The Bailout Will Succeed but What's Next?

Next week we will be relieved that Congress and Mr. Paulson came to an agreement on the structure for the new $700 billion investment fund. The markets may rally as investors come to this conclusion. What's next? Reality is about to set in.

This new fund is going to allow the banking system to sell their weakest distressed assets to clean up their balance sheets but it will also lead to a massive recapitalization of the financial system. Equity offerings will be aplenty. These new stock infusions may come from the capital markets or invstments from private equity firms, hedge funds, sovereign funds or other smart investors. The likely result will be the lower prices for the stocks of financial institutions. The hedge funds won't need to short these stocks to come to this conclusion.

In addition, the press will start to focus on everything else going on in the economy. Home sales are still down; foreclosures continue to rise; durable goods orders drop more than expected; retail sales are weak at the most prestigious stores; and the sounds of extremely weak holiday sales are about to come roaring. The bottom line is that the government needs to pass the bill for the $700B fund but that is not going to change the fact that the economy is weak and continues to decline. The reported GDP numbers have not turned negative yet but it would be surprising if we don't imminently see that occur.

The U.S. economy has been driven by loose credit for mortages and home equity loans. Both of these avenues of liquidity have been drying up and America is financially crippled. It will take a long time to clean up this wreck but leverage needs to decline precipitously and confidence by everyone must be restored.

America is not the economic power it once was and the next few years will likely lead to some tough times but we have the human capital and a great democratic society that will lead this country to better times. Ten years from now the United States will look back at this period with disbelief but once again it will lead the world to new heights.