It’s understandable for most people to see that Congress is proposing giving (actually it’s trading money for assets, which is generally described as buying, but I’ll use the verb most that most people hear when its explained to them) Wall Street $700 billion and think, “Why can’t I get some of that money?”  A <a href=”http://www.snopes.com/politics/taxes/dividend.asp”>recent email</a> has circulated around the Internet, suggesting that instead of giving (there’s that word again) AIG $85 billion, we give that out to every American taxpayer over the age of 18 as a “We Deserve It Dividend.”

That’s a nice idea, but here’s the problem with it.  How do we pay for it?  We have two options:

1. Borrow the money.  The government can issue $85 billion in new Treasury bonds to raise the money.  The good news about that is that with the uncertainty about the soundness of any asset besides gold or U.S. Treasury bonds, demand for T-bills is high, which means that prices are high and therefore interest rates are low.  And since inflation is at its highest point since 1991 (5.37% in August), the money that the government would pay back, plus interest, would be worth less when it is due than it is now.  But that really just refinancing private goods with public money; yes, everyone could pay off their mortgages, but we would all still owe the same amount of money, just to a different creditor.  And I can assure you that once people shifted their debt from private mortgages to public Treasury bills they will just double down on their loans.

2. Just print new money.  The upside: no new borrowing and no addition to the deficit.  But be careful when someone promises you something for nothing.  Everyone would know that the new $85 billion has no additional value.  It has done nothing to redistribute real assets; it has just increased the total pool of dollars that everyone has to bid for assets.  Expect prices, especially gas and food prices to rise accordingly.  Additionally, each individual dollar will be worth less, so expect prices on imported goods, like crude oil, to rise even further.  Once inflation expectations set in, they can be very hard to break.  If that were to happen, you can expect interest rates to rise and a recession to follow, like what happened in the early eighties when Paul Volker let the Federal Funds rate rise to 20% to stop the inflation of the seventies.

The $85 billion “bailout” of AIG is actually a credit line that has been extended to them by the Federal Reserve.  It is up to AIG whether or not they take out any money from this credit line.  The catch is that the interest rate on any loans from the credit facility is 8.5 point over LIBOR, which is about 4% right now.  So the toal interest rate is about 12.5%, which is about the same rate I’m paying on my credit card.  Additionally, the loans that AIG would take out would be secured by a preferred equity stake of up to 80% for the Federal Reserve, which would cause the shareholders of AIG to take a loss.  This whole idea was so unpleasant to AIG shareholders that shortly after the bailout was announced they scrambled to find enough equity to avoid having to use the Fed’s credit line.

I take a lot of calls from constituents who don’t understand what caused the problem and certainly don’t understand what is being proposed to fix it.  All they know is that they don’t want to pay to save the rich guys on Wall Street who caused this problem.  They repeat what they hear from Rush Limbaugh and Sean Hannity that we should let these banks fail and let the free market work itself out.  Any bailout is the first step to socialism.  What they don’t understand is that the Great Depression happened because the government sat on its hands during a panic and let a quarter of the existing banks fail.  GDP dropped to almost half of what it was before the stock market crash during the Depression’s worst year and didn’t recover until ten years after the crash.  The free market cannot work itself out because the participants are in a panic and hoarding cash until the storm passes.  By the time anyone has the courage to step in the market, everything will be gone.  I talked to a guy today who saw his 401(k) fall from $50 a share to $1.

Goldman Sachs has been so successful as an investment bank (at least it used to be an investment bank), because it was “long-term greedy” — it passed up short-term gains when it might risk losing business over the long-term.  Here, the proper solution is one that is “long-term free-market.”  People who advocate a free market solution to this have no idea that free markets cannot provide the solution unless investors are acting rationally.  They have no idea how long, painful, and costly it will be to fix this if it is allowed to play itself out.  And they have no idea how much the fundamentals of the economy will change towards socialism if the complete failure does occur, the Representatives who supported this thing get voted out of office, and a Democratic administration gets to revamp the economy in order to bring it out of a Depression.  In order to protect the long-term health of our economy, we must do something to backstop the slide in the financial markets.