UPDATE #2: Calculated Risk Continues his Thoughts on the TARP (or his version of TARP)

He provides some more thoughts on what he perceives TARP is going to accomplish, as well as what he believes TARP should accomplish.  He had a very similar previous post that he builds upon in his latest post (I commented on his previous post as well, here).

I have a few opinions about what the TARP will entail and how it will function that differ from CR’s here (but I’m going to repeat most of that in this post).

I have doubts the plan will achieve it’s primary goal, as assumed by CR (he seems to operating as if the purported goals and mechanisms of the Troubled / Temporary Asset Relief Plan are in fact true.  I have serious doubts, as I went into in more detail in my earlier post.  I believe the Treasury knows there is no REAL solution to the problem except to try to shift the crisis from a sudden fall to a slow bleed, and the only person with any blood left is the taxpayer… Even this isn’t a real solution though.  Nonetheless, the Treasury probably knows it’s not a good idea to tell the taxpayers you have volunteered them as donors).

If the primary goal is in fact to get banks lending again, not only do the MBSes and related assets have to be taken entirely off the banks’ books, with no recourse, but the TARP will have to (as CR says) bid at prices well above what the market might value them at currently.  Considering the mass of ‘troubled assets’ these banks appear to have and the prevalence of 30:1 leverage, even taking a substantial haircut through a much-higher-than-market-priced TARP purchase could lead to insolvency.  I think the TARP would have to pay near the full original-valuation price to keep many major institutions from failing (even if they aren’t technically insolvent after taking a taxpayer-subsidized mere 20% loss on their MBSes, having to report the 11-digit losses might incur enough shareholder wrath to make the bank unable to raise any more funds to support future lending and send them into the same descents that caught BSC, LEH, MER, AIG, etc).

***RAMBLING THINKING-OUT-LOUD COMING UP, UNRELATED TO CR’s COMMENTS**

The way I see it, the TARP may be designed to function by just taking on the assets and sitting on them, helping to relieve some capital concerns from the banks that way (perhaps, as I really don’t imagine investors being that consoled by it to return to business as usual) and restoring them to their original owners in some way after the market has calmed; sitting on them until inflation and (in the Treasury’s unlimited optimism) increasing home prices makes the MBS purchases look less subsidized-y; or just having taxpayers swallow the losses from reselling them at market prices

In more detail, I think the only purpose the framework for the plan is likely to serve when put into effect is either blessing these assets that the TARP takes with that special TARP touch (if the Treasury believes that the assets themselves are not of a real value so low as to constitute a solvency crisis for the institutions that hold them, then they may believe the lack of buying demand for them is due to an inaccurate pale being cast on these assets, diminishing their market value.  The TARP may intend to somehow reveal the true, “no one else can see it but me” value in these assets) or by purchasing these assets without showing the wider market what was paid for them (so no one knows how low the value is, or how much the TARP is overpaying by) and then discreetly selling them off (perhaps by re-grouping the underlying assets into new securities, selling the highest quality ones where the dollar amounts won’t cause a panic, and holding the worst assets until they can politically afford to liquidate them or until maturity).  As I said in my previous post, at $700 billion, they could certainly just hold the assets without much turnover and still make a huge impact on the market.

***RAMBLING CONCLUDED***

I am uncertain about how accurate CR’s gambler analogy is either.  He seems to look at the $700 billion cap as a fund that the TARP starts with.  From what I’ve read, the framework suggests that is the case but seems to leave it open that it could be much more costly.  As opposed to having $700B to blow on assets until the TARP is tapped out, I believe that the TARP is able to hold $700B at any given time, technically, so if they buy $700B, sell it all at a 50% loss, they can buy another $700B, thereby having cost taxpayers $350B right away, and still have another $700B owed.  The wording in the plan (a draft of which can be found here at the NYT) sets the national debt limit at $11,315 billion, an increase of $700 billion from the current cap ($10,600 billion), suggesting CR’s interpretation is correct.  Makes sense.  But it does have room for abuse.  As the current US debt is only ~$9,700 billion, couldn’t the TARP keep extending to the $11,315 billion limit, costing taxpayers over $1.6 TRILLION DOLLARS?  The TARP is just limited to “$700 billion outstanding at any one time”.  They could lose a  trillion and still have a full $700 billion of assets on hold.  Who thinks any room provided in the agreement, which clearly states that there will be no oversight, won’t be used and abused to the limits of human creativity? (Cernig at Newshoggers references a great term that I was not familiar with to sum up the passage of the draft that insures a blinding lack of oversight: The “God calls me God” clause)

CR’s final suggestion is a fantastic one, but I believe the whole point of the TARP (not just due to it’s clever abbreviation) is to provide a cover for these assets.  The actual value of the MBSes, assuming the 35%-40% falls from peak that many are predicting in US housing prices (Meredith Whitney, for one), are enough to bankrupt the overleveraged institutions (ex. ALL of the financial institutions), and no one is willing to face up to this reality, understandably.  There will be no disclosure, I am certain of that much, from the TARP’s side.  I can think of a few extraordinary excuses that could be used to dodge and delay disclosure, but our only prayer is that we can deduce the amounts from the seller’s books every quarter.  Or that my Euro holdings continue to rise and I can buy Hawaii in 2012.

UPDATE:

Naked Capitalism’s Yves Smith seems to agree with my interpretation of the $700 billion limit (please visit NC for the full post and context, but here’s the sentence in agreement with my point, emphasis mine):

“The bailout bill $700 billion figure (which could be larger, since that is the maximum outstanding at any one time; the real limit is the increase in the debt ceiling) amounts to $2000 a person.”

UPDATE 2:

Paul Krugman and Brad Setser seem to agree with my suspicion that even paying ‘fair’ market prices will be a problem (Paulson has now apparently suggested he plans to base the purchases on hold-to-maturity prices), unless they’re MUCH higher, the prices will still be low enough to bankrupt many overleveraged institutions.  Except unlike me, Brad Setser actually did some math.  Apparently … And The Cow Goes Moo is NOT the premiere site for serious economic analysis.

… and the cow goes moo