The political response to this economic downturn has differed from previous responses to downturns in a number of ways, the most economically significant of which lies in the extent to which failure has been subsidized. Counterproductive economic pathologies have been encouraged, financial structures that endangered global prosperity have been bailed out and trillions of dollars have been poured into industries that obviously needed to downsize. Far from providing “stimulus” such subsidies both deepen the recession moderately and extend its duration inordinately.

Let’s start with the most recent example, the $1 trillion Term Asset-backed Securities Loan Facility announced last week, the purpose of which will be to revitalize the securitized lending markets for credit card loans, automobile loans and home mortgages. This will have two major economic effects, one of which was advertized. The advertized effect will be to allow more consumer lending to take place, which in turn will at least in theory boost output. The unintended consequence is that it will provide subsidized competition for the US banking system, reducing the profitability of banks’ new lending. Those new bank profits are needless to say much needed in order to fund the losses on old loans that have turned out delinquent.

The theory behind TALF breaks down when you remember that the US economy has for years suffered from an inordinately low consumer savings rate. Since 2000, the economy has been imbalanced by a savings rate near zero, while the balance of payments deficit has soared to 6% of Gross Domestic Product. In order to arrive at an economy that is sound in the long term, the balance of payments deficit must be eliminated, or close to it, while the US savings rate needs to rise to its long term average of 8% — or preferably rather higher, to rebuild savings depleted from past savings shortfalls and asset price collapses. Subsidizing credit card, automobile and home mortgage loans is pushing the consumer towards behavior that has wrecked the economy, in precisely the reverse of the direction he needs to go. The $1 trillion is thus a subsidy to failure; as a side effect it will produce a high percentage of loans that eventually default.

The other effect of TALF, providing subsidized competition to the banking system’s attempts at recovery, is also pernicious. We have seen in the past two years what effect securitization has on the financial system. While it appeared for many years an innocuous (albeit excessively legally pernickety) addition to the financial toolbox, it has now become clear that since it separates credit origination from credit risk, it allows financially untrained salesmen with high-pressure techniques to make inordinate amounts of money at the expense of the nation’s credit quality.

Whether through zero percent loans used to finance unnecessary new automobiles, incessant unsolicited credit card offers encouraging consumers to run up their credit usage beyond all reason or home mortgage originations that place supermarket counter clerks in $700,000 homes, securitization has produced a great deal of lending that is thoroughly economically damaging. There is probably not a case for making securitization illegal; there is certainly a good case for a “stamp tax” transfer duty that makes it in most cases economically unappealing and limited to only a few particularly efficient uses.

Currently, the Federal Deposit Insurance Corporation is increasing the fees it charges to banks, further increasing the attractiveness of spurious securitizations over honestly acquired bank deposits as a means of financing loans — again a step in precisely the wrong direction. The US economy needs consumer credit that is limited in amount, offered only on a conservative basis and (currently) highly profitable to the banking system. It will get the opposite.

Looking to the future — although this program has now been hovering in the near future for six months, because the Treasury can’t figure out how to make it work without excruciating rip-offs of taxpayers – there is the $1 trillion proposal to buy toxic mortgage and other assets from bank balance sheets. This will divert $1 trillion into the most unproductive assets on the planet, the lowest quality mortgage, credit card and commercial real estate loans made during the crazed easy-money bubble of 2004-07. Pure subsidization of failure, nothing more, substituting unproductive uses of capital for others that could help the economy recover.

While we’re on the home mortgage sector, let’s not forget the new $300 billion program to reduce interest rates and in some cases principal amounts on mortgages that are delinquent or nearly so. No equivalent subsidy will be given to mortgages that were taken out on a sensible basis at reasonable long-term fixed rates for a sound percentage of home values. Thus the worst borrowers and the most overpriced home sales will be subsidized at the expense of the rest.

In the banking sector generally about $700 billion has been or will be spent through the Troubled Asset Relief Program, mostly used to provide preference share capital to banks. The largest recipients of these funds have been Bank of America and Citigroup, the two banks whose past lending and acquisition policies have been most egregiously foolish. Fannie Mae and Freddie Mac, poster children for a failed model of home mortgage finance, have also received several hundred billion dollars in TARP and other funds. It has been clear for some time that the financial services sector grew uneconomically dominant over past decades and needs to downsize, probably by about half; TARP capital works against that healthy cleansing process. Even in productive banks, any tendency to welcome TARP capital injections has been negated by imposed restrictions on dividend payouts and top management bonuses, intruding the dead hand of Federal meddling into the better banks’ operations.

The US Treasury’s encouragement of dividend payout cuts is another reward for failure. High dividends perform economically useful functions in preventing overaggressive corporate expansion, limiting grants of stock options (which are made less valuable by them) and focusing investor attention on the soundness of company operations rather than on chimerical earnings gains. The decline in global stock markets has returned investor attention to dividend yields; this will greatly benefit the world economy going forward. The US Treasury’s restrictions are especially pernicious in an era when, through unrestricted short selling and the credit default swap market, “bear raids” can be staged on banks, more or less without limit, thereby pushing them into catastrophic withdrawal of lender confidence. High dividends, which attract retail and other high-yield investors, are the one sound defense against such bear raids. Banks that have cut dividends sharply, such as US Bancorp last week, have found their survival endangered by collapses in their share prices.

Of the capital injections into financial institutions, the most damaging of all, even worse then prolonging the destructive careers of Fannie Mae and Freddie Mac, has been the $180 billion injected into the insurance company AIG. Not only has thus subsidized the continuation of AIG’s financial products operation, about the most wealth-destructive participant in a highly wealth-destructive era on Wall Street, but it also has subsidized by some large fraction of $180 billion the wholly unsound credit default swaps business. Had AIG been allowed to fail, the CDS market, the dangers of which I wrote about last week, would have been exposed as the destructive scam it is. Those AIG counterparties who themselves survived would have fired their CDS dealers and redeployed resources into more productive – or at least, less destructive – operations. As it is, the CDS market has been artificially endowed with a new lease of life, and will no doubt cause further even more expensive financial catastrophes down the road.

Then there’s the auto companies – my guess for their bill is $100 billion, all of which will go only into companies that fail, possibly excluding even Ford, just as American as GM and Chrysler but significantly better run.

Finally, in the public sector, much of the $787 billion “stimulus” bill also subsidizes failure and waste. Ignoring philosophical discussions about the value of new-age energy sources or Mag-lev trains to isolated casino resorts, the two largest items in the package are subsidies to states, the majority of which will go to the states that have overspent most, and subsidies to education, which, given the current structure of education and its funding, will mostly go to the districts that produce the worst educational results. About $300 billion is to be spent on these two subsidies to failure.

To estimate the economic effect of all these subsidies to failure, you need to estimate by how much these failed investments are inferior to the marginal potential use of capital, bearing in mind that each trillion dollars devoted to failure is a trillion that is not available for success. Clearly only a portion of these failure subsidies go to assets or operations that are completely worthless. Equally, few of the subsidized failures stack up adequately against free-market uses for money. Let’s be slightly generous and say that on average the subsidized operations are only a third inferior to the market as a whole.

The total of subsidies outlined above has been roughly $3.9 trillion, disbursed and committed. That $3.9 trillion of subsidies will reduce long-term GDP, compared with the free market, by about a third of $3.9 trillion, or $1.3 trillion. Naturally, that reduction will itself have a Keynesian multiplier – diverting capital to worthless uses today will likely result in further suboptimal activities tomorrow. However, even if you ignore the multiplier, $1.3 trillion is about 9.2% of current GDP. In other words, GDP over the next few years will be 9.2% lower than it would have been without the subsidies for failure.

9.2% of GDP is four years’ per capita US economic growth, at its average rate. Now perhaps you see why this column’s current economic forecast is for a recession that is not necessarily particularly deep, but is artificially appallingly prolonged.

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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)