Bailout & the Economy

Today the DJIA went up nearly 500 points. This is only a day after dropping nearly 800 points when Congress did not pass the Bailout. The purported 1 trillion lost with the drop is not an actual lost of dollars but a lost of perceived values.

The stock market is a marker for confidence in the economy. Basically if you believe that economy will grow, then the companies that drive, participate in, or benefit from the growing economy will gain in value. Buying these companies stocks is putting your wallet where your confidence is. But buying these stocks do not in itself drives economic growth until the stock are sold and then reinvested in other companies that need the capital to grow. Growing companies can also obtain the necessary capital from credit, which is leveraged against the perceived or stock values of these companies.

If confidence is low, then less capital is available and growing companies become more dependent on credit. With a credit crunch, then these companies cannot grow as easily. This does not mean a depression unless a substantial number of companies have leveraged loans against their perceived values. When the perceived values drop to less than the value of the loans, then these companies are at risk for bankruptcy. If enough companies suffer this, then the over all economy become at risk for a depression.

Most small businesses are particularly dependent on availability of credit for growth. However, unlike Wall Street small businesses values are more actual rather than perceived. Actual values are calculated based on brick and mortar and bottom line finances. Most small businesses do not exist as publically traded stocks thus there is less overvalued (inflated) or undervalued. In any period when confidence in the stock market is weakened, then the smart investors are even more attentive to actual values.

I would suspect that credit companies and bank would make similar analysis and make better investment, safer investments, and more money would go to business enterprise with actual values than perceived value. These credit companies and banks will still want to make money via their investments in order to offset the cost on interests being paid to depositors. And with the stock market less certain, more capital might be diverted from stock to savings and paying down debts.

All in all, I believe a significant market correction with the current financial crisis may be jarring in the short term but will be better off in the long term.

I believe we should not Bailout or “Rescue” the financial market and let the dead bill stay dead.