From href="http://londonbanker.blogspot.com/2008/09/quotable-on-bank-balance-sheets.html">London
Banker:

“The problem with financial institution balance
sheets is
that on the left hand side nothing is right and on the right hand side
nothing is left.”

It’s pretty obvious that financial institutions are struggling.
 We’ve had href="http://www.fdic.gov/bank/individual/failed/banklist.html">16
banks taken over by the FDIC in the past two years, 13
so far this year.  Other
failing banks have been taken over or merged, lest they too
have the FDIC take them over.   href="http://ml-implode.com/">286 mortgage lenders have
imploded in the past two years.  

News like that is why Congress went along with Bailout 2.0

Since August 2007, the Fed has developed programs to increase emergency
lending. One part of the strategy involves accepting securities of
questionable value, as collateral for loans.  In the past two
weeks, the Federal Reserve System has handed out something like $370
billion.  Most of this is very short-term lending.
 But it is happening so much that the total lending by the Fed
has expanded greatly.  All this Fed lending is what
constitutes Bailout 1.0.

Bailout 1.0 may have seemed like a good idea.  Good or not, it
did’t work.

Now, some are speculating that the Federal Reserve System is at risk of
running out of liquid capital. See London Banker:
href="http://londonbanker.blogspot.com/2008/09/brad-setser-extraordinary-times.html">http://londonbanker.blogspot.com/2008/09/brad-setser-extraordinary-times.html

For a graphical representation, see the (PDF) at Cumberland
Advisors:
http://www.cumber.com/home/Factors.pdf

The Cumberland Advisors graph is complicated, so if I shrank it to a
500-pixel width, it’d be completely illegible.  But it shows
that something very dramatic is happening in our financial system.
 The quantities of securities and currency held by the Fed
have shrunk.  The Fed is in trouble.

That is why Congress has passed Bailout 2.0…

href="http://www.washingtonpost.com/wp-dyn/content/article/2008/09/28/AR2008092800064.html?hpid=topnews">Congressional
Leaders Announce Breakthrough in Bailout Bill Negotiations
By Lori Montgomery and Paul Kane
Washington Post Staff Writers
Sunday, September 28, 2008; 12:47 AM

Congressional leaders and the Bush administration last night struck a
historic accord to insert the government deeply into the nation’s
financial markets, agreeing to spend up to $700 billion to relieve Wall
Street of troubled assets backed by faltering home mortgages.

Negotiators emerged from a marathon session in the Capitol about 12:30
a.m. to announce that they had reached agreement on a proposal to give
Treasury Secretary Henry M. Paulson Jr. broad authority to organize one
of the biggest government interventions in the private sector since the
Great Depression…

The announcement was made at about 12:30 AM, and the WaPo article went
up at 12:47 AM.  So I can forgive them for being imprecise.
 However, readers would be well advised to notice that the
$700 billion figure is NOT what Congress agreed to spend.
 What they agreed, is that the total balance in the program
won’t exceed $700 billion at any one time.

Think of Bailout 2.0 as a great big washing machine.  It holds
$700 billion.  The Treasury takes lousy securities is exchange
for cash or a cash equivalent.  The bad securities go into the
washing machine.  If the Treasury is able to take some out and
hang them to dry, they can buy more, and put those in the washing
machine.

It is, in fact, a giant money-laundering scheme, if you accept the
notion that the lousy securities were based upon loans that were made
fraudulently.  

The really cute thing about it is this: once the machine starts going,
then the corporations that borrowed from the Fed will be able to pay
back those loans.  The Fed’s balance sheet will look better.
 So Bailout 1.0 can keep running, right alongside Bailout 2.0.
 

This will all work out just fine, if the lousy securities ever regain
their value.  That will happen as soon as housing prices go
back up.  Housing prices will go back up once wages go up to a
level that will support the house payments.  

So everyone should join a Union right now.  Bargain for higher
wages.  The corporations, flush with cash from Bailout 2.0,
will gladly pay.  If they run short of cash from time to time,
they can fall back on Bailout 1.0.

The workers will take the higher wages, buy bigger houses, the lousy
securities won’t be lousy anymore, and we can all have a beer and a
Happy Meal.

Or, wages will remain stagnant, housing prices will continue to fall,
as price inflation eats away at those stagnant wages, property taxes go
up, and the cost of heating and cooling homes increases.  

Wages have to support the total cost of homeownership.  The
price of the house is only part of that.  If wages are
constant, and the other components of the total cost of ownership go
up, then the price of the house has to come down.

If that is the way it goes, it will end badly.  Our economy
will be a scrap heap.  Then the only thing that Bailout 2.0
will have accomplished, is that it will have given the Government the
power to decide who gets the best scraps.