The Incredible Shrinking Dow

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Whoa! What did I miss?

On Friday, the Dow Jones was up more than 300 points in anticipation that the House of Representatives would pass the mother of all bailout plans. And it did. Woo-hoo! Right?

Sadly, I see no champagne bottles. I see no confetti falling from the rafters. All I see is lots and lots of red, and one of the worst days the market has ever seen.

The Dow Jones fell nearly 600 this morning, plunging below the psychologically important 10,000 mark. The last time anyone got this animated over Dow 10,000 was March of 1999, when it passed the mark for the first time.

Thanks for nothing
Fast forward more than nine years, and here we are -- sub-10,000. Add in the perils of inflation, and the Dow has lost considerable value in the past nine years. What happened?

Let's start with the bailout. After the House first shot down the proposed bill last Monday, the market's attention immediately shifted toward whether the bill would go through at all. Once the bill became reality, the market's celebration got a fierce reality check: "Oh, yeah, that's right ... the reason we need a bailout is because our credit markets are shot to pieces. Resume sell-off."

And how about those credit markets? Remember, it's not useful to judge how bad our credit crisis is by watching stocks -- the real trauma lies in the debt market. On this front, things still look pretty bleak. The TED spread -- a measure of how willing banks are to lend to each other -- still remains disturbingly high at around 3.9%, almost four times where it stood a month ago. The Federal Reserve tried to ease this situation by doubling the amount it lends to banks through its term auction facility, with the total amount available to banks now standing at a whopping $600 billion -- call it the quiet bailout, if you will. In English: Despite the bailout, credit markets are still an abysmal mess, and that's scaring the pants off markets around the globe.                                                                                                    

Nice job, bailout
Just days after the president signed the bailout into law, I can already hear the sneers and jeers over its failure. "I thought the plan was supposed to prevent the economy from collapsing," the hecklers keep yelling. "Now stocks are plummeting. Way to go, bailout!"

Easy there. First, let's recognize that the plan wasn't designed to boost stocks; it was designed to keep the economy from imploding and banks such as Bank of America (NYSE: BAC  ) and JPMorgan Chase (NYSE: JPM  ) from going under. It was designed to put an end on the run-on-the-bank behavior that sealed the fate of Washington Mutual and Wachovia (NYSE: WB  ) . From that point of view, it's so far, so good.

The day before the bailout was originally announced -- just over two weeks ago -- Goldman Sachs (NYSE: GS  ) and Morgan Stanley (NYSE: MS  ) were staring disaster in the face -- a prospect that would have unquestionably made today's sell-off look like small potatoes. As easy as it is to point to today's weakness as a reason that the bailout's already a failure, keep in mind that it'd be much, much worse without one.

We enjoyed an enormous boom over the past decade that's coming home to roost. The bailout plan saved us from a looming collapse, but by no means does that mean markets are getting off scot-free. This plan was no panacea, that's for sure.

Markets correct. Problems resolve. Hang in there, Fools.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. JPMorgan Chase and Bank of America are Motley Fool Income Investor recommendations. The Fool has a disclosure policy.

Read/Post Comments (7) | Recommend This Article (15)

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 October 06, 2008, at 2:30 PM, Ishortyou wrote:

    Now that the 'bail out' plan came through, Wachovia needs fast to take advantage of it, it needs to sell its toxic loan portafolio from its banking subsidiaries around 122 billion if not more to the government close to even cost prices and take serious advantage of the tax break plan and remediate their banking book of business. They also need to contact their customers that did the run on the bank like chickens without head to bring their deposits back and reassure them that they are ok and there is not reason to panic because of the talking heads of FOX news and rest of media and the incompetence of the FDIC. This strategy will demonstrate to the public that the current 'bail out' plan is working and that Wachovia is the first product of it.

  • Report this Comment On October 07, 2008, at 1:21 AM, rd80 wrote:

    "Remember, it's not useful to judge how bad our credit crisis is by watching stocks"

    And yet, proponents of the plan (not necessarily Morgan) were quick to point at Monday's 777 point drop in the Dow as evidence we needed the plan. Opinion columns, news pieces and politicians were using the comparison between the value lost in the stock market and the $700 billion funding for TARP as evidence that we 'needed' this one, last fix.

    But, now that the plan's been passed, the stock market's fall isn't relevant anymore.

  • Report this Comment On October 07, 2008, at 2:45 AM, sharktrade wrote:

    it's only due to a human nature : fear and cupidity .

  • Report this Comment On October 07, 2008, at 11:51 AM, Daiko wrote:

    Quick correction on the last time the Dow was under 10,000:

    There was about a week in October 2004 when the Dow closed under 10,000 on each day (October 14 - 26, 2004).

    Still, a 25%+ fall in 10 months is impressive. The problems look big, but I'm sticking to the long term plan: consistent investment with opportunistic buys when stock gets discounted. For now I "celebrate" by buying a little bit more of a Total Stock Market index fund each time the market drops to "new" lows.

  • Report this Comment On October 07, 2008, at 2:17 PM, Tygered wrote:

    This is like telling the patient who has to have his foot amputated, that at least he's not losing the whole leg. So from that perspective the bailout is good.

  • Report this Comment On October 07, 2008, at 4:43 PM, specularii wrote:

    Your whole premise is flawed. It will get much worse precisely because of this bailout. I do not understand how a site that I respect as much as this one would let someone publish this stuff. You really need to do research on basic economics. Quite possibly this bailout, and it's mindset are turning a recession into a prolonged depression. The only thing that will change this for the better is letting it all fall down and beginning to rebuild, becoming a country of savers and producers again. You must eat bitter to taste the sweet.

  • Report this Comment On October 11, 2008, at 7:21 AM, TradeSeeker wrote:

    How much would the various companies on the stock market be worth if it was no longer possible for them to get credit - or if credit came at a really high price?

    Businesses that don't need credit from banks should be that much more resilient and valuable, all other things being equal.

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