What Did the Feds Think When They Gave AIG Money?

"Stone him to death!"

No kidding. Dilapidation may be coming back into style. That's what one of Madoff's victims proposed in front of the courthouse.

We're in the "anger" stage, writes John Authers in the Financial Times. No more denial...now, people want blood.

After the South Sea Bubble blew up, in the 18th century, the Walpole government was faced with similar anger. It seized the property of the company's directors and used it to pay off the victims. Then, a resolution was proposed in Parliament by which the bankers involved in the scandal would be tied up in sacks filled with snakes and tipped into the Thames River.

So far, Congress has not proposed stoning Fannie Mae or sending AIG directors to the bottom of the Potomac. But it must be warming to the idea.

"Congress is looking for heads to cut off," says the French press.

One member of Congress - Senator Grassley - retreated from his call for AIG executives to commit suicide. It would be all right with him if they just showed a little contrition, he says now.

But all over the world - and especially in Washington DC - the mobs are out in the streets with liquor on their breath and ropes in their hands.

The proximate cause of this anger is the bonuses paid out by AIG - after the company got a taxpayer bailout of $170 billion. According to the New York Attorney General, 73 AIG execs got $1 million + bonus checks.

"Livid Democrats demand AIG return bailout bonuses," says a headline in today's financial press.

We hope you realize, dear reader, that all of this, of course, is just a cynical sideshow. It's a distraction...a self-indulgent tantrum; the real story lies elsewhere...which we'll come to in a minute.

First, the rally is still going on. Stocks have recovered about 10% of their losses so far. And yesterday, the Dow rose another 178 points.

Don't forget, this is not a new bull market. It is a bear trap...a rebound in an on-going bear market. After this phase of anger passes...people will probably feel that the worst is behind us. They'll squint and see a "light at the end of the tunnel." Later on, they'll realize that the light is an on-coming freight train!

Yesterday's up-move was traced to a surprising report from the housing industry.

"Housing starts unexpectedly increase on condos," explains a Bloomberg headline.

And today, the Fed meets. Analysts are betting that the Fed will begin more "massive buying" of assets - especially U.S. Treasury bonds - in order to get more money into the system.

All the news is not favorable, of course. Auto loan delinquency rates are running 9% ahead of last year. Thornburg Mortgage is apparently headed towards Chapter 11. Caterpillar says it will lay off more than 2,000 workers; less construction means less need for heavy equipment. And AMEX says even its best customers are falling behind on their bills.

But let's go back to into the theatre and take our seats: The politicians give money to their pet projects...and then pretend to be outraged when the companies use it to pay their bills. Among their bills were billions in payments to other companies -notably Goldman Sachs, former employer and major source of wealth for the man who designed the bailout, Hank Paulson - and thousands of employment contracts with AIG's salarymen.

What did the feds think when they gave AIG the money? That they were donating to charity?

No, dear reader...the fix was in. And it's still in. And while the press and politicians huff about a few million in bonuses to AIG's hacks, billions more is being paid out to AIG's counterparties.

It's not only a waste of money, says our old friend Jim Rogers, the bailouts actually retard a recovery. How so? In the obvious way. Like any kind of subsidy or welfare payment, they invite people to keep doing what they've been doing - no matter how unproductive it is. Instead of letting AIG and its bosses and counterparties go broke, the feds give the whole brain-dead system a transfusion of taxpayers' money. So the executives don't have to go out and find other work. And AIG can continue peddling its mortgage insurance. And its counterparties, too, are protected from their mistakes.

Of course, the government doesn't want to raise taxes in order to keep these incompetents in business, so it bleeds the money from the next generation of taxpayers - who aren't around to protest. Instead of letting the debt be reduced by the natural process of deflationary default, in other words, the government adds more debt.

Already, as we pointed out yesterday, there's about $20 trillion worth of debt debris that must be brushed aside before the economy can begin rebuilding on a solid foundation. At the present rate of savings, it will take about 45 years to do the job. Which suggests to us that it ain't gonna happen. We don't think the feds can sit still that long. And they're not sitting still now. In fact, they're adding to the public debt faster than the private debt is getting paid down.

By our calculations, the private economy is paying off about $420 billion - net - per year. (Just based on higher rates of saving...not counting write-downs, and defaults.) But the federal deficit is expected to run to $2 trillion! In other words, the feds are adding debt 4 times faster than the private sector is paying it down.

This is not a formula for putting this problem behind us. Instead, it just pushes it ahead.

Now, we turn to Baltimore, to see what Addison has for us...

"'We do want foreign capital to come in here and we want private capital,' our favorite stammering Rep, Barney Frank said yesterday.

"After emerging from a House Financial Services Committee meeting," writes Addison in today's issue of The 5 Min. Forecast, "Frank found a few mics to spit into... and the off the cuff pontifications proffered fourth. This was our favorite:

"'We just had the Chinese raising the specter of not buying our Treasuries. Well, that would be troubling. I think they're bluffing, personally.'

"Ha!

"Bluffing? We thought bluffing meant you were acting strong despite a lousy hand... like this:

"This game is played with the cards up...and China's holding all aces."

Addison writes every day for The 5 Min Forecast, an executive series e-letter that provides a quick and dirty analysis of daily economic and financial developments -- in five minutes or less.

Back to Bill, in the land of wine and cheese...

Newsweek magazine offers bad advice: "Stop Saving Now!"

We didn't read the magazine's account; giving the editors the benefit of the doubt, we will guess they were being ironic.

All over the nation - and perhaps the world - people are cutting back, making do, and doing without. "Frugal families doing own chores," says one headline. "Beat the recession by growing your own vegetables," says another. And a popular new website, called Mint.com, is a runaway success; it helps people plan their budgets and find ways to spend less money.

All of this financial rectitude is having a deleterious effect on the economy. The old economists called it the 'paradox of thrift.' The man who plants his own vegetables spends less with the green grocer. Then, the grocer spends less with his suppliers. Then the suppliers spend less with their suppliers. And so forth. Soon, everyone is spending less money...and you have a depression.

So, a civic-minded reader might think he should step up his shopping - if he were an idiot. He might think we'd all be better off if he spent more money...and everyone else did the same.

But that's not how it works. We're not all better off when we all do something stupid. We're only better off when we all do something smart. And when people have spent too much money - and gone too far into debt - the smart thing to do is to spend less, not more.

*** Income-on-Demand's Wayne Burritt on last week's market bounce:

"As you can see from this chart of the S&P 500 - a good gauge of the broader U.S. stock market - last week's bounce has ignited a mini-rally that is just plain joy to see. In fact, from a low last Monday, the S&P 500 has surged a mind-blowing 15%. Wow!"

"Even better: The market's latest action snapped a series of down days that had just about everyone running ragged, me included.

"The market also bounced on higher volume, another big plus for a straightforward reason: When up-market moves are accompanied by higher- than-average volume, it's a clear sign that bullish investors are attracted by the positive market action and are willing to buy shares to prove it.

"But that's not all. Last week's bounce was not just a big volume day: It was the highest-volume day out of the previous seven trading days. I have to go all the way back to the bounce of late November to find a similar surge in buying volume.

"Significant? You bet. When the market bounced late last November, it immediately began a run that didn't end until the S&P 500 hit 944 on Jan. 6 of this year. From the November low of 741, that run marked a massive 203-point surge.

"Translation: A bounce similar to last week's ushered in a whopping 27% upside bullish run on the S&P 500 just a few months ago. Given that we've moved 15% in just a matter of days, this run could best last November's by a long shot.

"Now, I'm not about to say that it's time to pop open the champagne. But facts are facts, and current market action is certainly a step in the right direction."

That's going to do it for us today. Keep reading for today's guest essay from Bill Jenkins who will explain how he sees signs of socialism more and more in today's headlines.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

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