You can't fool the market

The purpose of the bailout was to stabilize the credit markets. We heard that it had to be done. The stock market plunge had to be halted. But the Dow has dropped more than 1,000 points since the House passed the bailout bill. Companies are cutting dividends by significant amounts.

Now doubt is creeping into the markets. Because you can't fool the free market.

Yes, the bailout has still not been fully employed. And it might help free up credit - but only temporarily. Because, again, as I have been writing, the bailout does not fix the underlying problems. Individuals, businesses and governments have relied on credit to hide deeper problems. Accounting games have hid real problems with phony shell games. The market will still tighten up on credit in a significant way. However, the bailout might prevent a freeze.

But, it seems that unintended consequences are creeping into the market. The bailout will allow the government to purchase "warrants" (part ownership) of companies that choose government help. Part of the stock market plunge seems to be due to the fact that great uncertainty has crept into the system.

Remember, the first problem was that investors had no idea what companies were worth with all the paper they held. Now, the question is being asked - if the government obtains partial ownership, won't that dilute the stock (decrease its share price)? But no one knows how much ownership the government will have in each company. And if, with these warrants, the government is the first 'payee' what if that is a significant portion of value of the company? This would leave very little shareholder value for the regular shareholders.

Plus, there is probably a deeper cloud of doubt creeping into the market. If the government owns 5% of a company, don't they own all of it? They have regulatory powers and law enforcement powers as well as tax policy powers. What if they use these against a company they "own" to greatly increase the power that 5% ownership would entail? Or, what if they use such powers to produce a competitive advantage against other companies? Of course, the government would never interfere in the private market of an industry to such an extent that they might destroy it! Oh, yeah, they already did that in the mortgage industry.

The lesson is always simple. And it is so easily forgotten. Free markets work, even in the face of government intervention. In fact, the Soviet Union proved that free markets 'work' even when they are totally controlled by the government. Which is why there were bread lines and you had to wait ten years to get a phone or a television set.

For all the advocates of the bailout please admit something. While it might have been necessary to prevent catastrophe, it is not the fix for our underlying problems. Such government intervention will also have unintended negative consequences. And government intervention will only delay the inevitable. And this inevitable crescendo will only be that much worse the longer we try to prevent it.

The free market regularly squeezes out excesses and inefficiencies that are built into the economy during prosperity. This is a contraction, or a slow down or a recession. Rarely, it can be a depression. The longer we try to prevent this process, these inefficiencies continue to build and increase. And the greater they are the greater the pain as the inevitable contraction process eliminates them. Then, the system builds back efficiencies which create future wealth. Because free markets work. Even if the government tries to control it.