This Game Of Financial Russian Roulette Could Ruin Our Life Savings

US markets surge, but the credit crisis problems still remain. Whatever happens, we all have a heavy price to pay, whether we like it or not. And that may include losing your house.

So now we know.

We know how the US stock market reacted the day after the night before. The Dow Jones Industrial Average jumped 485 points or 4.7%, with the Nasdaq showing similar percentage gains.

Not surprisingly, the markets gained on the hope and expectation that an amended US$700 billion bank rescue package would head back to Congress as early as this week for approval.

As I said yesterday, there is no choice for US politicians but to pass the rescue bill. The consequences for ordinary citizens around the globe of not passing the bill were plain for all to see - a 777 point fall in the Dow Jones Industrial Average, the biggest one-day point fall since the great crash of October 1987.

An Unpopular Bail Out

I fully realise this bail-out is not universally popular. There are many smart people who think it would be best to do nothing.

Jim Rogers, Chairman of Rogers Holdings and the man who famously predicted the current commodities boom, said on Bloomberg TV yesterday, doing nothing would cause "A sharp correction in the stock market and the economy, we would hit bottom, we would clean out the system, and we would start over (again)."

Jim Rogers has been bearish on the US economy for some time now, and he's been right, so his opinions should hold some weight.

Then there's the ordinary American citizens who have lost, are in the process of losing, or will lose their homes. You can understand why they are unhappy with the prospect of a Wall Street bail out when they are being left hung out to dry.

It's House Prices, Stupid

Unfortunately, there are no easy solutions. The Jim Rogers "do nothing" solution fails to address what happens to depositors when banks fail, what happens when the crisis goes global, and what happens to the value of pension and retirement accounts, amongst other things. And it still doesn't address the root cause of the problem - house prices, and people's ability to service their humungous mortgages.

There are two realistic things government can do to address people's ability to pay their mortgages.

1. Stabilise the economy as much as possible, including injecting some much needed confidence in the banking system. Falling interest rates will ease some of the mortgage burden. It won't save everyone, and it won't stop a recession, including rising unemployment. As money is pumped into the system, inflation will rise, in the short-term at least. There remains a heavy price to pay for the debt fuelled excesses of the last few years.

2. Introduce some sort of tax credit for people on low incomes with high mortgage commitments. But this solution is practically unworkable. What about people who have high incomes and high mortgage commitments? What about people who are renting? Why should people who didn't take on large mortgages and lived within their means subsidise the more profligate?

Winners & Losers Of The Last Bubble

I can't think of any other solutions. With the bursting of each bubble, there are many losers and few winners.

The dot com bubble was effectively a pyramid sales scheme. Buoyed by the success of some early dot coms, like Ebay (Nasdaq: EBAY), Amazon (Nasdaq: AMZN) and Cisco (LSE: CSCO) in the US and Autonomy (LSE: AU.) and ARM Holdings (LSE: ARM) here in the UK, private money poured into venture capital funds.

As share prices rose, private investors were lured into the market. This pushed share prices even higher, encouraged venture capitalists to invest seed capital in more and more dot coms, and the bubble blew bigger and bigger. By the time it started deflating, the smart people had already sold out of the pyramid scheme, leaving the Johnny-come-lately's holding worthless share certificates.

Lose Your House, Job Or Lifestyle - We All Must Pay

This house price bubble is different.

It affects far more people than the dot com bubble. Crucially, it involves large amounts of debt, magnifying the bubble more than it would have otherwise. It is global. Whether we benefited directly or not from the bubble, whether we are in serious financial trouble or not, we all have to pay.

Some people will lose their houses. Some will lose their jobs. Some will lose serious amounts of money in the stock market. Most will see the value of their pensions plummet. Unfortunately, there is little that can be done.

With the bail out bill, market forces will still largely play out.

Without the bill, we'd be playing a game of Russian Roulette, not knowing which financial institution was going to be the next to fail, and when.

Buffett's Last Word

I'll leave the last word to my favourite investor and one of the richest and smartest people on the planet, Berkshire Hathaway (NYSE: BRK.A) Chairman Warren Buffett, who in an interview on CNBC last week said.

"Last week we were at the brink of something that would have made anything that's happened in financial history look pale. We were very, very close to a system that was totally dysfunctional and would have not only gummed up the financial markets, but gummed up the economy in a way that would take us years and years to repair. We've got enough problems to deal with anyway. I'm not saying the Paulson plan eliminates those problems. But it was absolutely, and is absolutely necessary, in my view, to really avoid going over the precipice."

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> Of the companies mentioned in this article, Bruce Jackson has a beneficial interest in Berkshire Hathaway B shares.

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