Like it or not, more government rescues are on the way

Despite the public outrage that will inevitably arise from a government (and thus taxpayer) bailout of Wall Street firms and borrowers caught up in the mortgage crisis (rumor has it homebuilders have been told not to expect much, if anything, from the White House), it looks like a series of smaller bailouts (such as Bear Stearns) will ultimately result in a much larger rescue. For renters waiting to pounce on heavily discounted homes, that may come as bad news, and they continue to rally against a bailout. But what they don't understand is the consequences of doing nothing is far more important than their desires to (a) allow the market to punish the greedy and the stupid; and (b) snap up a bargain once the dust has settled. From an article in the L.A. Times:

...some experts say Bear Stearns' woes warn of potentially larger calamities that will severely test the Fed, the economy and, ultimately, taxpayers as the government gets more deeply involved in fixing the markets' troubles.

"We will lose, in some form, several major financial institutions before this is over," said veteran economist Allen Sinai of Decision Economics Inc. in New York.

The heart of the problem is that the nation is living through an unwinding of a 25-year-long, consumer-led borrowing binge. Bear Stearns was a key player in financing that binge, most notably in high-risk mortgages...

"We have far too much leverage in the system, and we're now in the process of de-leveraging," said Tom Atteberry, a money manager at investment firm First Pacific Advisors in Los Angeles. "We think there's a lot more to go."

That mentality is widespread, and it is feeding on itself: Investors don't want to pay current market prices for mortgage-backed bonds and other debt because they worry that more borrowers will have trouble making payments. That further shuts down lending, making credit tighter and squeezing more borrowers...

At times like this the focus for Wall Street firms primarily is on surviving. No bank or brokerage will lend to a peer, even in routine daily transactions, if there is any doubt at all that the borrower can repay. Failure then can become assured once rumors start about a firm...

Wall Street's propensity to abandon its own has sunk all sorts of financial institutions over the last century. In 1984 the government had to rescue Continental Illinois, then the seventh-largest bank, once creditors pulled the plug. Brokerage Drexel Burnham Lambert Inc. failed in 1990 after its funding lines were cut...

But the current crisis is far larger in scope than those. Because so many banks, brokerages and investors were involved in financing the recent real estate boom -- the biggest housing bubble ever, by many accounts -- the growing problem of mortgage defaults infects nearly every corner of the financial system...

That is why a bailout is becoming more of a certainty --when the U.S. economy is at stake, politicians have no choice but to risk the ire of angry renters who don't support such a move by risking their tax dollars.

Across Wall Street, there is a widespread belief that the Fed's use of its own capital to shore up Bear Stearns is just the first step toward an eventual government bailout of the housing market.

"The history of major financial crises is that the government is going to come in at some point," said Richard Sylla, a professor of financial history at New York University.