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Spend in haste, repent at leisure: America’s latest bailout plan

Cambridge – With minds concentrated by fears of another 1930’s-style Great Depression, America’s politicians have adopted, virtually overnight, a $700 billon bailout plan to resuscitate the country’s rapidly deflating financial sector. The final deal is an elaborate piece of financial and political engineering whose ultimate effect is almost impossible to predict. There are good reasons, however, to be skeptical that this will be the panacea that credit markets are (literally) banking on.

The plan’s central conceit is that government ingenuity can disentangle the trillion-dollar “sub-prime” mortgage loan market, even though Wall Street’s own rocket scientists have utterly failed to do so. To boot, we are told that government is so clever that it might even make money on the whole affair. Perhaps, but let’s not forget that a lot of very smart people in the financial industry thought the same thing until quite recently.

Just a year ago, the United States had five major freestanding investment banks that stood atop its mighty financial sector. Collectively, their employees shared more than $36 billion dollars in bonuses last year, thanks to the huge profits these institutions “earned” on their risky and aggressive business strategies. These strategies typically involve far more risk – and sophistication – than the activities of traditional commercial banks.

In mid-August, I had the temerity to predict that risks had come home to roost, and that a large US investment bank might soon fail or be forced into a highly distressed merger. Little did I imagine that today, there would be no freestanding investment bank left on Wall Street. Indeed, after years of attracting many of the world’s best and brightest into ultra-high paying jobs, collapsing investment banks are now throwing them out left and right. One such victim, a former student, called me the other day and asked, “What am I supposed to do now, get a real job?”