Misunderstanding the bailout

Ever since Jim Cramer had his fixed income meltdown, I can't help watching him. It is the strage mixture of arrogance, ignorance, and greed, that makes him so compelling.

In this clip, Jim says if only the US government appointed him as the head of this new bail-out fund, the US taxpayer would actually make money. Like all good salesmen, he would "buy low and sell high".

Admittedly, that suggestion was only half serious. However, Jim's understanding of how this bailout scam will work was more worrying. He thought that the new fund could buy distressed mortgage debt for 20 cents on the dollar. Later, when markets have stabilized, he could sell it at a profit.

That would defeat the object of the bail out, since the remaining 80 cents have to be recorded as a loss on bank balance sheets. The losses would have to be netted out against capital, leaving the banks crippled.

Here is the key point of this bailout; in order for it to work, the government must buy this debt close its original face value. That way, banks can maintain their current level of capital and then restart their lending activities. This scheme, if it is to work, must transfer the bulk of these mortgage losses directly to the goverment balance sheet.

This scheme is not about "buy low, sell high"; it is about "buy high, sell low".