To bankers and politicians who insist that the world will come to an end if the US Congress does not approve the proposed US$700 billion bailout package, I wish to say: “It is not the end of the world. It is just the end of you.” Sadly, it won’t be. America’s financier caste will live to fleece another day.

There are no atheists in the trenches, and no free-marketeers in Congress after a nearly 10% fall in stock prices. A chorus of erstwhile conservative voices led by the likes of Newt Gingrich, the Republican firebrand of the 1990s, now argues that the proposed $700 billion bailout package is flawed, but it is better to enact it than to do nothing. This simply is not true.

In the event of bank failures, the government will not “do nothing.” Two of America’s largest banks, Washington Mutual of Seattle, Washington, and Wachovia Bank of Charlotte, North Carolina, were forcibly merged or taken over by regulators during the past several days, without a ripple of disruption to depositors or borrowers.

When a bank runs into trouble, the American government takes it over via the Federal Deposit Insurance Corporation, an entity created during the Great Depression. Why doesn’t Congress vote authority for the FDIC to add capital to stricken banks in order to continue their lending operations – after the existing shareholders have been wiped out?

The trouble is that the banking system is insolvent; that is, it lacks sufficient capital to hold its existing portfolio of assets, let alone to make new loans. Its capital is dissolving as loan losses mount. Banks have written off nearly $600 billion of mortgages or securities backed by mortgages during the past year. Against this, they have raised $350 billion in new capital from investors. But investors believe that losses will continue to rise in the mortgage market – and that is before other asset classes begin to decay, including credit cards, and corporate loans.

The banks need capital. The private market has had a very bad experience giving them capital. Distressed investors, such as the Texas Pacific Group, which invested in the defunct Washington Mutual, or the JC Flowers Group, which unwisely poured money into Hypo Real Estate, have lost money. Sovereign wealth funds have lost even more. It is getting harder and harder to persuade private investors to put more money into banks, given their string of losses.

The US government has no mechanism for giving capital to the banks. It hasn’t done anything like that since the early 19th century. What Treasury Secretary Henry Paulson has proposed is a backdoor way to put capital into banks, by purchasing securities from them at higher-than-market prices, as I observed last week (see E Pluribus Hokum, Asia Times Online, September 23, 2008). Federal Reserve chairman Ben Bernanke quaintly called the higher price the government is to pay a “hold to maturity price,” as opposed to the “fire sale price” now available in the market place.

Which institutions would get the capital injection, and at what price? In effect the Treasury would be dispensing capital gains to institutions it liked, but not to institutions it did not like (such as the unfortunate Washington Mutual). Shareholders in favored institutions would receive an enormous benefit, which is why some amended versions of the bill propose to allow the government to claw back some of the capital gains through the right to buy company stock.

Why anyone believes that the Treasury plan will prevent widespread economic misery is unclear. Assuming that the Treasury overpays for the so-called “troubled assets” it purchases from banks, it cannot overpay by too much. Let us suppose that it overpays by 20%. In this case, it would effectively give the banks a $140 billion boost. That is a small fraction of what they have written off already, and an even smaller fraction of what they must write off as American wealth continues to shrink. It will help the shareholders of a few big institutions, and that is about it.

The banks need a good trillion dollars or so of new capital. The Paulson plan, unfair and indirect as it might be, cannot provide more than a small fraction of that amount. But there is wealth aplenty in the world eager to find a permanent home in the United States, in the sovereign wealth funds and in private equity funds around the world.

If American banks are permitted to fail, and their operations maintained intact by the FDIC, new investors can restart operations with a clean slate.

What is so awful about wiping out the home price bubble of the past 10 years? Suppose home prices were to plunge by half (which is where homes in foreclosure clear the market in California or Florida)? Young people would find it easier to start families and old people would work longer before retiring.

Nonetheless, the bailout package will pass in some form. America’s intellectual class, right, left and indifferent, is too dependent on the begging-bowl proferred to the financier class to conceive of its existence after the prospective demise of its patrons. Republican congressmen whose constituents fervently oppose the bailout quake in terror at the prospect of absorbing blame for a new depression. If the depression comes despite the bailout, of course, they will have even more explaining to do, but that is a different story.

Ultimately, it is the Americans who lack the guts to oppose it. As I argued on September 23, they are like gamblers who pass a tax to bail out the town casino, after unpaid gambling debts threaten to sink it. Americans will not easily give up the illusion that ever-expanding wealth is their birthright.

As I reported on September 29, America’s wealth was about three times family income in 1962, and over 10 times family income in 2004 (see US wealth in shrink mode). Leverage applied to housing created an illusion of wealth on top of a stagnant base of income. Take away the banks, and the wealth illusion will die forever. Americans will actually have to save, rather than speculate in the property market.

The bailout will pass in some form. But the next time you see a talking head on television telling you that the bailout is imperfect, but that it is the only choice, remember: it just ain’t so.

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