Not too bad

If you're an AIG executive, you've got to be thinking: it's really not too bad. I mean, think of it: you and your colleagues, as a class, have contributed to the collapse of the world economy, causing trillions of dollars of wealth to evaporate, millions of jobs to disappear, and all the rest of it. And do people want to throw you in jail? Do they want to banish you from the country? Do they want to seize all your assets? No--all they really want is some symbolic gesture of humility that demonstrates that you acknowledge that you're not such hot stuff after all. Apologize in front of a Congressional committee--give back your bonuses. That's all.

The AIG execs should be thanking their lucky stars that they live in a country where even the most pitched populist rage amounts, substantively, to so little.

I sat out Kosovo

If you want to understand the situation with bank bailouts, I highly, highly recommend the latest TAL. Among other things, I finally learned what the hell liabilities, assets, and capital are on a balance sheet!

Also: truly informative sources, like these finance-related episodes of TAL or, say, Krugman's blog, make you realize just how awful the mainstream press is at actually educating people about the issues of the day. Could you imagine Brian Williams explaining how a bank balance sheet works on the evening news?

How did the world function before the internet? I'm coming around to the conclusion that, pre-internet, everyone was just far, far dumber.

Shooting the moon

AIG is an insurance company, except instead of insuring cars or houses or someone's healthcare, it insures people who lend money. For example, say I want to lend money to Joe. There is a small probability that, for whatever reason, Joe won't be able to pay me back. But I want to eliminate the possibility of a disasterous loss. So, for a modest fee, I buy an insurance policy from AIG that says that I will be reimbursed the full amount of the loan in the unlikely event that Joe defaults on my loan. From AIG's perspective, it has essentially placed a bet that Joe will be able to pay off the loan.

The problem is, AIG placed too many bets: it sold more insurance policies than it could deliver on in the event of widespread defaults. In the same way that a bank is screwed if everyone decides to withdraw their money at the same time, AIG became screwed because everyone came to them with a claim at the same time. There was a "run" on AIG.

Now, predictably (and rightfully), scorn is being heaped on the executives at AIG. But the Opinionator also brings up this interesting point, which is that financial institutions that took out policies from AIG were also acting poorly:

John Carney at Clusterstock... recommends we...“direct a bit of our righteous anger at the customers of A.I.G., those financial institutions who bought insurance from A.I.G.”

Why? “They are truly accomplices of A.I.G. in the scam.”

Many of them were well aware that AIG couldn’t possibly fund the insurance policies it was writing. But they didn’t worry about that because they were operating under the same assumption AIG was: that the policies would never have to be funded on any widespread scale. Defaults on credit products were supposed to be isolated and non-correlated.

What’s more, many assumed that a complete AIG meltdown was what we call a “Financial Armegeddon” bet. The idea was that AIG would never be allowed to default on its obligations — it would be bailed out by the American taxpayers. And if the American taxpayers couldn’t afford to bail out AIG, well then you’d be in such dire straits that your main concern would be food, shelter and ammo and not the performance of your loan portfolio.

By bailing out AIG, and therefore bailing out its counterparties, the US government is rewarding this kind of reckless behavior. And it is punishing responsible credit insurance writing, essentially telling anyone who placed a premium on buying insurance from a solvent insurer that they were suckers. They should have bought the cheap contract from AIG instead.

Well. If a few people make a Financial Armegeddon bet, that's just fine--but if everyone makes that bet, then, well--you get Financial Armegeddon. But of course, for each individual, making this bet was the rational thing to do--so here we are.

How could anyone have argued for deregulation in this area? Isn't this, like, the canonical scenario where everyone agrees that regulation is required?

More on supply shock

Re the post below, Alex sez:

This domino effect idea is kind of hard for me to buy. It reminds me of the Y2K bug or something.

Basically, the disaster rests on the idea that if a bunch of consumers (car manufacturers) of some product (car parts) cease to exist, then the manufacturers of those products (car part manufacturers, natch) go out of business.

Uh, what? I thought that when demand goes down, even drastically, supply goes down to match, not to 0. Sure, they'll have a hard time for a while. But to me, the natural thing to happen would be the following: all suffer for a little while, until one fails, then another, then another. As these part manufacturers fail, business gets better and better for the rest, until we reach equilibrium, and the supply meets the demand. It's not like they'll all fail exactly simultaneously.

Why would this not happen? Admittedly, this is still very bad.

Apparently, it's a bit more complicated than that. I've found a better explanation of the supply shock phenomenon here--definitely worth a read.

The problem isn't so much that globally people won't be able to manufacture cars--it's that nobody will be able to manufacture cars in America for the next year or so. And this will cause all car manufacturers in America to shutter their plants--even the ones who were performing well, like Toyota, Honda, etc. Moreover, the problem is greatly exacerbated by the fact that we are in the midst of a once-in-a-century credit crisis: normally when companies encounter short term revenue shortfalls they simply borrow money to cover operating costs, but these days they can't get a loan, and so a short term revenue shortfall can spell doom for a company. Given a long enough horizon things will even out again, but most of the car manufacturing will have moved overseas by then.

In the end, the potential number of jobs lost is staggering: it could be as much as 200,000 just from the car companies alone, plus like 600,000 more from all the companies that support them. To put that in perspective: suppose that tomorrow, Adobe, Google, and Oracle all went out of business. Imagine how that would affect the economy of the Bay Area, and even California as a whole. You know how many people those three companies employ? About 90,000. So if all this really happens, it's going to be, like, Armageddon in the Rust Belt. And when you think about all that economic devastation, and the timing of it--coming as it does in the midst of a credit crisis and on the brink of recession, if not depression--a $20b loan seems like a small price to pay to keep the auto companies alive until things get stable again.

Supply shock

A must-read article in the NYT--one of the few I've read that actually do a good job explaining a concept from economics. Apparently, one of the main risks of GM and Chrysler failing is that it will effectively destroy the entire car manufacturing industry in the United States, including companies like Toyota and Honda, which have factories in the South. The reason is because GM and Chrysler generate a lot of the revenue for parts suppliers--the companies that make axels and sparkplugs and such--and, do to the credit crisis, these parts suppliers can't borrow money to stay in business. But if they go out of business, then all the other car companies--Ford, Toyota, Honda, etc.--will suddenly not be able to buy parts, causing their assembly lines to stop:

As a result, the hypotheticals about the domino effect of the companies’ troubles through the vast network of auto supplier firms — which employ more than twice as many workers as the carmakers — are becoming real.General Motors and Chrysler, for example, owe their suppliers a total of roughly $10 billion for parts that have been delivered. G.M. has held off paying them for weeks, and Chrysler is paying in small increments. But the cash shortages at G.M. and Chrysler are getting more severe, according to their top executives and other officials.

...

Many of their suppliers are teetering on the verge of bankruptcy themselves, and do not have the luxury of extending credit much longer.

“I don’t think that suppliers will be able to get through the month without continued payments on their receivables,” said Neil De Koker, chief executive of the Original Equipment Suppliers Association in Troy, Mich., a trade group.

When suppliers big and small start failing, the flow of parts to every automaker in the country will be disrupted because as suppliers typically sell their products to both American and foreign brands with plants in the United States.

“There’s no question it will hit Toyota, Honda and Nissan too,” said John Casesa, principal in the auto consulting firm Casesa Shapiro Group.

“Many of the small suppliers will simply liquidate because they don’t have the resources to go reorganize in Chapter 11 bankruptcy,” Mr. Casesa said. “They’ll just go away.”

It is the dire scene laid out at the first set of Congressional hearings on an auto bailout in mid-November by Ford’s chief executive, Alan R. Mulally.

“Should one of our domestic competitors declare bankruptcy, the effect on Ford’s production operations would be felt within days, if not hours,” Mr. Mulally said.

...

In years past, suppliers have often been able to assist a troubled automaker by extending payment periods to get through tough times.

But by Mr. De Koker’s estimation, hundreds of suppliers no longer have that flexibility. They cannot borrow money in a frozen credit market, and they cannot buy raw materials without first being paid for parts they already shipped.

The Big Three, along with their foreign competitors, are what most people think make up the entire auto industry. But the car manufacturers are just the top of the pyramid.

While G.M., Ford and Chrysler employ 239,000 people in the United States, the country’s 3,000 or so auto suppliers have more than 600,000 workers.

If the bailout effort fails, and GM and Chrysler go under, can't the government work out some kind of plan to extend credit to the parts suppliers, so that they can keep feeding parts to the surviving car manufacturers in the US? At least that way GM and Chrysler wouldn't take everyone down with them...

PS: Here's a quote that doesn't bode well for the Mixed Metaphor Index:

“It’s like the dog chasing the tail,” said Tom Mullen....

“Everyone is stretched like a bungee cord,” he said. “We are waiting to hit the bottom of the river and waiting to be slingshot back up, hopefully."

I count four, with some pretty serious incoherence. What kind of a river slingshots you up when you get to the bottom of it?! First we're a dog, then we're sinking in rivers...there's even a bungee cord thrown in for good measure. Insanity.

Perspective on the bailout

Sullivan points to a comparison of the bailout, in inflation adjusted dollars, to past gigantic expenditures and finds that the bailout is costing more than all of those combined. The numbers:

• Marshall Plan: Cost: $12.7 billion, Inflation Adjusted Cost: $115.3 billion
• Louisiana Purchase: Cost: $15 million, Inflation Adjusted Cost: $217 billion
• Race to the Moon: Cost: $36.4 billion, Inflation Adjusted Cost: $237 billion
• S&L Crisis: Cost: $153 billion, Inflation Adjusted Cost: $256 billion
• Korean War: Cost: $54 billion, Inflation Adjusted Cost: $454 billion
• The New Deal: Cost: $32 billion (Est), Inflation Adjusted Cost: $500 billion (Est)
• Invasion of Iraq: Cost: $551b, Inflation Adjusted Cost: $597 billion
• Vietnam War: Cost: $111 billion, Inflation Adjusted Cost: $698 billion
• NASA: Cost: $416.7 billion, Inflation Adjusted Cost: $851.2 billion

TOTAL: $3.92 trillion

So far $4.6165 trillion has been committed towards the bailout.

However, I think the comparison is specious. Unlike most of those other things, the money is being invested--in other words, the United States is essentially nationalizing a significant chunk of the financial industry. The real "cost" will be the difference between what we paid for that ownership and what the upside will eventually be when the government withdraws its stake. This cost will undoubtedly still be very very high, but it won't be anything like four and a half trillion dollars.

"Final total panic"

Was perusing a collection of reactions to the Citigroup bailout, and saw this comment from one Bruce Wilder:

This is so completely beyond ridiculous, it is hard to even express it adequately. I really wouldn't be surprised if the sheer cluelessness on display doesn't eventually trigger the final total panic.

Hah--I love that. "Final total panic". I almost wish it would just come already so we could get this financial melodrama overwith. Ladies and gentlemen, we have achieved FTP--repeat...

By the way, the consensus opinion seems to be that this latest bailout was a staggeringly incompetent move, and an outrageous giveaway to Citigroup.

PS: The features of the deal: the taxpayers lend the company $27 billion at 8% interest (which are worse terms for the taxpayers than the terms that Warren Buffet got recently for lending Goldman Sachs money--he lent at 10%); taxpayers buy $2.7 billion worth of stock at a price of $10.61/share (the closing price Friday was three times less, $3.77/share); taxpayers agree to insure up to 250 billion fucking dollars in losses on mortgage-backed assets. So if those assets take heavy losses, the taxpayers are going to get soaked.

Auto bailout

I've been watching the Sunday talk show videos about the looming bailout of the auto industry, and been trying to figure out what I think about it. Generally speaking I agree with what conservatives (and most liberals not from Michigan) say, which is that we should not be in a situation in which the government is keeping alive a handful of giant corporations that otherwise would go out of business. At the same time though, General Motors is gigantic, employing just by itself millions of people, with many more millions of jobs (parts suppliers, dealerships, etc.) directly dependent on it. Were it to go under, it would be an incredible shock to the industrial economy.

Ordinarily, in a normal economy, I think I would advocate letting the big car companies go bankrupt (which would mean filing for Chapter 11), but soften the blow by 1) boosting unemployment payments and providing assistance for relocating to a different region, 2) making sure health care is affordable or free, especially for children, and 3) investing massive amounts of government money into infrastructure improvements and green industries in the devastated regions. But the problem now is that we're not in a normal economy: we're in a crisis economy, where the financial sector nearly imploded and the real economy is headed towards a severe recession. And so I don't think anyone knows exactly what would the effects would be of these gigantic companies failing, especially in the midst of rising unemployment and a collapsing retail sector--it could trigger even lower consumer confidence, causing the recession for everyone to be much, much more painful than it otherwise would be. It's a timing thing, and the timing is right now is bad.

Of course, these are all just tentative thoughts--I'm not any kind of economics or finance person, after all, so maybe I'm just wrong about some things. But I think I have the outline right. I think maybe the prudent thing to do is give Detroit the bailouts it needs until we get out of the crisis--and then, once out, have the political fortitude to tell Detroit that it's on its own.

Oh nos

The economy is continuing towards collapse: credit markets are still completely seized up, with the TED spread at a record high. (See my attempt to explain the significance of the TED spread here.)

Without credit, people cannot buy cars and houses, and businesses cannot cover operating expenses during a slow period, purchase expensive equipment, or expand (and, of course, entrepreneurs cannot get the loans they need to start new businesses). Ultimately businesses are forced to lay off workers, and consumer spending goes down--which in turn causes businesses to fare even worse and lenders to become even more tight-fisted--a vicious cycle that, if left to go past the point of no return, lands us in a bad recession or even depression.

Hopefully the government's $700 billion investment in the financial system will instill confidence in lenders that their loans will be repaid, and there will be enough affordable credit available to break that vicious cycle before it really gets going.

Circumstantial evidence

Tell me if the following twos ought to be put together:

• McCain--behind in the polls, paired with a floundering running mate, and desperate to sieze control of the campaign narrative--makes the grandiose gesture of suspending his campaign and postponing the debates--including the VP debate--until a bailout deal is worked out.
• McCain goes to Washington and--in conjunction with House Republicans--scuttles the bailout deal, thus regaining the initiative by appearing to be driving negotiations and pushing back the VP debate to give Palin (even more) time to prepare.
  

Admittedly, it's a leap. It could be that McCain didn't want to scuttle the bailout plan (although, curiously, he never lent it his explicit support), and McCain may yet show up to the debate even with no bailout plan in place. However, I am a big believer in the idea that cognitive dissonance and good old-fashioned self-delusion can exert a powerful--albeit unconscious--influence on a person's decision making. My little conspiracy theory does not require McCain to have evil intentions--it merely requires that he (perhaps with the help of his campaign advisors) has persuaded himself that these actions really are what's best for the country, and that it just so happens that they benefit him strategically in the campaign.

In the end, though, there's no way to know, so this line of inquiry is a non-starter.

Uh oh

Today when I left work, everything looked on track for the bailout. All sides had agreed on the principle points: $700 billion, government buys equity in the firms, oversight of the federal purchase of assets, relief for Main Street, limits on executive compensation. The consensus was that a bill would be signed by the weekend.

But after a thoroughly enjoyable evening dining with Marian and the great Harinder Chahal, I come back home to find this NYT headline staring me in the face:

Talks Implode During Day of Chaos; Fate of Bailout Plan Remains Unresolved

When the economy is on the verge of utter, Depression-level collapse, the last thing you want is some salient public event to panic everyone into thinking that everyone else is panicked, thus causing everyone to pull their money out of the system. It's a collective action problem. So words like "chaos" and "-plode" in the morning headlines do not bode particularly well.

Moreover, it is not a good sign that the level-headed authorities that are supposedly piloting us through these troubled waters are doing things like entreating House Speakers on bended knee and pleading with them not to blow things up:

In the Roosevelt Room after the session, the Treasury secretary, Henry M. Paulson Jr., literally bent down on one knee as he pleaded with Nancy Pelosi, the House Speaker, not to “blow it up” by withdrawing her party’s support for the package over what Ms. Pelosi derided as a Republican betrayal.

“I didn’t know you were Catholic,” Ms. Pelosi said, a wry reference to Mr. Paulson’s kneeling, according to someone who observed the exchange. She went on: “It’s not me blowing this up, it’s the Republicans.”

Mr. Paulson sighed. “I know. I know.”

Before tonight, I thought there was an air of cautious optimism that some kind of package--however suboptimal--would be agreed upon that would stave off financial collapse. But it seems like that has been replaced with something far more ugly, visceral, and frightening: panic. It's palpable. It's in the language people are using. "Madness", says Krugman. "This sucker could go down", says Bush. Bailout plans are in "disarray", says WSJ. And Drudge? "BREAKDOWN" (although, it should be noted that there are no siren animated GIFs--close shave there). And on top of all this, Washington Mutual failed and was bought out by JPMorgan.

Of course, all this is just one layman's gloss of the whole thing. Hopefully I'm mildly embarrassed tomorrow and nothing extraordinary happens. But I have the sinking feeling that tomorrow will soon have the word "Black" attached to the front of it.

PS: Apparently, the key figure to keep an eye on is not the stock market but the so-called "TED spread". This measures the difference between the interest on 3-month Treasury bills (T-bills) and the 3-month LIBOR. Let's see if I understand this well enough to explain it coherently:

A T-bill is a security that the federal government issues as a way of borrowing money from the general public: you pay, say, $1000 for the T-bill, and the government agrees to pay you back $1100 in three months. T-bills are considered one of the safest possible investments, because they are backed by the federal government--the government, of course, being the only player in town capable of raising funds by coercive force (taxes) or, if it comes down to it, by simply printing more money. Interestingly, the interest rate of the T-bills is determined by a regularly held auction, so that it is constantly fluctuating depending on how much demand there is for people to lend money to the government (or, put another way, how much demand there is for T-bills). If there are lots of people who want to lend to the government, then the government can command a lower interest rate for itself, because lenders will be undercutting each other at the auction with lower and lower interest rate offers. If there aren't a lot of people who want to lend to the government, it will be forced to borrow at a higher interest rate. If investors don't have confidence in private institutions, then they tend to flock to the safety of federally-backed T-bills, driving down the T-bill interest rate.

Meanwhile, in just the same way that the government borrows money from the general public (including big banks), big banks borrow from other big banks. The LIBOR is the average interest rate at which this interbank borrowing takes place.

The upshot of all this is that, when times are good and investors are very confident in the private banking system, then banks will consider loaning to other banks to be as safe a bet as loaning to the federal government--and so the interest rates will be about the same for lending to each, and the difference between the rates (the TED spread) will be small. However, if there is little confidence that banks can repay their loans, then no one will want to risk lending them money unless they get a juicy interest rate in return (e.g., I'm not gonna take the risk of lending First Shitty Bank International a billion dollars unless there's a significant upside in it for me--like, say, that First Shitty will borrow from me at high interest rate). And so the average rate at which banks lend to each other--the LIBOR--will be higher.

To put it all together: if there's high confidence that private banks can repay their loans, then these banks can demand interest rates as low as what the government demands. However, when confidence in the banks' ability to repay is at an ebb, borrowing banks cannot command a good interest rate from lending banks, and so the average interest rate of interbank loans (LIBOR) rises. Moreover, since investors are flocking to the federal government (since it's too risky to lend to private banks), the interest rate of T-bills goes down. The rising LIBOR and falling T-bill rate means a higher TED spread.

The TED spread, then, reflects the amount of credit that is available: a high TED spread means there is not that much credit around (i.e., not much money available that can be borrowed), and a low TED spread means that credit is plentiful (i.e., it is easy to get an affordable loan).

The big danger is that credit will "freeze up"--become unavailable--and that all of the parts of the economy that rely on there being credit--people being able to buy houses and cars, businesses being able to stock inventory and keep operations going during a revenue slump, financial institutions being able to pay investors who unexpectedly want their money back--will simply stop. And this will cause a negative feedback loop of investors pulling their money out of the system (i.e., liquidating their assets--i.e., selling their assets--i.e., turning their assets into cash), leading to a flooding of the market with assets, which will cause the value of the assets to plummet (too much supply, not enough demand), which will cause the financial institutions--whose net worth is tied up in the assets--to have even more losses, which will make confidence in these institutions' ability to repay their loans sink even lower, which will make interest rates even higher (and thus, credit even scarcer), and so on, until we wake up and Depression II is upon us, and a huge chunk of the economy has gone out of business, and unemployment is at 25%.

Phew! So, I'm not sure if all that is correct. It is my best understanding of the whole situation, and I am, I hasten to remind you, a layperson when it comes to this stuff. But I think the basics are there, and in any case, I recommend keeping a tab on Paul Krugman's blog tomorrow, as he will no doubt have some kind of analysis of that all-important TED spread figure.

Oh, and by the way: here is what the TED spread actually looks like. We're already way up in the 3% "credit hell" zone--let's see what tomorrow brings.

Basic fairness

I usually admire George Will for being a good and intellectually honest writer, but I think he really misses the main liberal concern over McCain's noninterventionist approach to the credit and housing crisis. Says Will approvingly:

[McCain] says "it is not the duty of government to bail out and reward those who act irresponsibly, whether they are big banks or small borrowers." For now, he is with Senate Republicans in opposing the Democrats' proposal to empower judges to rewrite the terms of some mortgages, an idea that strikes at the sanctity of contracts and hence at the ethic of promise-keeping that is fundamental to social life.

He goes on to criticize liberals as typically anti-market:

With the command-and-control propensity of contemporary liberalism, Clinton predictably advocates a policy that has a record, running from Roman times to the present, that is unblemished by success. It is the policy of price controls: Her proposed five-year freeze on interest rates would be a control on the price of money.

And concludes with a standard conservatives-are-all-about-
individual-responsibility-and-ipso-facto-the-free-market comment:

Obama says that McCain's (again, relatively) noninterventionist response to credit difficulties proves that he favors a "you're on your own" society. McCain, a center-right candidate seeking to lead a center-right country, should embrace Obama's accusation as an accolade, saying:

"This is the crux of the difference between the two parties -- belief in the competence, responsibility and accountability of individuals. When Obama characterizes my position as 'little more than watching this crisis happen,' he again has part of a point. The housing market must find its bottom, and no good can come from delaying the day that it does."

For all this talk of personal responsibility and the sanctity of the free market, it is amazing to me that Will doesn't so much as mention the 400-pound gorilla in the room: the Fed's multi-billion dollar bailout of Bear Stearns. There is widespread agreement--from economists of both liberal and conservative stripe--that it was right for the government to bail out Bear Stearns, because it and other firms in similar liquidity trouble are "too big to fail". That is to say, if Bear Stearns and other Wall Street financial institutions were allowed to sleep in the disheveled beds that they've made for themselves, the ramifications would be so extreme as to usher in a second Great Depression--causing a chain reaction of firm failures and a credit drought that would cause the economy to grind to a halt and implode (metaphors mixed: 4!). Since that would be a horrible disaster for everybody, it is widely agreed that, though doing so constitutes a "moral hazard"--i.e., would be rewarding bad behavior in the market--it is nevertheless necessary for the good of all to bail out these huge firms.

The liberal--or not even really liberal, just the common-sense question is: how can you justify bailing out the financial institutions while at the same time leaving individual homeowners to fend for themselves? It seems to me that basic fairness dictates that what is good for the goose is good for the gander: if you're going to bail out some players, you have to bail out all the players, irregardless of the accidental fact that some are "too big to fail" and others aren't. Sure, this consitutes a "moral hazard"--but isn't it true that your market morality has already been heavily compromised by the Bear Stearns bailout in the first place?

To George Will's credit, it appears as though, if it were up to him, there wouldn't have been bailouts for anyone, Bear Stearns included. At least, that's what I glean from this comment from his appearance on This Week with George Stephenopoulos:

The Republicans have now put themselves in a bind because people now say look if you have Wall Street socialism, whereby you save Bear Sterns, or at least save JP Morgan to buy Bear Sterns, and you are thereby socializing the losses and keeping the profits private, why not help everybody. Soon we’ll hear from everyone in the country who has a student loan. This is,it’s a burden, help me.

Setting aside the empirical question as to whether or not this course of action would have caused Depression II--a result that I think we can all agree is a lot worse than violating "the sanctity of contracts" and, by way of slippery slope, inviting the collectivist ire of indebted grad students--I think Will is guilty of the same sort of ideology-induced fallacy that affects liberals who want troops out of Iraq just because they never should have been there in the first place. In both cases, the question is of the form: Given that x has already occurred, what should we do about y? You can't just give an ideologically-pure, pat answer that condemns both x and y. The answer needs to acknowledge that the fact that x has already happened complicates things, and that, pragmatically, this affects our decision about y. For the liberal on the Iraq issue, that means acknowledging the possibility that leaving Iraq could be way worse than staying; and for Will on the housing crisis issue, it means acknowledging that there is at least a problem of perceived unfairness with regards to bailing out Wall Street while ignoring Main Street.

Uh-oh

In an effort to keep financial firm Bear Stearns from going bankrupt, it was agreed that JP Morgan would buy it out (at a bargain price of $2/share) and that the Federal Reserve would help JP Morgan guarantee Bear's financial obligations.

The hope is that bailing out Bear Stearns will buoy investor confidence enough to prevent the US financial industry from sliding into complete ruin. I suppose this is an effective strategy: if you're an investor, what could give you more confidence in an institution than backing from the guys who print the money?

But it's kind of disconcerting. As this WaPo op-ed points out, there is "abundant evidence from the currency and gold markets that the world has just about all the dollar bills it cares to hold". This suggests that maybe the Federal Reserve's trick of pulling new US dollars out of its hat every time a teetering financial giant needs righting might not be viable if things continue to worsen. And this very fact, of course, will cause things to continue to worsen.

So it looks bad. Though overall prices held steady last month, inflation is up for the year. Stocks are tumbling. Gold is soaring. And Intrade.com has 70% odds that we're heading into a recession this year.

:(