main Street, but this will soften the blow by greasing the wheels of commerce as banks get back into the business of financing real economic activities. Think of the plan as a sort of giant breakwater, dampening the power of the financial wave as it moves “inland.”
10.    It will dramatically improve the outlook for returns on everyone’s retirement portfolios over the next three to five years. A majority of households are stock holders, through 401(k) plans, pensions and other retirement accounts — indeed, it was the uproar from this group after the House vote to reject the initial bailout bill, sending stocks plunging, that arguably led to the about-face. By healing the financial system, this plan will allow their equity assets to rise in value over time. Our research of six of the largest financial crises over the last 20 years — Sweden, Mexico, Russia, Thailand, Hong Kong and Japan — shows that markets tend to bottom sometime between “immediately” and 12 months from the bailout announcement. And while returns during this bottoming process can be volatile, the average market appreciation in local currency terms from the point of the bailout to three years out was +49%. This is not a forecast, and every financial crisis is different, but the data suggests that the next 12 months present a historically good time to average into equity markets.  Three years from now, odds are good that we’ll all be better off.
Commentary of Stephen Auth, Director, Global Portfolio Management, Federated Investors.

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