Government Bailouts Gone Wild!

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With bailouts for Fannie Mae, Freddie Mac, Bear Stearns, WaMu, AIG and Lehman Brothers, you would think that getting a bailout is almost too easy these days. All you need to qualify is to have overpaid executives allow their companies to make foolish loans to beef up corporate profits so the US government can bail them out a few years later because we are in dire of need market stability. Sounds unfair, doesn’t?

Are these corporate bigwigs really to blame?

While it’s easy to point fingers at them for encouraging lax lending standards, those 1% teaser loans that you got 4 years ago sounded just as enticing. Why not? Banks were all too happy to give them out, until the hot potato landed in your lap. Your interest rate for your home skyrocketed to what you couldn’t afford, and you were left with supersized payments. But hey, if a bank underwrote your loan, they must know what they are doing, since underwriting loans is their business. No matter where the fingers pointed to, the results were catastrophic.

Once foreclosed loans hit the balance sheets of corporate America, those banks, brokers, insurance and mortgage companies got their foot caught in the door. One by one, seemingly strong financial companies would report bad earnings until it was discovered that you can’t keep reporting bad earnings without possibly going bankrupt.

You see, Wall Street was betting that the real estate market would rebound with the Fed offering lower interest rates. These lower rates proved fruitless as banks were unwilling to offer substantially lower rates after taking a bath on bad loans. In addition, people were equally unwilling to buy more homes, as they were tapped out from the higher payments, inflation and soaring oil prices.

So now, the government faces this enormous problem from large banks and brokers who are in the hole and can’t get out. And when they start failing, the government has to step in to help curtail a panic. The government also has been financially encouraging the few healthy financial institutions to take over the failing ones like Bear Stearns and Merrill Lynch to help defray potential costs to the government.

Hopefully, swift action from a large bailout will add confidence and stability to the market, and more importantly, help restore the potential for future growth and earnings, which in turn drives the stock market.

Easy Sneezy, Right?

While these types of bailouts are not uncommon as with the S+L bailout of the late 1980s, they come at a cost to taxpayers, especially with government’s burgeoning $10 trillion dollar debt. If more companies “expect” the US government to help out, the government ends up taking on more debt than it can handle. Think about it. Would you keep loaning a friend who keeps get getting further and further in debt? Don’t you think their risk of defaulting on those loans becomes greater?

When the risk of default increases for the US government, the cost at which the government can borrow money goes up. This is similar to your credit card rates climbing when you add more debt. And just like the credit card companies can punish your credit score with a higher perceived degree of default, the same thing happens with the government. In this case, the US government’s credit score is the US dollar. The more debt the US government takes on, the lower the US dollar can become, and in turn your own money becomes worth less.

What will happen?

The bottom line is we don’t know how bad this situation can get, if the worst is over, or whether these bailouts will have a small or large negative affect on our dollar. Heck, not many saw this coming a few years ago. But the government figures a short term bailout is much easier to deal with than eroding the confidence of the markets to a point where more companies may start to go out of business.

In the end, this bailout will strengthen the financial markets in the short term, and tighter mortgage regulation will ensure this will not happen again. But we should not be fooled. Our growing debt from this bailout will burden the future health of our economy unless something is done.

What you can do to help protect yourself

Voting for a President that strongly opposes debt is a great start. For that too happen, our future President would need actively cut government programs across the board, end the war in Iraq and discontinue tax incentives for the rich. Simply put, we need to vote for leadership who is willing to make the sacrifices for a better future.

While I sincerely hope this will happen, we can’t always put our eggs into one basket. Diversification has to become the key to our success. We should consider making investment beyond our borders. If the dollar continues to slide, our internationally diversified money will be protected from a falling dollar. However, should the next President take significant steps to improving our economic and debt situations, we can expect the dollar to rise. Since we can’t predict what will happen, making international investments apart of our portfolio could become a wise choice.

But before going willy nilly into such investments, I encourage you to speak with your broker, learn about ETF investing, growth and market timing, use a stop program, and consider my guide to investing. Once the markets regain a certain level of stability, diversifying your holdings can become a great way to help secure a better future.