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When the first details of the government's proposed mega-bailout for Wall Street firms started leaking to the public late last week, the stock market rallied. Investors started thinking twice today, however. Let's take a closer look at the costs and consequences of the proposals that will likely be rammed down our throats.
Frankly, this bailout is simply yet another bad idea in a very long and costly string of bad ideas that have basically destroyed the very financial system its proponents claim they're trying to save. With a price tag currently estimated somewhere between $700 billion and $1 trillion, if not more, the direct costs of this monstrosity are far too large to be swept under the rug. In addition to the up-front charges, though, the long-run effects will likely be far worse.
Let's grant for a moment the very generous assumption that this bailout will succeed where all prior ones have failed. The first thing you'll probably notice is a higher property tax bill as a result. The unspoken benefit of the housing price correction has been the revaluation of houses to more affordable levels -- and their tax assessment levels, too. If the bailout reinflates the bubble, up go property taxes, too.
As if that weren't bad enough, the ultimate price tag must be paid somewhere. While Uncle Sam is looking to borrow the cash, the debt service won't come free. Either it'll have to be paid back some day, or the interest will need to be paid in perpetuity. At current long-term Treasury bond rates, the interest alone works out to somewhere between $30.6 billion and $43.7 billion per year.
Additionally, by printing a whole mess of borrowed money to pay for this monstrosity, the Fed will begin circulating a very large chunk of change. As that cash and credit finds its way into the economy, it'll start chasing the limited goods and services that are available. Too much money chasing too few goods is the classic definition of inflation, and with several hundred billion of new dollars floating around, it'll be guaranteed to rear its ugly head.
Even the mere rumor of the bailout was enough to send gold and oil soaring, and the dollar plunging -- classic signs of projected inflation. Within the past decade or so, too much cash chasing too few products has helped the Internet stock bubble, the housing bubble, and the commodities bubble form in the first place. Add an extra few hundred billion to the excess cash floating around, and the next inflationary bubble will be quite disastrous, indeed.
More and bigger risks later
Perhaps the most pernicious part of this bailout, however, is the way it punishes the innocent to reward the guilty for taking on excess risks they couldn't handle. The moral hazard involved is outrageous. Successful financial institutions like Wells Fargo (NYSE: WFC ) and US Bancorp (NYSE: USB ) , which didn't make all those bad loans, should've been able to start cleaning up by now. Instead, their reward for following prudent financial practices is to see new life breathed into their competition by governmental mandate.
On the flip side, failures like Washington Mutual (NYSE: WM ) now get what may amount to a "get out of bankruptcy free" card. As the credit-and-housing bubble formed, Washington Mutual and its excessive risks outperformed the more conservatively managed Wells Fargo in the 2001-2005 housing cycle.
If Washington Mutual gets to survive by forcing Feds to buy its bad debt as part of the bailout package, the message comes through loud and clear: "You'd better risk everything in running your business. Your shareholders will get the rewards, and the government will take on the risks." Essentially, every bank will be encouraged by direct government subsidy to act as irresponsibly as Freddie Mac and Fannie Mae.
Can you invest through this mess?
Unfortunately, Congress appears to be hell-bent on passing something resembling this horrendous bailout plan to show how they're "doing something" in this critical election year. If the legislative train wreck can't be prevented, the least you can do is make sure your portfolio is prepared for the chaos that will ensue.
Companies like Wal-Mart (NYSE: WMT ) and CVS Caremark (NYSE: CVS ) that specialize in providing value-priced critical necessities will likely be able to weather the inflationary storm. Likewise, global titans like Coca-Cola (NYSE: KO ) and General Electric (NYSE: GE ) may be reasonable choices. Their strong international presence can buffer them from the plummeting dollar and worsening financial conditions in the US.
No matter how you try to invest, though, be forewarned. If this nightmare bailout passes, things will certainly still get far worse before they get better.
For an alternative Foolish take on the bailout situation, see Morgan Housel's story "Can We Afford All of These Bailouts?"