"America can always be counted on to do the right thing, after it has exhausted all other possibilities." - Winston Churchill

The recently passed $700 billion bailout bill does contain the authority for the Government to buy new preferred stock in troubled financial institutions. At yesterday's news conference, Secretary of the Treasury Henry Paulson indicated that he might just do that. This would be following the lead of the U.K., which yesterday indicated that they are buying major stakes in its most troubled banks.

This is exactly the approach that will do the most good. The core problem right now is that we have an over-leveraged financial system which is trying desperately to de-leverage. When all try to de-leverage at the same time, it drives down asset prices, which pushes down equity even further, which actually causes leverage to go up.

Simply buying troubled assets is likely to be very ineffective in such a situation. If a firm is leveraged at say 25:1, with $1 billion of equity supporting $25 billion of assets, then an incremental billion spent buying assets will only reduce leverage to 24:1. On the other hand, injecting that same $1 billion onto the equity side of the balance sheet will reduce the leverage to 12.5:1.

In addition, equity prices are very transparent, so there will not be a question of if the Government is deliberately overpaying to favor some institutions with more political pull. The "toxic assets" prices are anything but transparent.

Buying big slugs of preferred stock also accomplishes two other critical objectives. First, it gives the taxpayers the best possible shot at actually making money out of this whole mess. Second, it punishes the existing shareholders by diluting their stake. If those that enjoyed the fruits of all this poor lending on the way up do not suffer -- and instead are simply bailed out -- then people will be encouraged to act recklessly in the future.

We knew that the authorization was in the package, but honestly I did not think that this administration would use it. After all, government ownership of major financial institutions, even if only temporary, is pretty much the dictionary definition of Socialism. I was hopeful that the next administration would, however, and am very happy that Paulson has come to his senses and seriously considering such a move.

The coordinated rate cut yesterday by most of the major central banks of the world was also the right thing to do. The question is: Is it enough? There was a little bit of evidence yesterday that the credit markets are becoming unstuck, but it was tentative at best. The longer the credit markets are frozen the worse the damage will be on Main Street. A nasty recession is pretty much already baked into the cake, but a depression is not.

The market is deeply oversold, and is already 35% off of its highs, which is worse than the average bear market.