KEY POINTS:
The United States House of Representatives was right early this week to reject the proposal to protect imprudent financial institutions rather than provide more support for prudent individuals and savers. However, a rescue package is needed and hopefully the Senate will get it right today.
The bailout plan aimed to restore liquidity (credit) to the US financial system. Nothing wrong with that, but the method proposed put too much emphasis on Wall St and not enough directly on the American people.
Financial institutions in the US in particular have stopped extending credit (lending), and as debt (credit created) is repaid, the money supply created by bank lending is shrinking.
There is nothing much wrong with the wealth-creating part of the economy yet. The loss of confidence is in the financial system that provides the credit to finance transactions and investment to keep the economy working and expanding.
The Government's response to date has been the knee-jerk public debt-funded bailouts of Fannie Mae and Freddie Mac at US$200 billion, and AIG Insurance for US$85 billion, and now the larger broad bailout proposal of the financial markets of US$700 billion. None of these efforts so far has restored confidence in the financial system. In fact it's increasing the concern of all taxpayers who ultimately foot the bill.
The projected government deficit for 2009 of US$482 billion could now double or even triple.
This will drive up interest rates and taxes, and to the extent the Federal Reserve purchases US Government securities to help support bond prices, it will devalue the US dollar, cause inflation and cause foreign money to take flight. All of this, including sharply increased interest rates and/or a collapse of the US dollar, could aggravate the debt crisis that the bailout plan sought to address.
Action is needed, but what? Neither the G8 Group of countries nor any government has asked for a paradigm shift in the way money and credit is created. No one has said, for example, let's replace a portion of the debt-based money with a debt-free money supply. (The word replace does not mean increase).
All the attention is going on trying to rescue the system we have, and a great deal of careful prioritisation and speed is necessary to deal with the unravelling of our debt-based money system.
We should hope that Congress avoids a sharp rise in interest rates by limiting institutional bailouts. Any bad private sector debt it does buy up should be at discounted prices.
But rather than protecting imprudent institutions and speculators, we need to hope the US Government emphasis goes toward protecting prudent individuals and savers by strengthening existing safety nets, including the Federal Deposit Insurance Corporation (FDIC) which insures bank depositors, the Securities Investor Protection Corporation (SIPC), which is the Congress-backed fund that insures brokerage firm accounts, and state guarantee associations that cover insurance policies.
The FDIC says 1479 of its member banks and 158 thrifts with US$3.2 trillion assets are at risk.
In fact the FDIC is not funded sufficiently to handle a large number of bank failures. So rather than bailing out imprudent financial institutions, the Government priority needs to be on protecting the deposits and insurances of prudent individuals and savers.
In turn, we need to hope that prudent individuals will seek out banks with the financial strength ratings of B+ or better, US Treasury bills, and money market funds that invest almost exclusively in short-term US Treasury securities or the equivalent.
It's then important that the Federal Reserve support these banks by ensuring they have the capacity to commence prudent lending again.
It's not rocket science. The rules of banking and credit creation are rules made by humans and they can be changed, just as they are for rugby and cricket.
* Alasdair Thompson is chief executive of the Employers & Manufacturers Association (Northern).
