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The Federal Government In The Tranches: A Bailout?

The idea that the government should bail out Wall Street [1] has got a lot of pundits and market experts to come out of the woodwork.

Jim Cramer of Mad Money [2]
Bill Gross of PIMCO [3]
Paul Krugman, NYT Columnist [4]

In reality…

A government bailout does not equal a cut in the federal funds rates…it is something more far reaching.

The US housing market shows more weakness than strength around the country. Parts of the economy are not doing so badly. In fact some are doing quite nicely, thank you. The inflation scare seems to have melted away [5] with the summer heat (and the tightening of credit).

Yet there has been a growing call for the government to save Wall Street. Chuck Schumer, Senator from New York [6], has already made this plea for a while now.

Hedge funds and investment banks sliced up risk into tranches to the point where high risk subprime paper ended up wrapped within AAA paper without anyone really realizing it. Understanding the collateral behind the paper is a mystery. And credit won’t likely loosen until there is a better handle on what actual risk is in those portfolios. That may take a while.

The New Yorker’s James Surowiecki article Beware Bailouts [7] has a good article on this. It was also refreshing to come across this post on Naked Capitalism [8], which articulates the bailout point better than I can.

My initial thought is that a bailout reflects the lack of understanding of risk by Wall Street, which was the problem to begin with. Doesn’t a bailout make risk a one way street? Won’t this incentivize the financial markets to take even greater risks next time there is a market boom of some type?

Its got a lot of people worked up [9].