TARP: The 700,000,000,000 Pound Gorilla

An insightful (and surprisingly accusatory) article at Bloomberg, found at Naked Capitalism.

This article corresponds to me greatest fears and addresses a very underserved thought.  As it has become clear that the only quality that the now-passed TARP possesses was it’s property of being ’something’ as opposed what was assumed to be far inferior course of action, ‘nothing’, the validity of that claim has to be addressed.  The Bloomberg article (among many posts at various economics blogs that I am not linking too, but I’m sure readers have stumbled upon in their own readings, that posit the adverse role the various emergency lending facilities have so far played in the economic breakdown we’re experiencing now) provides a fantastic and concise review of some of the dynamics previous interventions have produced.  It surprises me to no end how rarely active members (including Henry Paulson) of the financial sector have been consulted as to the effects the various federal market intrusions have had, or what to-be-enacted policies will have.

The Bloomberg article describes how the improvisational approach to a systemwide rescue so far enacted by Bernanke and Paulson have caused little beyond confusion paralyzing uncertainty within the financial sector.  My concerns are summed up in a single quote from the article:

“Every time you tinker with this delicate system even small changes can create big ripples,” said Dino Kos, former head of the New York Fed’s open-market operations and now a managing director at Portales Partners LLC in New York. “This is the impossible situation they are in. The risks are that the government’s $700 billion purchase of assets disturbs markets even more.”

Just as the introduction of the various lending facilities may have (in my limited knowledge, it seems highly logical that is has) frozen interbank lending by helping to hide the value of toxic assets (further clouding the balance books of banks, hence their trustworthiness), and by providing an alternate source of funds that demands little asset scrutiny, doesn’t the TARP run the same risk?

The Federal Reserve has managed to introduce itself into the lending market with an unfair competitive advantage, using its mandate to provide liquidity at all costs to effectively muscle out every other lending source.

Now the TARP seems intent to inject itself as a behemoth within the frozen MBS market as the only game in town.  By paying “hold to maturity” prices, even if that value could be accurately ascertained, they would be effectively outbidding all the existing competition.  As no investor has a comparable freedom of capital or low credit expenses as the TARP, and certainly no investor can operate on the expectation of likely loss that the TARP appears to operate on, how can a competing investor possibly outbid the TARP for a desirable asset?  Though MBS transactions appear to be rare, they do exist when a MBS holder is willing to lower their price (exemplified by Merrill Lynch’s sale at a 75% financed $0.22 on the dollar).  What limited activity that would be available to a willing seller is now shifted entirely to the public sphere.

Why should Merrill Lynch or any other bank sell to Lone Star Funds at $0.22 on the dollar (or effectively $0.055) when the TARP is willing to pay perhaps several times the amount?

Better yet, why should a private investor attempt to outbid the TARP when the TARP’s own objective is not even to achieve a probably return on investment, even with the TARP’s highly advantageous capital  conditions?

The backhanded compliments being paid to the TARP as being “better than nothing” are a drastic overstatement.  It is, in fact, far worse than nothing.  It greatly adds to the national debt (or is likely to do so), it paralyzes the very few active participants in the MBS market, and it drastically increases moral hazard, potentially exacerbating the cascading effect of this crisis or the onset of future crises.

The only positive action that could have come from the TARP as it existed (in any of its forms) is by it’s mere threat of use, as this fiscal nuclear bomb, it appeared to have paralyzed the declining market as investors watched and waited for the Fed and Treasury’s next crazy intervention.  This period of relative calm could have been used to find (or at least attempt to find) a solution that did not replace low-functioning private markets with 100%-subsidized public markets.

Instead, lawmakers from both parties, from the Senate and the House, and major players within the financial sector who stand to benefit (see Warren Buffet’s recent self-serving support for an omnipotent Paulson and TARP on Charlie Rose, shortly after taking, effectively, a $10b stake in Goldman Sachs), as well as their public counterparts (though it is hard to see how former Goldman Sachs CEO and current Treasury Secretary Henry Paulson can be a counterpart in any practical way to one of GS’s major investors) have opted to support the TARP as “better than nothing”.

I fear they are far too optimistic.

… and the cow goes moo (if it pleases God-King Paulson)