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February 19, 2009

Bailing out Investors Threatens Savers

Dow at five-and-a-half year low! That's the 4PM headline which inspired this post. Actually, of course, that's no reason for general panic in itself. No one ever said the Dow was supposed to go straight up. However, if you put a substantial part of your "savings" into stocks directly or indirectly, you may have a very good reason for individual panic.

If the government continues to insist on baling out investors, however, savers will be exposed to a risk they don't deserve.

Saving means protecting your principal while earning a very low return (zero in some cases). Investing means risking at least some of your principal in the hope that you'll make a better return than you will by saving. Once of the great innovations since the Great Depression is FDIC insurance. You can SAVE a reasonable amount of money without risk to the principal assuming that inflation isn't greater than your interest after taxes (hold onto that thought). If we don't have a rerun of the 1930s (and I don't think we will), we will be spared to a large degree because we had no reason to panic and take our savings out of banks (assuming that we didn't have more than $250,000 in any one account name in any one insured institution).

Unless you're a rock star, an athlete, or a vastly over-paid executive, it's hard to get rich just based on savings. Most of us don't earn enough to be able to put aside enough to build what we would consider wealth even with the miracle of compound interest. So we're tempted to invest some of what we were saving so that we can get a better return and live or retire in a grander style then we would have been able to based on savings alone. Nothing wrong with that so long as we remember that investing means taking a chance on losing the principal AND we're prepared to deal with that loss. Of course it's easy to forget the risk when you invest in a stock market that seems headed for the sky or when you "invest" in real estate by buying a house that costs more than you can justify paying EXCEPT for the fact that it is "sure to" appreciate. But it really hurts when you realize that your retirement will be much more Spartan than you planned because luck went against you, especially you're near the end of your working life and/or have no opportunity to restore the savings you lost. If we weren't out-an-out swindled, we make these choice and we live with the consequences – MAYBE.

But if a large constituency (recent home-buyers and refinancers) or politically powerful constituencies (bankers, automakers, for example) are feeling the pain of bad investments, then a democratic (small "d" deliberate) government is tempted to offer a bailout even though the investors were never promised nor did they pay for any insurance against failure. If there happens to be a recession going on at the same there's lots of clamor for bailout (and that's likely, of course), then tax revenues are also down. The only way a sympathetic government can bailout the unfortunate investors is by borrowing or printing money.

But borrowing or printing money eventually leads to inflation which erodes the value of what the savers saved. That's NOT FAIR. The savers made the choice to forgo large possible gains in return for safety. It's simply wrong as well as very bad policy to use inflation as a way to tax away their savings to provide a bailout to investors who decided to take a risk.

Note that a "stimulus" bill is not necessarily a bailout and can be very good policy. If the government spends money now on infrastructure or anything else which it would eventually pay for anyway but is cheaper now, then the spending helps flatten out the economic cycle and can naturally decelerate when many needs have been met for the next few years. The government can recoup this spending by not competing as much with the private sector for scarce resources doing boom periods.

The TARPs, aid to AIG, the "loans" to the automakers, and many plans which have been floated to help homeowners with mortgage payments are bailouts. They protect investors against losses. Since they don't create demand, they don't create jobs – just shuffle them around from one sector to another. These are the bailouts which rob savers to pay investors. They are a bad idea.

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