Bottom line: Paulson brings a bazooka to an H-bomb fight.

Bond update first:

As usual of late, today’s action in Treasuries was the exact opposite of the stock market: a massive sell-off.  High bond prices reflect fear, which hit a new high earlier this week. Today’s action was not just a short-squeeze. It was collective relief, a pause for our nerves. We will need them for what is yet to come. Here are the bonds (Bloomberg):

Click image for sharper view.

Does he even know how that thing works?

Like all of the bailouts, the planned socialization of (admittedly bad) mortgage debt puts another chain around Lady Liberty’s neck for the short-term of benefit of a few bankers. But hey, what’s another trillion or so when taxpayers are already on the hook for $100 trillion?

Here’s Paulson on the program’s ostensible goals:

The federal government must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy. This troubled asset relief program must be properly designed and sufficiently large to have maximum impact, while including features that protect the taxpayer to the maximum extent possible. The ultimate taxpayer protection will be the stability this troubled asset relief program provides to our financial system, even as it will involve a significant investment of taxpayer dollars. I am convinced that this bold approach will cost American families far less than the alternative – a continuing series of financial institution failures and frozen credit markets unable to fund economic expansion.

*Opposite rule of government action

According the rule of opposites (the most reliable indicator for predicting the outcome of government actions), we now know that the program will threaten the economy, not protect the taxpayer, cost far more than the alternative, and impede economic expansion.

The Sum of All Debts

And yes, these kinds of programs are highly inflationary, but they still pale in comparison to the size of the debt and equity that is imploding. The Fed’s balance sheet is 900 billion and growing, the deficit next year will certainly be over $1 trillion, and GDP, which used to ostensibly be $13.8 trillion, is shrinking fast. These figures put upward bounds on the payload of government’s bazooka.

To put this in perspective, Paulson’s gang is squaring up against the following:

• Private debt is roughly $50 billion (Federal Reserve: sum of domestic non-financial and domestic financial).
• The total capitalization of the US stock markets is roughly $15 trillion.
• Total residential real estate has been estimated at over $23 trillion.

The amounts by which the latter figures are contracting exceeds the government’s reflation efforts by some multiple. Deflation will continue — accelerating in the near term — and not abate until so much wealth has gone to money heaven that government’s expenditures finally surpass its rate of implosion. Despite the bailouts, and what will surely be a new New Deal and probably an expanded war in Asia, that point of equilibrium will arrive years from now. In the meantime, cash is king once more.

Risk hangover

One more point on the banks: they may be relieved of their bad debt and provided with fresh reserves, but the inflation machine will remain impaired because individuals and corporations have just learned a very hard lesson about debt and will be averse to borrowing for many, many years to come. Borrowing like we have seen in recent decades requires an appetite for risk, but the stuff now makes people nauseous.

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*Rule of opposites as applied to government action: Every action that government takes results in the opposite of its stated intention. (credit to Mish for identifying this law of nature)

• Affordable housing programs make housing unaffordable.
• Deposit insurance makes the banks unsafe.
• The SEC creates risks for investors but does not protect them.
• Free trade agreements are thick books of rules restricting trade.
• Social welfare programs create poverty and poor health.
• The Ministry of Peace (er, I mean Department of Defense) conducts offensive wars.
• Homeland Security makes Americans feel insecure at home and relaxed abroad.
• FEMA inhibits recovery from emergencies.
• The FDA keeps Americans hooked on drugs, many of them dangerous, and inhibits accurate labeling on food.

The list goes on ad infinitum.

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PPS — For a full rundown of why these bailouts won’t stop deflation, read chapter 13 of Robert Prechter’s Conquer the Crash. He predicted this exact scenario years ago.