The Worst System Of All - Privatized Gains, Socialized Losses

Recently Noah Chomsky made the point, as have many other commentators, that the financial meltdown illustrates the failure of the market. As he points externalities or side effects, such as pollution or changes to systemic risk due to the private transaction, are a key issue. However, after describing the failure of capitalism and the merits of government intervention he then goes on to point out that the US actually is not an example of a free market system at all but is in fact a system with strong government intervention. He dubs this system 'State Capitalism' and correctly reminds us that the presumed high priest of the markets, Reagan, was actually the "most protectionist president in postwar American history". So what is interesting is that Chomsky who calls for government to be the solution to the ills of the world has actually identified government intervention as the cause.

Despite his double think Chomsky eloquently leads us to the culprit in the current financial crisis; namely the forces of government interfering in the market place for the benefit of its lobbyist paymasters. The market system is where the gains are privatised and the losses are privatised. In other words, if you err in your investment judgement then you should lose. What we have, as has been clearly pointed out in most national papers of the world, is a situation where the gains are privatised and the losses are socialised. Regardless of whatever name we give to this system it is a formula for disaster as it clearly encourages everything from imprudent investment of scare capital to fraud.

The US state capitalist institutions, the Federal reserve and the Treasury, have been constantly bailing out the failed ventures of their anointed ones. The most egregious bailout, because of its size and timing, was the 1998 bail out of the highly leveraged hedge fund Long-Term Capital Management (LTCM) as it created huge moral hazard and set the stage for the impending disaster to come a decade later. LTCM had all the properties of the new world of finance which created the belief that certainty had now been brought to the world of investment. Genii at the helm (the best of all with two Nobel prize winners in economics) using cutting edge computer based mathematical models for valuation and speed of light trading, taking advantage of the latest financial technology, such as derivatives, in the no restrictions hedge fund environment. Despite some initial success LTCM lost $4.6 billion at almost the speed of light. If this hedge fund had been allowed to fail belief in this type of trading which has caused the current global crisis would have been checked and the moral hazard from being too big to fail removed. What is strange now is Alan Greenspan believes that the market failed a recent Congressional hearing saying "Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief" when in fact by bailing large failures out he actually removed the incentive of lending institutions to protect shareholders. If there's no safety net you make damn sure you do not take any risks.

Time to Test the Theories

The Great Depression may have destroyed economic wealth but it generated much wealth and doctoral titles for generations of economists as they battled each other for the true causes and remedies for the Everest of economics. For simplicity, this battleground could be divided into two main areas of debate and study:

a) What were the precursor conditions to the Great Depression and once identified what steps could have been taken to prevent it from happening
b) Once started how it could have been escaped from

Unfortunately theories on the prevention of the Great Depression have been completely theoretical, perhaps until now, but the work of Milton Friedman has been accepted as the winner in this class. With respect to escaping from the downturn, we know plenty of things which did not work and may actually have made it worse, like the Smoot Hawley Tariff, and what policies, Keynesian deficit spending, that are supposed to have led to end of the it. However, as Keynes's General Theory of employment Interest and Money was not published until 1936 it is not possible to say for certain that government stimulation of aggregate demand did lead to the end of the Depression. Seven years of asset bubble deflation had already occurred so it is entirely possible that the stage had been already reached in the business cycle where pricing power had returned.

The conclusions of a 2002 study by the Federal Reserve on Japan's deflationary experience of the 1990s, that policymakers should become more aggressive in reducing the target rate as it approaches zero, highlighted Milton Friedman's influence. Alan Greenspan's post tech bubble slashing of the interest rates, and Bernanke's 2002 apology to Friedman for the Fed's inaction (ie not undertaking massive monetary pumping), which Friedman's "natural experiments" had shown caused the Great Depression, illustrates that the toolkit the Fed would use to combat Depression/Deflation threats. As Bernanke said in 2002 while to thanking Friedman and Anna J. Schwartz for showing them the light:

"What I take from their work is the idea that monetary forces, particularly if unleashed in a destabilizing direction, can be extremely powerful."

As the sub prime fall out shows the monetary forces were indeed very powerful with loose money creating a housing boom and ultimately bad debts which has led to the virtual collapse of the banking system. So now we know unfortunately that Milton Friedman was dead wrong. All the same Bernanke and the Central Bankers around the world are not ones to be easily discouraged and are continuing with even more monetary pumping. Further, now that it is being noticed that this method is proving ineffectual, governments are resurrecting Keynes with massive government spending to ward off recession. Competition among governments has broken out for which can come up with the best bailout and stimulus package. At least at the end of all of this we shall know if the theories were right but at the moment it is looking like it could be a very costly experiment. The get out clause then for Bernanke and the rest of them will be that it would have been even worse if they hadn't acted but as Greenspan is finding out now if things get really bad then nobody will believe your protestations any longer.

The Future Has Arrived

All people have a list of goods and services they need and would like and they rate them in order of necessity according to affordability. Goods rated most highly are consumed now and ones desired saved for to be purchased hopefully at some point in the future. There is a gap where there is a good or service rated highly for consumption now but the money to purchase it is not available. Consumption that should really take place in the future, after much savings, is preferred to take place in the present. As human existence is finite the value of a good and service changes at which point it is consumed. A person may not be able save enough to pay for a college education until they are 65 years old but at that point its value to the person is far less. This is where the capitalist system comes in to play and someone with capital can lend the money to allow the consumption take place. A price is charged for this service which is usually the interest rate in addition to the capital which must be returned at some agreed point in the future.

There are some things of note with this. Firstly all that is of interest to the supplier of the capital is the return with investment. So what the borrower uses the capital for is an important consideration. If they want the money to travel around the world on a very expensive cruise, i.e. current consumption, as opposed to funding something like the bar exams, an investment, there is a higher risk that the capital will not be returned. So usually the activity of the borrower was considered by the lender and refused if thought that the chance of repayment low. However, the drawback with this approach is that there is a loss in the present time for people selling goods and services (the cruise lines). They now have to wait for that market and income stream in the future. In recent times the financial system decided to address this market failure and provide money so that all desired future consumption, luxury cars, second homes, designer watches etc could become present consumption. Competitive pressures of the boom years and availability of capital ensured high prices for the future consumption made current and highly indebted consumers. The problem of risk to capital remained but complex financial products were created and valued by complex financial models to remove much of this risk. Unfortunately this risk can never be removed only transferred which is becoming apparent more and more each day.

All of this leads of course to high levels of debt which may or may not be paid back and if it is not paid back capital is destroyed. With respect to current purchasing, highly indebted consumers have less disposable income to buy products leading to a slow down in sales and economic activity. An additional problem not currently spoken about is that eventually the future, where this consumption should have taken place under the old savings approach, arrives and the demand is gone. People already have the car and watch they would have bought so demand falls even further with further employment and income affects for the economy. These multiple effects on income make the high debt levels even more unsustainable and in the face of deflating prices the incentive to walk away from debt becomes higher. This leads to the final whammy for the economy for in a deflation spiral it make economic sense to delay consumption where possible. Is it rational to pay x amount for a house now when in twelve months, factoring in non purchasing costs such as renting, it will be y% cheaper? In cases such as this the consumer is very rational.

Short Sighted Cheering

During the current credit crisis the initial reaction of any large scale coordinated government action on the stock markets around the world is instantly positive. When the Central Banks around the world recently announced a synchronised decrease in interest rates to fix the credit crisis, despite the illogicality of using lower interest rates to fix a problem caused by lower interest rates, the markets instantly rose. When the government coordinated again to inject hundreds of billions into the ailing financial sector the markets again rose instantly amid the cheers of harried traders. Presumably numerous traders make a nice risk less return off this guaranteed bounce effect and their actions, ipso facto, make the bounce happen.

If only everything positive in life was so certain and if only the short run could be turned at will into the long run. After this initial upward movement caused by the guaranteed activities of traders then the fundamental reason for the intervention comes back into play and also what is the longer run effect of this government intervention itself. The financial system is in crisis due to massive over leverage from lending out as much money as it possibly could to anyone who would take it in a low interest (low price of risk) environment leading to poor investment decisions and consequently the return to capital went missing along with the capital itself. As mentioned above lowering interest rates can hardly turn the clock back on this wealth destruction so when this was realised stock prices fell again with banks in danger of collapse. The problem of bank solvency still remains so a new solution is sought.

The new step of capital injections and nationalisation of banks will remove the danger of collapse but the capital is still gone and the downturn threat is still there. So this time one fear is replaced by another. The further and equally important consideration that the stock market realises, after the initial bounce is gone, is that this government money comes from taxpayers who are also consumers. With less money available for consumers to spend in the wider economy, leading to contraction in private business and layoffs, the threat of recession become even higher. There is also the loss stemming from those tax dollars which are used to bail out reckless lenders as opposed to funding capital investments such as infrastructure, education etc which would contribute to economic growth in the future. The cheering of traders is rather short sighted.

The Krugman Hemline

Geeks with formulas creating digital value, outrageous monetary pumping by an egomaniac central banker claiming a new paradigm, psychotic type A financiers stoking the frenzy of prices increases, and now competition between governments for the best Keynesian bailout to keep stock prices up at stratospheric levels the market has been trying to correct. The Nobel prize in Economics is become more like watching the fashion pages recently as it rewards disciples of very different and sometimes mutually exclusive schools depending on the economic season. It's an interesting coincidence that as policy makers turn to Keynesian government spending policies to prevent the recession Paul Krugman should be granted the Nobel prize in Economics. Krugman, a noted Keynesian, is major proponent of preventing downturns with government intervention and cannot seem to understand why bad investments should move into the wider economy:

"nobody has managed to explain why bad investments in the past require the unemployment of good workers in the present."

For a Keynesian economist who believes in the multiplier effect for getting economies on the move again it is odd that he doesn't see it working in the other direction. The bad, as Krugman would call them, workers directly related to the over investment (in the current downturn examples would be bankers, builders, property lawyers, real estate agents) are the ones making up the rise in unemployment. Their large disposable income emanating from the boom times will surely not be available in the same quantities to purchase the services of other workers who are not directly related to the bad investments. 'Good productive capacity' cannot be used in an absolute sense with relation to workers and capital, excluding workers/capital providing necessities such as undertakers/funeral homes and doctors/hospitals. A worker is neither good or bad but is in demand or not in demand.

But in Krugman's world things are very simple:

"Here's the problem: As a matter of simple arithmetic, total spending in the economy is necessarily equal to total income (every sale is also a purchase, and vice versa). So if people decide to spend less on investment goods, doesn't that mean that they must be deciding to spend more on consumption goods—implying that an investment slump should always be accompanied by a corresponding consumption boom? And if so why should there be a rise in unemployment? "

So when investment collapses there should be no problem as the slack will be replace by people going off on a consumption boom. The fact that people are poorer due to the collapse in prices at the margin from the slump doesn't seem to matter. Further, philosophically difficult mental constructs about how the poor information signals on account of the malinvestment during the boom period might have caused opportunity costs and destroyed wealth (for example a gifted teacher thinking they'd never be able to afford a house becoming a lawyer or an economist instead) leading to lower real wealth and income prospects for the economy as a whole are far beyond his simple way of looking at things. Keep it simple stupid especially if it brings you the Nobel prize.

Worrying Asian Prospects

In addition to the malignant outcomes such as corruption, inefficiency, misallocation of capital, large scale government intervention can lead to even greater financial disaster if it is based on just plain wrong philosophical tenets. The governments of Asian countries like China and Japan have been pursuing mercantilistic economic policies to create the environment where domestic production is directed toward export production at the expense of other economic activity. To prevent their own currencies appreciating as a result of selling large quantities of exports these governments have been buying US dollar investments and effectively lending the US consumer the money to buy their products. Like some perverse boomerang theory no matter how much American consumers tried to spend their money it kept coming back and as a second engine to credit expansion along side the Fed's profligacy with the money supply they have inputted into their own problems. With easy money in the US economy reckless investment decisions were carried out greatly increasing underlying risk and the potential for a negative return somewhere along the line. As is illustrated by China's case where it is estimated to hold a fifth of its currency reserves -- as much as $400 billion -- in Fannie Mae and Freddie Mac debt. It is hard to feel sympathy for the Asian government (though you would for their people) in this precarious position of holding bad dollar debt which if they try and diversify out of will further reduce their investments as they believed this activity would actually increase their own wealth (it is unlikely such activities were undertaken out of a charitable bent toward the American consumer).

That they allowed it to go on for so long is indicative of how much belief the Asians have in the US as the economic producer and protector of wealth. The most serious outcome of the implosion of the US financial system is in Asian terms the Americans have lost face and the funding of America to the degree that kept the country afloat for the last decade will decrease greatly. The cost to Asians is a poor return on their capital and a destruction of the market they hitched themselves to and which was driving their own economic expansion. As this external market closes much of Asia's recent capital investments will be shown to be obsolete and the cost of not following a more sustainable level of economic development will become apparent. Bad debt, misdirected investment and slowing economic activity will lead to severe challenges for Asia with massive populations and large quantities of people existing at the margin of poverty. In China's case the booming economy, though leading to an even greater income inequality, has helped contain political unrest but when things go into reverse this containment must come into doubt. The dark clouds appearing over China are ominous.

Let's hope Bernanke isn't always wrong

The current chairman of the federal reserve is the embodiment of human awe in the face of illustrious academic qualifications and technical language that can make people believe that the possessor has some secret special knowledge. As he has admitted, he learned a couple of tricks from a true master of illusion, Alan Greenspan:

"Our understanding of the best practice in monetary policy evolved during Alan Greenspan's tenure at the Fed, and it will continue to evolve in the future"

At a different time that comment would have been amusing as opposed to chilling. The evolution of his understanding of the best practice appears to be following in Greenspan's steps in what should really be described as 'worst outcome' as opposed to best practice. Bernanke spent a good deal of the early days of the sub prime crisis expounding his learned view that the problem would be self contained and was unlikely to even spread to the broader housing market.

"We believe the effect of the troubles in the subprime sector on the broader housing market will be limited and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system"

Oh to be back in those carefree days when the only worry was an effect on the broader housing market. As a member of the Federal Reserve team that watched the housing sector, due to its slashing of interest rates to just above zero, prevent a downturn after the popping of the technology bubble this would seem an oversight. What is astonishing is that he as Fed chairman had not access to some information that would have enlightened him about the relationship between the booming housing sector and the booming financial sector. Outside of a pure multiplier effect there was clearly a direct threat to the financial industry from its massive exposure to leveraged sub prime assets.

Across the globe politicians who have openly admitted to a problem they don't really understand, presumably unconcerned by the fact (or unaware of it) that he has been continually wrong throughout his time at the Fed, are still relying on Bernanke for guidance. He, along with former Wall St banker Hank Paulson, finally after a few wasteful efforts came up with the large scale bailout plan for the banks and the EU, not to be outdone, have followed suit. As this global response is being prepared to bail out the financial sector lets hope this time Bernanake is right and once again this costly intervention won't cause even further wealth destruction. I suppose nobody can be wrong all of the time.

The Crimes of Alan Greenspan

As the Noble economist Coase put if 'If you torture the data long enough, it will confess' and this is where the neoclassical focus on data to avoid subjective bias of the economist comes unstuck. The data going into the models of the economy and the data coming out has been continually redefined to make the model paint a pretty picture. The assumed though unseen productivity gains based on new technology needed to justify the monetary expansion were made appear using hedonic adjustments (if the computers CPU is faster then add this into the productivity figures). Definitions such as unemployment and inflation were continually revised to make the data looks good (for example rent increases as opposed to house price increases was taken in the inflation figures). Then of course variable inputs that were based on assumptions were always positive (house prices never fall). At the centre of all this the neoclassical belief in the efficient market hypothesis meant that unregulated behaviour of markets such as derivatives that used similar models for valuation was considered optimal. Whether the market prices are always correct as the efficient market hypothesis claims or not, any short run efficiency is prevented when the market is prevented from working correctly and is prevented from punishing incorrect decisions. When Greenspan intervened to bail out Long Term Capital Management when its trading model created gigantic loses it undermined one of this key efficiency assumption of the models and created new incentives for reckless behaviour and a new market in betting on such companies that would be too big to fail and would bailed out by tax payer money.

So the environment for trouble was set and in this environment the real conditions for disaster were entered into. When the picture looked good the prices went up and when the prices went up the amount of capital investment banks and funds could lend out went up. The longer the models painted a pretty picture the more outlandish the assumptions and the more capital could be leveraged. The problem is that at such high degrees of leverage only a small fall in stock prices means that the required ratios of capital to lending are no longer there. Now with the new emphasis on meeting these regulatory requirements funds all over the world are falling below these ratios and with people increasingly demanding their money from the funds wide scale liquidations are inevitable and with multiple sellers of assets the prices can only collapse. As the central banks pull the same rabbit of interest rate cuts out of the same hat and in a new regulatory falling stock price/deflationary environment the chance of its effectiveness is slim. It's simply pushing on a string.

Wall Street's Trick - Marginal Pricing

The role of the bank is to provide capital to borrowers who intend to create wealth with the loan from lenders who have surplus capital to invest. The task of the bank is to judge if the borrower will make enough wealth to repay the loan and their charges of acting as the intermediary. If the bank is successful in doing this it has acted as a catalyst in the wealth generation process but it is not the direct producer of the wealth. Unfortunately with sub prime lending the banks have failed in their role. The banks themselves exists as part of the stock market and financial industry which is a larger process of matching borrowers with lenders. In order to have users (i.e the investor/lender) of their services the financial system must promise (its sales pitch) that enough wealth will be generated via their good judgement in the direction of this capital to reward the investor - minus their charges. Dividends and stock prices are the indicators of the wealth created. Dividend payouts and more importantly stock price increases are the way the financial industry shows that its service has delivered.

Stock price increases are more important because they happen more frequently than dividend payout and cost less as they only reward the marginal sellers (i.e most people are happy with the psychic income of the price going up rather than taking it as they wait for even bigger gains). This pricing at the margin is the key marketing technique that the financial industry uses to sell its services and takes advantage of the lack of understanding of the difference between marginal and absolute prices and the financial industry advertises marginal stock prices as absolute prices. In other words, if there are 1,000,000 shares of a company and last 100 shares of a company sell for $100 then people believe that all 1,000,000 shares are worth $100. It is this misunderstanding the leads people to believe that we are now wealthier than we were before and also that the financial industry has actually creating this wealth. All the financial industry needs to do is keep driving up the marginal stock price by getting more buyers than sellers and it looks like they are generating real wealth. The problem of course is when the sellers become much greater in number than the buyers and quickly discover that there is a much lower marginal price and the repricing of all the shares makes it look like wealth has instantly evaporated. The financial mantra is not to sell and wait until the recovery as in the long run shares go up. However, the new demographics of the western world do not bode well for this as older people do not have the time wait for the recovery and being very risk adverse will remain sellers.

No Downturns Allowed

When the collapsed Berlin Wall revealed the collapsed socialist economies of eastern Europe the benefits of organising economies using the efficient resource allocation of the market was undisputed. Government attempts to organised the production of goods and services clearly removed incentives, lacked the directional information provided by the pricing mechanism and led down the road to stagnation destroying wealth and capital along the way. Now the the market was clearly seen as the best method all that governments had to do was simply control the market. This would be achieved by having people in charge of the key economic institutions who understand the market and could ensure that steps were taken to prevent downturns and recessions whenever these unwelcome characteristics of market behaviour reared their ugly heads.

Luckily developments in econometrics built on the the neoclassical assumptions such as rational expectations and the efficient market hypothesis meant that mathematical modeling could be done by gifted economists such as Alan Greenspan and his even more accomplished model building successor Ben Bernanke. They've been aided of course by the increases in computing power, which allowed them to model all the variables necessary to control something as complex as the global economy. These assumptions of rationality and efficiency allow all the model builders, as many banks and hedge funds also turned to their own neoclassical alumni, to find equilibriums, maximum points of value, minimum points of cost, true price of derivatives and whatever else they needed to find and predict. Naturally anyone who can predict the future and guide investment decisions accurately must also be paid handsomely and occupy high status positions. In ancient Rome they had to rely on augurs and the entrails of birds to predict the future but in the modern world of finance there are economists armed with computers.

The advantage of mathematical economics allied with computers is the product looks so complex and sophisticated that few people dare to question it even when it fails spectacularly badly as it has over the past number of years. Even when Alan Greenspan himself admits that the models, even with the simplifying assumptions, cannot capture the global economic reality, people are still turning to these same prophets to fix the problem they actually caused. The fact that these attempts by governments and rent seeking finance companies to control and predict the market are actually a market interference which makes the market inefficient and are causing market distortions seems to be lost amid the mathematics. Each time the market tries to correctly value the goods and services of the most recent past accurately, ie downward, government and central banks try to fight this process and with their actions guided incorrectly by more incorrect models they are preventing the market's righting mechanism. When no downward corrections are allowed by even more credit expansions to correct asset bubbles caused by earlier misguided credit expanisons by statist central banks is it fair to say the market doesn't work? The market is working but more slowly than it should be as it is struggling against the headwind of government intervention being guided by models that really should be on the scrap heap.

Nothing Saved For Far Too Long

In 1999 as the DJIA was around 11000 James Glassman and Kevin Hassett published Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market. They timed the publication perfectly with the peak of the technology bubble where financial assets were clearly out of line with real assets and within a few months the stock market began to move in the opposite direction to 36000. It illustrates once again how financial commentators and economists (Kevin Hassett has a PHD in economics from the University of Pennsylvania) are little more than confidence tricksters who extract large income from in the main being completely wrong about what they are predicting. Granted they use the elaborate props for their deception, taught to them in the neoclassical economics departments of the world, such as complex evaluation techniques based on the efficient market hypothesis wrapped up in fancy computer modelling clothing, to carry out this charade but as they continually get it wrong it is astonishing they can still command the attention and remuneration they do. Even now six years later as the Dow is actually below 11000 Kevin Hassett is still being listened to as a commentator on Bloomberg and a senior economic adviser to John McCain which doesn't bode well for the future of the US economy post November if John McCain gets into office.

What is serious outcome of the world being misguided by the deeply flawed neoclassical school of economics is the fact that the DJIA is actually below where it was at its peak in 1999 a full nine years ago. The baby boomers are nine years closer to retirement and in reality they have saved very little. In fact adjusted for inflation their savings have actually been negative and if you throw in the recent decrease in house prices, the only recent asset appreciation that was looking good for them, the savings required for the retirement years just aren't there. Sure retirement can be put off for another few years should the employment situation not become too dire but eventually they will need to start drawing down on whatever investments they have left and that can only be another headwind to the DJIA as equities are cashed in to fund retirement. It is hard to know where to start with the problems for the US economy at the moment but this has to be one of the main contenters.

Revaluation Not Market Breakdown

In the world that the everyone is currently trying to save with bail outs and cash injections a person who worked hard to qualify in a career that produced a real product (in this case the word 'real' means its demand is not related solely to the financial return it provides) or provided a real service was a poor person. Sure you might be a dentist or a teacher but your value to society, as determined by your purchasing power, was deemed to be far below someone who used a vast array of marketing techniques to extract the maximum price for whatever was being sold no matter what its value could possibly be in relation to what is actually earned on the average.
Alan Greenspan's misunderstanding of the role of money and his hunch that technology and globalisation had led to a new productivity that had overcome inflation meant that there was for far to long a new bundle of printed paper to make the sums add up and keep the game rolling on. What the market does eventually, no matter what interferences are undertaken to distort and slow down this operation, is reward action at the margin based on its product of demanded goods and services. For the duration of Greenspan's Ponzi scheme where the seemingly risk less return became the product the purveyors of such a service rewarded themselves handsomely for their actions. Now that the service these people provide is actually providing a negative return they will find themselves revalued by the market and the people who provide services that are still in demand in this new environoment will be revalued in real terms. The hedge fund executives will be revalued out of the houses and apartments they occupy into the appropriate parts of town. Relative prices might be changing quickly at the moment and in a downward direction but the end result will be an environment where the providers of services that are still demanded will be able to purchase goods and services they require. A teacher will suddenly be able to buy a house again close to the part of town the school is in which is hardly a world to be feared.

What Really Matters - Employment

The financial crisis is grabbing the headlines and the conventional wisdom is that the government bailout of the reckless trading and chicanery of the financial sector will prop up asset prices and save the world from ending up in a very nasty place. With all this emphasis on the bail out and how it will make things better the fallout in the real economy where the really bad things are happening is being overlooked. In the space of a few hours someone can lose 30% of their portfolio but considering how they hadn't done much with those paper numbers for years, except logging in to look at the paper gains and revel in their increasing wealth, its immediate impact is one of unhappiness and wishing they'd sold at the peak. If the government bailout or even talk of it brings the numbers back up 20% the following day then things are not so bad after all and all they have to do is wait until everything really comes back up and this time to promise to sell and bank the profit.
However, what the government bailout may slow but won't reverse is the job losses due to the slow down in economic and bubble activity. For non retirees if your portfolio falls but you still have a job things aren't so bad really especially if prices are falling for what you consume. Houses are even affordable now when during the boom when we were all suppose to be better off they weren't. All this relative mental balancing is irrelevant though when unemployment strikes and the real lasting image of misery of the great depression was the unemployment that blighted the economy. The employment timeline for the USA during the depressions highlights this all too well:

1930 The unemployment rate climbs from 3.2 to 8.7 percent
1931 unemployment rises to 15.9 percent
1932 unemployment rises to 23.6 percent
1933 unemployment rises slightly, to 24.9 percent

When employment becomes the problem it will finally become clear why what happened in the 1930s was called the great depression and that a lot more is involved than bailing out banks who never should have been bailed out in the first place.

Taking candy from a baby

There is a saying in poker that if you don't know who the sucker is at table then it's you and nothing applies so well to the US government (with other governments like Ireland joining the sucker division) in this case. Taking advantage of this sucker of course is Wall St behaving like a child turned down in the toy store after seeing the denied money going back into the parents purse. It dived 1.2 trillion dollars on Monday to show the government what will happen if the free bag of money already priced into the system does not materialise. Then the following day, like a child trying the softly, softly approach it shows what gains will be possible if the bill is passed. The new magic trick is to buy something that is low due to its high risk and then use the tax payer to remove the risk and hence increase the price.What's more important to point out is not that the banks and worthless toxic assets are being nationalised but that the government is being 'marketised'. In other words the actions of the government are becoming more and more part of the market and the market intentions are determining government action. As the government is sucked into this game there is an ever increasing by-product of moral hazard leading to even more wealth destruction via the inefficient allocation of scare resources. If you spare the rod you spoil the child and when the child starts to run your life, as every parent will tell you, it's a bad road to be on. In the marketplace, where the government and Wall St meet, the end of that road is where there is no surplus money left for Wall St to extract to bail out high risk investments that went wrong or the government simply refuses to play the game. In light of the lobbying and vested interests of Wall St in Washington the former is more likely. Market efficiency will return when the government is bankrupt and government action is completely ineffective on investment decisions. Then the only way left to investors to make a return on capital will be to make prudent investment decisions through the provision of capital to companies that are producing desired goods and services. Spoiling the child just makes growing up to maturity a longer and more difficult process - assuming the child hasn't been completely ruined in the first place and its not impossible that Greenspan, Bernanke and now Paulson have given in to the tantrums just too many times.