Despite the hopes and prayers of the US government (to the extent that Big Hank reportedly got down on one knee in front of Speaker of the House Nancy Pelosi), Democrats and Republicans gave the Paulson bailout plan the big thumbs down in Congress yesterday, sending global markets into a tailspin in the process. Risk Watchdog was not overly surprised by the decision: after all, with America heading to the ballot box in less than two months, US Representatives up for re-election in marginal seats are extremely wary of upsetting an angry Joe Public. However, the gravity of the situation must surely force Washington to take measures this week to restore confidence in the US financial system, or risk an even worse fate. Indeed, looking at some of the awful charts out there, a run on some of the country’s battered commercial banks cannot be ruled out.

What happens next is anyone’s guess, but here’s what I think:

A watered-down version of the original plan could yet be on the cards, probably with a reduction in the amount made available for debt purchases, increased oversight of the purchasing programme, and with more protection for the taxpayer.

Failing this, the government must look to alternative measures to ease Main Street’s fears. I suggest taking a leaf out of Ireland’s books and enacting an increase in the level to which deposits are insured by the Federal Deposit Insurance Corporation (FDIC). This number could be much higher than the US$100,000 currently protected by the FDIC and should be accompanied by a statement by the President, or better still, any other high ranking official available for comment, to ram home the fact that Americans’ deposits are safe. Such a measure would surely receive the blessing of every member of congress regardless of political ideology.

If I am proved right, an equity bounce could be around the corner, particularly given the magnitude of Monday’s sell-off, although it would be far too early to call a bottom. The state of the money markets is dire, and if funding pressures on US businesses continue, the real economy will be negatively affected, and the danger of a long and prolonged recession will increase. The risk that I have been shouting about for ages, that the Dow drops to 9,000, is still very much in play.

If I am proved wrong… well in the words of George W, this ‘sucker could go down’!