Why did the markets like the bailout

As you can see from the graph in Scott's post, the markets plunged when the bailout failed to pass the House.

Why? I can understand the financials plunging, since the bailout would have been a transfer from taxpayers to them. But why the market as a whole? Does that mean the bailout would have been good for the economy?

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Tentative explanation: When

Tentative explanation:

When money is borrowed, it is not borrowed from savers, it is printed in the hope it'll be saved later on. The government borrowing an additional $700B to buy the securities would have been inflationary, thus beneficial for business who generally have debt.

Animal spirits.

Animal spirits.

That too. I'm convinced (not

That too. I'm convinced (not that I have any real evidence of it) that certain financial signals are important to stock markets largely because they are important to stock markets. My favorite is when the Dow swings by hundreds of points on announcements of a quarter-point cut or raise in the federal funds rate. I'm aware of no macroeconomic theory that could support such wild gyrations (though I'd love to hear them) on the basis of minor changes in the interbank loan rate.

Are you kidding ? The

Are you kidding ? The interbank loan rate affects the entire economy, it determines almost all investment through credit, it is the source of all fresh money in the economy.

Besides, if it were truly irrational, you would see a long term trend opposite to the move following the fed fund rate change : you don't.

I'm not saying that I think

I'm not saying that I think the effect of Fed funds rate changes on the economy is zero; I am saying I have an non-empirical belief think the stock market swings more than it "should", in my lay opinion. I'm not particularly attached to this belief.

System vs companies

Hypothesis:

Even if we assume that the failure of the bailout is good for the system, i.e., the economy, it still could be true that a ton of companies that have been living on bad credit will suffer. Their valuations go down bringing the indices down. The system will grow stronger as eventually new sounder companies take their place. That's when the markets will recover.

Since we're throwing out

Since we're throwing out random hypotheses, here's mine. It's not that the markets necessarily think the bailout is good for the economy, but it's at least relatively well understood. Suppose the bailout really would cost $700 billion (I don't actually think it would), that it's entirely funded by debt, and that it really would work. So, the interest payments on that would be, what, $30 billion per year? That's bad, and the taxes to pay it would be a downer on the economy, but (assuming it worked) it's not a big deal as these things go.

Now suppose there's no bailout. I don't see how anyone with a straight face can claim to know what's going to happen. But if there's a major meltdown/depression, then a whole lot of stocks suddenly become worthless. And it wouldn't take much of a risk of that for the effect on the economy to swamp that of the extra $30 billion in taxes. So even if it's more likely than not that the bailout is bad for the economy, in expected value terms the bailout could still be positive.

But what do I know? I haven't taken a stand on the bailout, and am continuing to decline to do so, because I don't understand enough about finance to say if the depression risk is real, or how a bailout would help.

For what it's worth, I think

For what it's worth, I think you're spot-on.

Stocks aren't worth more, dollar is worth less

The stock market is "up" in terms of dollars because the bailout involves issuing more dollars, thus decreasing their value.

Your "look past the money to the stuff" is critical... but it's also critical to remember that contracts about "stuff" are valued in dollars, so either inflation or deflation is bad because it confuses economic calculation.

An interesting question is why we don't let grain elevators lend out 20 times more wheat than they really have...
http://www.strike-the-root.com/62/walker/walker1.html

Because no one borrows

Because no one borrows wheat. Besides fractional reserve bank do not lend more than their deposits, they lend more than their reserve. There's a difference.

<Vader> Your lack of lack of faith disturbs me...

>Because no one borrows wheat.

Then how do you sell it short? And I think in a famine, you'll be trying to borrow my wheat all right.. you'd better have good collateral. You're getting no subprime wheat mortgages from ME, buddy.

>Besides fractional reserve bank do not lend more than their deposits,

Step 1. Bank receives deposit.
Step 2. Bank calls deposit "reserves".
Step 3. Bank lends out 20 times amount of deposits, I mean "reserves".

Step 4. Confuse citizens about process, then get "bailout" payments in printed dollars.

a) You sell wheat short by

a) You sell wheat short by shorting a wheat future, which does not require you to borrow wheat.

b)
1. Banks receive 'deposit' (really a specific kind of loan)
2. Banks lends 19/20 of the deposit
3. Banks calls the remaining 1/20 reserves

good luck with your grain elevator business, you Sith

>a) You sell wheat short by shorting a wheat future, which does not require you to borrow wheat.

It does require you to borrow a promise of wheat (and sell it, to create the short)... which unless you're a @#%! crook, is wheat at some point in time.

>b)
1. Banks receive 'deposit' (really a specific kind of loan)
2. Banks lends 19/20 of the deposit
3. Banks calls the remaining 1/20 reserves

OK... try that with wheat, and how well does it work ;)

As you well know, the other 19/20 finds its way back into a bank, becomes "reserves", and gets lent out in turn. Otherwise, frac-reserve banking would not be inflationary, which it is. (BTW, since you know this better than I, a simple biologist, why are you obfuscating? Are you an interstellar lizard disguised as the Queen of England, or are you some kind of "do a bad deed daily" Sith Scout?)

Some Scottish banks in their period of free banking had "fractional-reserve" banking, but they had clear contracts about what that meant... they reserved the right to delay payments by specific amounts of time, then pay you interest.

Somewhat different from simply promising to pay people money that's not actually in the vault, but which you HOPE your friends in the Fed will print up for you at need.

a) No it does not, it's just

a) No it does not, it's just a bet. Besides many futures are settled financially (you do not have to deliver wheat, merely the dollar difference between the strike and the market price)

b) Again no point, people don't want to borrow wheat.

19/20 finds it's way back into banks only within a fiat money system. In a free banking world, the money that find it's way back into banks isn't reserve, it's exchanged for gold at the other bank, hence no multiplier effect.

Free banking has multiplier

"In a free banking world, the money that find it's way back into banks isn't reserve, it's exchanged for gold at the other bank, hence no multiplier effect."

You were doing good up till this point. There is a multiplier effect in free banking with a gold based currency. What "multiplies" is the deposits, or claims on gold, in comparison to the total amount of gold.

When the percent of deposits held in reserve is lowered the multiplier increases and you get monetary inflation, when the percent held in reserve falls you get deflation. The multiplier is the inverse of the reserve amount. If the reserve amount is 25% = .25 = 1/4 then the multiplier is 4/1 = 4.

Call it that way. I was

Call it that way. I was referring to the effect whereby money issued from credit by a given is used as a reserve in another bank.