Bailouts, bankruptcies and cold, hard cash

First the world witnessed the US government's 700 billion Troubled Asset Relief Program (TARP) in 2008. Over the weekend, Europe followed suit with a combined EU / International Monetary Fund (IMF) Euro 750 billion program designed to 'save' the European economies.

The US was brought to the brink by the collapse of a 'smallish' investment bank, Lehman Brothers. Europe reached the edge due to the shenanigans of a 'smallish' economy: Greece.

It was not the two individual events that created the collapse. It was the aftermaths of the Lehman and Greece bankruptcies (yes, Greece is bankrupt) which precipitated the crises.

The systemic risks were revealed by seemingly minor incidents, the law of unintended consequences at its best.

TARP has seemingly achieved its purpose as the US financial sector remains intact. The details of the EU / IMF program have not yet emerged though initial stock market reactions were wildly bullish.

Irrespective of the short term benefits of the two programs, there are serious long term consequences which the world cannot ignore.

With each passing moment, US federal government debt increases. The US debt clock moves faster than ticks on the New York Stock Exchange ticker tape on a thousand point day!

Europe will be no different. The bailout package, which amounts to approximately 8% of EU gross domestic product, will result in EU nations adding tremendously to their national debt.

Financial liabilities are just as real as financial assets.

Sara, who owns shares worth one hundred dollars, has a real, marketable asset. Wasim, on the other hand, owes one hundred dollars to the bank. Wasim has a loan and liability just as real as Sara's assets (shares).

The world seems to be overrun with borrowers lately– both in the form of individuals and countries. Hence, 'rich' government's step in and somehow 'adjust' the liabilities. (Rich = able to borrow or print money without immediate financial repercussions.)

However, no matter what governments' do someone has to take the pain of Wasim's one hundred dollar loan that is neither being serviced nor repaid. Wasim returns to normal life, without the debt, and the bank writes off the loan. The government guarantees the bank so everything's fine.

Back to the government – where does it get one hundred dollars? It borrows or prints the money because it does not wish to upset the quality of life of people who have already borrowed too much. Even governments' cannot borrow or print money forever. Or they become the Greek government.

In other words, the US and the EU must raise taxes or cut spending in the coming years if they are to remain financially solvent. The other option is to 'inflate' away the problem – repay the debts with paper money that is printed and worthless.

Many parts of the developed world partied hard for two decades, from the 1990s until 2008. Entire populations lived beyond their means for years. (For various reasons, whole swathes of the world, the 'Emerging Markets,' could not crash the party.)

The world can wait for the next bailout to rescue us, again. Then again, the 'shock and awe' strategy behind bailouts is fast losing its sheen. Perhaps, the old fashioned values of thrift and common sense (remember the notion of spending less than one earns?) remain the only sustainable hope to ride out the financial crisis.

Alternately, we can all start praying that the problems miraculously disappear in a few years.