Fool Blog: The Madmen in Authority Have Spoken

So this is what a financial catastrophe feels like. Yesterday, the House of Representatives rejected the government-sponsored bailout bill, and the Dow Jones industrial average experienced its biggest point drop ever. Every single stock in the index declined, and some stocks, including GM (NYSE: GM  ) , Intel (NYSE: INTC  ) , and Bank of America (NYSE: BAC  ) , fell by more than 10 percentage points.

Despite the warnings of seasoned investors such as Warren Buffett, Bill Gross, and John Mauldin on the need to pass this bill quickly, a majority of our representatives decided that doing nothing was preferable to the possible solution at hand.

Up to this point, the government had pursued a fairly active policy. It supported the takeover of Bear Stearns by JPMorgan Chase (NYSE: JPM  ) back in March. More recently, it took action to save Fannie Mae (NYSE: FNM  ) , Freddie Mac (NYSE: FRE  ) , and AIG (NYSE: AIG  ) .

One of the only times the government chose to look the other way -- when it allowed Lehman Brothers to implode -- may well have been what led to the current meltdown, according to The Wall Street Journal.

Financial Mellon-cholia
Regardless, yesterday's "nay" vote signals that the "do nothing" policy (or, perhaps, the "not do this" policy) is in the ascendant. And as a result, the prognosis for our economy is not good. In fact, it's really, really dire.

History provides us with an example of when the "do nothing" approach was applied to a financial catastrophe. The economist J. Bradford DeLong points out that the American government did little to prevent the onset of the Great Depression during the period from 1929 to 1933. He quotes President Herbert Hoover on those individuals who counseled inaction:

The "leave-it-alone liquidationists" headed by Secretary of the Treasury Mellon … felt that government must keep its hands off and let the slump liquidate itself. Mr. Mellon had only one formula: "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate." … He held that even panic was not altogether a bad thing. He said: "It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life.

According to DeLong, "liquidationism" was a very powerful current of thought arguing against any government action to alleviate the Great Depression in the early 1930s.

The great economist John Maynard Keynes viewed the disease and remedy very differently. He famously wrote:

I find the explanation of the current business losses, of the reduction in output, and of the unemployment which necessarily ensues on this not in the high level of investment which was proceeding up to the spring of 1929, but in the subsequent cessation of this investment. I see no hope of a recovery except in a revival of the high level of investment. And I do not understand how universal bankruptcy can do any good or bring us nearer to prosperity.

What would Keynes think?
Keynes, who once referred to politicians as "madmen in authority," would likely be pessimistic about the chances that Congress will figure out something in time to unfreeze our credit markets. In my opinion, we need to pass this bill now to stabilize our markets, and buy time to come up with more creative solutions. With greater stability, we might be able to pursue improved regulatory policies and new measures to limit the harmful effects of foreclosures.

Doing nothing, however, is not an option worth pursuing at this critical time. Ironically, Hoover realized that himself when writing his memoirs in the 1950s.

For more discussion on this topic, head to our message board.

John Reeves does not own shares in any of the companies mentioned. He does confess that Keynes is an intellectual hero of his. JPMorgan Chase and Bank of America are Motley Fool Income Investor picks. Intel is a Motley Fool Inside Value recommendation. The Fool has a disclosure policy.  


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 30, 2008, at 2:39 PM, irvhomer wrote:

    Enough is enough!

    Why am I paying the Fool to send me emails encouraging me to support the further socialization of our country/economy?

    Please focus on providing your customers with advice on investments instead of trying to scare us into supporting government intervention… and don’t tell me they’re one in the same as I don’t buy it.

    Why not provide a balanced view of economic policy? You site J. Bradford DeLong and John Maynard Keynes, but you don’t mention anything about Friedrich Hayek (Nobel Laureate) and American economist Murray Rothbard?

    I believe the Great Depression was made worse by government intervention, and I’m not alone in my belief.

    This problem was caused be the government tinkering with the market… why would more of the same make things any better? Even if it was the right thing to do, I certainly don’t trust our current congress or Fed with this responsibility. We’re better off letting the market work it out.

    Instead of vague statements on how bad it will be if a bailout plan isn’t approved, can anyone site specific data that will show what happens if the bailout is, or is not, approved. Why $700, billion, what’s the math behind that magic number? Will it really prevent the eventual correction this market so desperately needs? I doubt it, I suspect just like the initial attempts to contain the S&L crisis it will just delay and compound the problem. I believe there are people in positions of power/influence that have a lot to gain by the bailout, at the expense of inflation and/or deferred taxes on the rest of us.

    How many more articles will the Fool publish encouraging the bailout? It’s clear the majority of your customers don’t agree. Please get back to investment advice. I’m really growing tired of these articles.

  • Report this Comment On September 30, 2008, at 2:39 PM, mcdiv wrote:

    Rather than spending $700+ billion dollars trying to artificially prop up an inefficient market, why don't we just suspend the mark-to-market rule for the MBS market? If we had this stupid rule during the S&L Crisis, the system would have melted down then.

    People such as Dick Bove and William Isaac believe this would help a lot.

    What the heck happened to TMF? Most of what I read here is full of the same hysterical platitudes I read elsewhere. Has TMF lost its ability to think about alternative solutions to problems?

  • Report this Comment On September 30, 2008, at 2:49 PM, carstenjansing wrote:

    mcdiv, do you believe hiding the problem (=suspend mark-to-market accounting) will make it any better?

  • Report this Comment On September 30, 2008, at 2:52 PM, LisaPA wrote:

    Voting against a crappy bill is not the same thing as doing nothing. And the difference between "doing nothing" and "not doing this," which you dismiss in an aside, is quite large.

    In fact, I heard lawmakers yesterday say they expect to have something else (almost inevitably better) to vote on by the end of the week. You'll also notice the world didn't end yesterday and the market is already climbing again.

    Also, Lehman Brothers did not make this happen. This has been coming for years. Stop being a chicken little. It's insulting to the intelligence of your readers and I'm sick of reading this kind of tripe from people who should know better.

  • Report this Comment On September 30, 2008, at 2:53 PM, UncleSkell wrote:

    I'm not so sure. I can't put any numbers on it, so I go on general experience and gut level impressions.

    We've got near-unanimity among the elites that Something Has To Be Done. Warren Buffet, the Democrats in Congress, the President, both major candidates for President, the media, all tell us something must be done soon, or else, as Homer Simpson put it, "ACK! We're all gonna die!".

    This alone is enough to make me suspicious, but we have also the question of, If the bailout was such a bad idea, why did 140 Democrats vote for it? And if it was such a good idea, why did 90 Democrats vote against it? One reason is that the voters don't like the looks of it, and frankly, I don't either.

    Finally, experience suggests that virtually everything Congress does has the net effect of some form of "take your money and run your life", usually with disastrous consequences. (Recall that the whole Fannie Mae/Freddie Mac problem goes back to the Carter-era attempt to increase minority homeownership and end "redlining" in 1977.) So, in general, the less the government does to try and fix the problem, the happier I am with the results.

  • Report this Comment On September 30, 2008, at 2:56 PM, jdgee2 wrote:

    The people spoke, and for a short period of time, some "madmen" remembered who works for who. About time !

  • Report this Comment On September 30, 2008, at 2:58 PM, whereaminow wrote:

    I'm done with Motley Fool. What a disgrace. Here is a letter from a responsible bank. Check out John Allison, CEO of Branch Banking and Trust Co.'s letter to Congress. BB&T operates 1500 banks throughout the United States and is in completely sound footing:

    http://media.gatewaync.com/wsj/pdfs/2008/09/allison.pdf

    Please read this letter to hear the other side of the story.

    I never thought I'd say it: but this website is dead to me.

    Cheers,

    David

    www.mises.org

  • Report this Comment On September 30, 2008, at 3:01 PM, KarolKarol wrote:

    I disagree that the 'do-nothing' attitude was ascendant following the stock market crash of 1929 and don't believe it applies to the present situation. Following the crash in 1929 the Hoover administration raised taxes and passed the Smoot-Hawley Tarrif which inadvertantly ruined the market for US exports and contributed to the severity of the Great Depression. In the current situation I think something will be done but we have to be certain it is the right thing or risk long term damage to the economy. In case you didn't notice, the world did not end when they failed to pass the "bailout" bill.

  • Report this Comment On September 30, 2008, at 3:02 PM, Flashman007 wrote:

    I second irvhomer above. I am getting tired of the chicken little scenarios. It is not like any of this is a surprise. It has been known for quite some time that this bubble was going to burst. Let it POP. I find it odd that the govenments proposed solution here is primarily to inject more liquidity into the system so that the american consumer can go back to buying what he can't afford.

    Since when did we believe that the economy can chug along endlessly without a recession? Capitalism embodies the right to fail as well as succeed. Right about now there are a lot of people who deserve to fail. Don't save their necks on the backs of the people who lived within their means for the last 20 years.

  • Report this Comment On September 30, 2008, at 3:10 PM, fooldotcom76 wrote:

    I have LOST ALL RESPECT FOR THE FOOL.

    Now Lehman Brothers has caused this? What is wrong with the Fool?

  • Report this Comment On September 30, 2008, at 3:32 PM, stoutjw22 wrote:

    It looks like everyone making comments on these articles agrees. Maybe we should make our own investment website since The FOOL has been brainwashed by the socialists. Let capitalism rain, I am educated, hard working and conservative and I would rather see my investments tank than bailout the a--holes who caused this. We need to go through a quick depression. I will emphasis a QUICK depression. We can either have a quick depression were capitalistic ideas fix our system or an endless recession brought on by bailout after bailout after bailout.

  • Report this Comment On September 30, 2008, at 3:34 PM, TheBiggestJC wrote:

    I like something that Newt Gingrich said yesterday, something to the effect of being opposed to "capitalism on the way up and socialism on the way down."

  • Report this Comment On September 30, 2008, at 3:57 PM, acssgt316 wrote:

    Wow this article has solicited quite a strong response. I am also suspicious of this bailout plan. I dont like the idea of taxpayers being involuntarily exposed to this risk to the tune of 700 billion. The federal deficit is large enough. Also could someone explain to me why the earth will implode if we dont sign this? I know to people that are close to me who were just approved for a home loan this week. If it is open credit that will tighten, ie credit card debt, than I say good deal. I would very much like for my country to move away from the idea that neverending debt is the only way for an economy to prosper. Perhaps for the next few years Americans dont buy a new house or a new car. Will the rest of the economy really explode if this happens? For those of you who are aggravated by this article please keep in mind that Alice Lomax wrote an article against the bailout that was posted on this site. "Its the end of the world as we know it, and I feel fine."

  • Report this Comment On September 30, 2008, at 4:01 PM, acssgt316 wrote:

    My apologies, the correct name of the article is "Bailout, The sucker punch." The quote I posted above was more to do with my frame of mind. LOL Fool On!

  • Report this Comment On September 30, 2008, at 4:04 PM, ButtSauce wrote:

    You are encouraging Congress to act - super, thanks for that. I think stressing how to act is just as important. This mess does not need to be unloaded on the back of the American tax payers. Did you guys even take a look at the fine print on the failed bail out? Remember how Congress said they had solved the golden parachute problem that citizens objected to? What finally made it through was either a 20% surcharge on their salary, or a tax hike for salaries over $500,000. Oh, that's a mission accomplished, folks. Gee, I wonder where this credibility gap comes from.

    This bill was an absolute insult, and people do not like Paulsen playing chicken with Congress and the Senate. You think the tax payer won't let the ship take a couple torpedoes when you dangle a mistake of epic proportions in front of them and tell them they better like it? Outrageous. We have a feeling we're screwed anyhow, so let's take the pigs who made this mess with us. I think that distills a fair amount of the sentiment.

  • Report this Comment On September 30, 2008, at 4:10 PM, whereaminow wrote:

    Here is my new financial adviser (Peter Schiff)'s view of this mess. Unlike you jackasses at Motley Fool, he and other Austrian School economists predicted this very turn of events. So now I ask you, why the BLEEP would I listen to you over him? or Ron Paul? or The Von Mises Institute? They were right, as usual. You were wrong. So, suck it, Fool!

    September 26, 2008

    Making a Deal with the Devil

    Just yesterday, Henry Paulson’s “bailout” bill, with only a few anti-Wall Street, pro-Main Street fig leaves slapped on by Democrats, appeared ready to sail through Congress on a bi-partisan tide. But something funny happened on the way to the printing press. It appears as if some conservative House Republicans are reluctant to sell their souls and ditch any remaining pretense towards American-style capitalism.

    What’s left of the Barry Goldwater wing of the Republican Party, which maintains its natural tendency to trust the markets and not government, has dug in its heels. But, Bush, Paulson and the Democrats have argued that our problems are so dire that free enterprise principles must go out the window. The struggle is historic, but the Congressmen are fighting a losing battle. Sadly, Americans now appear willing to abandon their economic heritage at the first sting of financial pain.

    Although passage does seem inevitable, it is nevertheless the wrong thing to do. Central government planning did not work in the Soviet Union and it will not work here. Only free market forces are capable of sorting through the mess. Political meddling will make the problems worse.

    In selling the bill to Americans, many are pointing to the Resolution Trust Corporation as an example of similar intervention that worked in the past. However, there is no proof that RTC actually helped as we have no way of knowing what might have happened had the government stayed out.

    Missing in this discussion is that the Savings & Loan crisis of the 1980’s, much like the current crisis, was a byproduct of government interference in the free market. By insuring bank deposits through the FDIC, the government created a moral hazard that resulted in extreme risk taking among member banks, whose depositors sought only high yields, without any regard for the risks that the banks were incurring. Banks that refused to take big risks lost deposits to those banks that did. Absent FDIC insurance, depositors would have considered risks as well as rewards, and the S & L crisis never would have happened in the first place!

    The urgency for passing this bailout bill is based on the claim that the American economy will collapse if nothing is done. If the government were to stay out, and allow the market to function, there will certainly be a great deal of economic pain. Companies will go bankrupt, banks will fail, real estate and stock prices will keep falling, and many people will lose their jobs. However, government action will not prevent any of this. At best, it will merely delay the inevitable, but only at the cost of increasing the severity of the underlying problems, thus making their ultimate resolution that much more painful to endure.

    The bottom line is that there is no way to resolve our economic problems without a severe recession, and our politicians need to level with the public. As a nation, we gambled on the alluring riches of real estate and we lost. The price must be paid. Contrary to the Bush Administration rhetoric, the fundamentals of our economy are not sound. If they were, we would not be in this mess. Recessions are meant to restore balance, purge excess, and liquidate mal-investments. On that score we have a lot of work to do.

    We are being told that this plan will help the economy by keeping the spigots of consumer credit flowing. However, to really address the fundamental problems, those spigots must be tightened. Since we have already borrowed and spent ourselves into bankruptcy, the last thing we need is for consumers to borrow more.

    Our leaders maintain that without this bailout consumers will not be able to borrow money to buy cars. So what is wrong with that? We already have plenty of cars, and if we are broke, why do we need to buy more? Instead, we need drive our old cars longer, pay off our underwater auto loans, and produce more cars for export. It is also argued that without access to credit parents will not be able to borrow money to send their kids to school. That’s fine by me as it will force Universities to reduce tuitions to levels families can actually afford. They will either have to cut out all of that bureaucratic fat, or go out of business for lack of customers.

    In the end it is impossible for the American economy to be rebuilt on a sounder foundation of savings and production without a lot of economic pain. Government efforts to reinforce the shaky foundation of borrowing and consuming will result in the entire structure falling down around us.

    For a more in depth analysis of our financial problems and the inherent dangers they pose for the U.S. economy and U.S. dollar denominated investments, read my new book “Crash Proof: How to Profit from the Coming Economic Collapse.”

    via Euro Pacific Capital by CEO Peter Schiff

  • Report this Comment On September 30, 2008, at 4:12 PM, jfergason wrote:

    The fact that you refer to Keynes as a great economist should belie your socialist bent. There are many truly great economist like Hayek, Friedman, etc. that believe and logically argue that the Great Depression was as bad as it was precisely because of government intervention and that we are still suffering the consequences of the large government policies that FDR implemented, today!

    Any shred of respect I had for the Motley Fool is now entirely gone.

  • Report this Comment On September 30, 2008, at 4:19 PM, ferg6 wrote:

    Why is Fool urging us to follow the piper? I, too, am surprised and not pleased.

    As to the crisis - this will (is) causing a credit squeeze which will hurt lots of people and businesses. Why doesn't someone get themselves in front of a t.v. camera and explain it in less than 5 sentences and no Paulson phrases. "Our tool kit is substantial..." - what does that mean?

    Oh, that Bush would do that but he has no idea what's happening? Does he know how the credit markets operate? Does he have a credit card?

    And as to the Gardner guys? No doubt wealthy, obviously dependent on vigorous financial markets - do you guys really think we're getting good information or a good plan? Did you guys have a hint of the bad money that was chasing other bad money for years?

  • Report this Comment On September 30, 2008, at 4:49 PM, cycle924 wrote:

    I cannot support any financial assistance to the croneys who serve this insipid administration and failed financial institutions. Come what may. And my guess is, that it won't be nearly the scary disaster that they would care to have us think. We know these things: The folks that contributed to this were the same ones who "didn't (care to) see this coming"..... Had rules and parameters to abide by, but wouldn't enforce them and police the traders and perpetrators who were building up piles of cash because their lobbyists are more influential than we (the citizens of the US) are..... Aren't really experts or the ones with the answers because they kept denying to us that there was even a housing bubble to begin with....want tons of our cash in their pockets before they have to leave office....If it is something that our executive branch wants, we should be strongly against it! There is definitely more here than meets the eye, and the more we don't know the more dangerous it is to hand over any kind of "bailout" dollars for the sake of saving the economy. Our economy is in real trouble and this financial handout will not change that at all. I say let it all shake out, fire all the Republican and conservatives whose "ideals and market theories" lead us down these poisonous paths. And keep them out.

    As to the market, apparently the world will be taking a few licks but, hopefully, in the end, we can root out these groups of individuals and so-called "leaders" that use our emotions and votes to collect their cash. What we need are fair markets, not "free" markets. There really is no such thing anyway. It is people who manipulate and control this "free" market unfettered and use fear to keep it that way. Maybe with some luck and persistence, we can even get them in the prisons which should serve as their homes for the remainder of their lives.

  • Report this Comment On September 30, 2008, at 4:53 PM, carstenjansing wrote:

    about the supposed "hearing to the people" congressman did by turning the rescue bill down. They better listen to their constitution as being a "represantitive" and not an e-mail driven "do this or that"-guy

    http://www.bloomberg.com/apps/news?pid=20601087&sid=aE7q...

    If there is no rescue bill soon, the credit markets will freeze as trust evaporates more and more, and than really nothing will prevent a great depression. But that seems to be what many of the commenters here seem to wish?

  • Report this Comment On September 30, 2008, at 4:54 PM, WilyInvestor wrote:

    It's interesting to hear the shift in the Fool, or should I say fool's opinion over the past few months. At first, the mood was now now don't panic we need to look for deals. Now, we have sheer panic from the "Fool." You writers @ Fool have definitely lost your Fool privileges; you're just plain fools now :)

  • Report this Comment On September 30, 2008, at 5:16 PM, lachoyatw wrote:

    What a sad/pathetic/desperate plea for gov't intervention... This article was a total waste of time.

  • Report this Comment On September 30, 2008, at 5:34 PM, mcdiv wrote:

    carstenjansing,

    I really don't appreciate the condescending tone of your question.

    Just because you suspend mark-to-market doesn't mean firms shouldn't account for them at all. The securities could be treated as held-to-maturity securities instead of trading or available-for-sale securities. This means they would mark them down from par if they ACTUALLY DEFAULT.

    Under the current rules, they must mark them down regardless of whether or not they are actually still performing because the market for them has been gripped by fear and become inefficient. The current fear is greatly exaggerated and has driven prices ridiculously low. Mortgage default rates are around 6%. The market is pricing these securities as if default rates are 40% or higher. To write down securities on this basis is absurd.

    This is the very reason the government sees an opportunity to make money. They know these assets are worth more.

  • Report this Comment On October 01, 2008, at 6:31 AM, westwinds3 wrote:

    I am reluctant to comment, because I am (a) British, (b) a socialist, and (c) a life-long trade unionist. (I am also a trustee of a billion-dollar pension fund, and a life-long investor).

    However, I find the responses of fool members to a fairly sensible article astonishing.

    There is a real danger that continued blockage of the credit market will induce a massive recession. When that happens personal savings will be wiped out, tax revenues will plummet and social security will have to default. Do Fools want to afford to eat in their retirement?

    If done right, the 700 billion will preserve the economy, maintain tax revenues, make a profit, and still leave plenty of pain on Wall Street.

    But then my hero Keynes was a Brit

  • Report this Comment On October 01, 2008, at 10:04 AM, WCSMD wrote:

    The first comment by irvhomer at the beginning of this chain says it all. I have nothing to add except to say I agree and hope that the new bail out plan only increases taxes on individuals who support it.

  • Report this Comment On October 01, 2008, at 11:54 AM, theeconomicsguy wrote:

    I work for a large regional bank that did not get involved in the purchasing of these mortgage derivatives. As I write, we continue to lend money, and have not cut off credit. Why? Because we were responsible in our credit risk management, which should allow us to clean up now and acquire banks that chose to engage in riskier behavior for a nice discount. The bailout plan will essentially tell us we should have engaged in riskier behavior, because we could have made more money in the good times, and just passed on the risk to others once the party ends. This bailout is largely being sold by fear, since the impression is given that no lending is going on, all banks are failing, and recessions are a terrible thing of the past that must be avoided in the future. The truth of the matter is that there are still banks lending, those same banks are strong and stand to reap the rewards of their responsibility without the bailout, and recessions are a part of the business cycle. When your car engine overheats, you don't just splash some water on it and keep going. You have to give it some time to cool. Our economy simply needs some time to cool now, and the recession will give us that.

  • Report this Comment On October 01, 2008, at 4:20 PM, GoNuke wrote:

    I think that we are witnessing a debate where fear is pitted against anger and clashing mythologies that have emerged to support each sides' view.

    I think it is time to discard dogma and face the fact that we are in the midst a great economic crisis. In our regulated free market economies capital is allocated by the market. The market is deemed to be the "wisest" at allocating capital resources.

    It draws upon the collective wisdom of all investors and on the great body of information that our regulations require objects of investment to provide. We apply our wisdom to good information and make good collective decisions.

    This process breaks down when investors are acting out of fear. When the market is being driven by powerful emotions capital is not allocated rationally. Wisdom is not heard.

    We need people to see beyond their fear and anger and their dogma to look at the problem with wisdom.

    Economic activity is slowing down dramatically and it is reasonable to presume it will slow down further given the credit freeze. There are many wise investments that will not be made today because of fear. People and corporations are hoarding cash because they fear they will not be able to raise more due to the seize-up of the credit markets.

    Credit markets have seized up because many securities cannot be valued due to lack of transparency. We don't know what these mortgage backed securities are really worth so we assume they are worth nothing.

    We do not have the information necessary to make wise decisions and our wisdom has been replaced by emotion. Government intervention at this point will remove some of the opaque assets and allow them to be properly valued. It will also alleviate fears which will make it possible for people to proceed with wise decisions.

    Anger towards Wall street is not misplaced but the thieves have already made away with the money or they have been crushed by the melt-down.

    The rescue package is designed to prevent the Wall street crisis from spreading to the rest of the economy.

    Opponents of the rescue package need to see beyond their anger at crimes already committed and focus on the danger these crimes pose to our whole society. It is time to stand up and protect the family and keep the economic engine running. Address the fears so that wisdom can return to the markets.

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