While politicians played politics, markets moved. Money raced out of stocks ($800 billion in equity was wiped out on the S&P alone today) and commodities and into ’safety havens.’ Those havens were treasuries and gold…ironic if you think about it. In the mean time, the bailout stalled, as the last batch of conservatism has prevailed and looks to hold true until Thursday (The Jewish holiday Rosh Hashanah will prevent another vote until Thursday at the earliest).

At this point, I don’t mind going out on a limb to say this: members of Congress are terrified of how markets reacted to the vote. For that reason, the next vote will be all that’s necessary to pass this bailout, regardless of the draw up.

All in all, it’s irrelevant. Sure there’s the moral hazard, as well as the economic consequences that goes along with this sort of financial socialism, but we really have two choices to navigate this. Both come at the same cost…inflation

Real Price of the Bailout

To understand this notion, we first need to understand a couple of the basic fundamentals of this bailout that make no sense. The first of those issues is one of the large reasons this bailout is having trouble getting through Washington. I’m referring to the question of what price should be paid for these troubled assets.

If the price is set too cheap, say actual market value that these securities would be realized at if sold, there’s no reason for Wall Street to partake because they would be left with negative asset value. To read more on this topic please click here.

For that reason, the price will obviously be set above marked-to-market levels while regulators hide behind the ‘hold to maturity’ excuse. What that really means for the bailout is an INSTANT LOSS to the tune of HUNDREDS OF BILLIONS OF DOLLARS that will be PAID FOR BY TAXPAYERS.

Bailout Envelope Math

It’s really very simple. If this bailout uses $700 billion to buy assets above market value, they won’t be getting $700 billion in assets. The best way I can explain this to you is to simply share with you the exact back of the envelope math I did.

$700 billion equals the initial value of these assets times 20 cents on the dollar. The 20 cents on the dollar is the estimated price that the government would pay for these assets at current:

($7×10^11)=(.20)x(Initial Value)

That gives us an initial value of $3.5 trillion. The actual value of these assets is closer to one or two cents on the dollar. For our sake, we will use a CONSERVATIVE real value of 5 cents on the dollar. The next thing I did was multiply that $3.5 trillion by 5 cents on the dollar to figure a more realistic price of these assets:

($3.5×10^12)x(.05)=(1.75×10^11)

Using these figures, the government is paying $700 billion for $125 billion in assets that were originally worth $3.5 trillion…ouch. That an instant loss REALIZED BY THE TAXPAYERS of $525 billion. Now, the 20 cents on the dollar is based on bailout rhetoric. The 5 cents on the dollar is my own figures that I believe to be conservative considering the length and nature of this credit crisis.

What we do know is that politicians and regulators have OPENLY stated that they will be paying more for these assets than their worth. As previously mentioned, this is because Wall Street can’t afford to sell these assets at marked to market. So whatever figures you decide to use, it is easy to see that by simply passing this bailout, taxpayers are IMMEDIATELY hit with $100s of billions of dollars in losses.

Both Forks Lead to Inflation

At this point, you’re probably thinking I’m biased against the proposed bailout plan. I wouldn’t necessarily say that. I wouldn’t say I’m for it either. What would I say? How about buy gold.
Put it this way, the bailout is inflationary. The money is created out of thin air, and the losses are realized in our nation’s deficit. The deficits are themselves inflationary, and the larger they get the more inflationary pressures we will see.

What about the alternative? What if we let decades of socialistic financial practice end with capitalism? In short, we would have massive bankruptcies on Wall Street and Main Street. We would INSTANTLY have bank runs equal to or greater than the Great Depression.

Who foots that bill? The answer is the U.S. government via the FDIC, because the FDIC would be forced to take trillions of dollars in loans from the Fed in order to back the deposits. That money would come from the exact same place as the money for the bailout…the printing press. And you better believe that Washington will give the FDIC as much capital as they need because without the full faith of the FDIC behind bank deposits, the financial system WILL COLLAPSE.

So either way you look at it, inflation is what’s on the docket. My personal opinion is that we will see a combination of both the above mentioned circumstances. We still have a long ways to go. Let’s not forget that this bailout only focuses on one systemic issue. We still have Detroit, the airlines, and struggling municipalities that will be forced into either bankruptcy or government bailout.

Nicholas Jones
Analyst, Oxbury Research

P.S. At a time like this, it’s very difficult to find a safe place for your money. What I’ve done throughout this turmoil is share with you some of my favorite investments. Included in those are two short sales where the underlying company ended with a declaration of bankruptcy that can be viewed by clicking here. I’ve also shared with you a spread in the commodities market that has had a fantastic return since I first wrote about it and including a 13.5% spike during today’s market swoon. You can read that issue by clicking here. Knowing the success I’ve had in not only specific plays, but also in foreseeing essentially every major occurrence in this financial meltdown. I just wanted to share with you that one place I feel safe putting my money can be read by clicking here.