"We were told less than six weeks ago by the Congressional Budget Office that the taxpayers may have to spend up to $25 billion dollars bailing out Fannie Mae and Freddie Mac. Secretary Paulson and Federal Reserve Chairman Bernanke assured us that beyond that, all was well. Why is anyone still listening to Paulson and Bernanke?
The resulting central-bank-induced disequilibrium relationships between price and risk is bound to generate massive movements in the prices of debt instruments back to their equilibrium relationship, a process that in its infancy has already destroyed the capital of the world's private-banking systems.
The federal government — through the Department of the Treasury and the Federal Reserve — is now committed to assuming the entire credit risk of the financial-services industry of the United States, and quite possibly much of the industrialized world. The US government itself is already insolvent in an intertemporal sense, with a budget deficit over time of $30 trillion in present discounted-value terms. How the federal government's assumption of the American and world financial systems' risks is supposed to be credible on a long- or even medium- and short-term basis is totally unclear.In a bubble, asset prices are by definition far above equilibrium values. The federal government is now committed to guaranteeing the difference between the real equilibrium values of all debt securities and their stated/nominal value, which was created during the greatest credit bubble in history.
That difference between nominal and equilibrium/real value must by definition be a massive number because of the extent of the credit bubble, on the order of $5 trillion dollars in the United States alone.
Unlike the short-attention-span monkeys of Wall Street, the reasonable analyst will conclude that all the federal government's options for making up the difference between nominal and real values have bad implications for Wall Street.
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