Should the Government Bailout the Banks?

Yesterday, congress rejected the Emergency Economic Stabilization Act of 2008. Consequently, the DOW Jones Industrial Average dropped 777 points (7%)and Wall Street lost $1 trillion in value. Although yesterday was certainly a crummy day, it was no where close to the 22.6% black Monday crash in the summer of 1987. Today, the market is initially rebounding as investors speculate that the US government will eventually pass some form of the rescue package.

So, what would be the continued effect if the government bailout fails? Credit becomes tighter as illiquid banks struggle to sell debt assets to other possible buyers. The increased credit crunch will squeeze companies dependent on bank money to run businesses, including meeting payrolls in many cases. Some small and mid-size companies would have layoffs. Corporate bankruptcies would increase in the immediate term. Innovations and entrepreneurship would most definitely suffer for some time.

For many taxpayers, the impact of the government inaction could be a lot closer to their homes. The housing market will continue to slide and homes will be devalued further with a shortage of qualified buyers with money. With most families' largest asset in houses, the credit crunch will hit everyone's net worth.

However, the financially strong will survive and even take advantage of the discounted value of companies with good businesses but poor cash flow. The struggling banks will eventually sell their debt assets at more market-appropriate rates than the artificially propped-up rates offered by the government rescue plan. The market has a chance, after some time of tremendous turmoil, to correct itself with better financial fundamentals. How long would such a correction and rebound take? That's up to much debate.

If the government comes back with an approved bailout plan, troubled banks would be liquid again and able to support businesses and individuals. Companies would continue to use credit to sustain and grow businesses. Some possible bankruptcies and insolvencies could be potentially avoided. In the short-term, jobs would be saved. The stock market would rebound at least to some degree. The real estate market would be saved from further deterioration.

However, a government bailout would most certainly be setting the economy on an inflation climb by printing so much more money. What will a dollar even be worth by the time the credit market fundamentals are truly back on course? And do we really trust that the government will be able to do something worthwhile with the assets purchased in the bailout? The long-term impact of a government intervention could end up being a more prolonged correction of the capital market fundamentals and a bleak economic forecast with inflation and the possible devaluation of the US dollar.

So, should the government bailout the financial market? Vote your opinion.