The markets in the US did not take at all well to Henry Paulson’s announcement that he wanted to get his hands on the rest of the TARP allotment (a remaining $350 billion) and spend it so as to help consumers go to the mall again. As one correspondend, Andrew, noted:
1) Is the dog-chasing-its-tail nature of using taxpayer money to buy securities backed by taxpayer (consumer) debt not immediately and effortlessly obvious? It took almost no imagination for me to realize how absurd and self-defeating that is.
2) Do you think that Paulson and his cadre are completely aware of how absurd it is, and laughed and slapped each other five when they came up with it? Or are they incredibly dense?
Needless to say, the nasty selloff in Asia overnight says they are not very impressed with this move either.
As we have noted before, intervening in a tightly-coupled system like a nuclear reactor or our financial system, as Richard Bookstaber said, often makes matters worse (the system is so tightly integrated that any move will create diffcult to predict and often destabilizing knock-on effects. We have discussed these unintended consequences in the past.
One is that, particularly with stock prices low and trading in equity and other markets thin, forced selling by hedge funds is even more disruptive than at normal times. And with hedge funds deleveraging for a whole bunch of reasons (margin calls, investor redemptions, tougher standards at prime brokers), distress in one market leads to margin calls, which can lead hedge funds to sell not the asset subject to the margin call (if that market is tanking, you will get a terrible price and would make any similar positions worse) but one that is less impaired, which could be in a completely different market.
As reader Steve pointed out, courtesy Calculated Risk, the ABX (an index of asset backed securities derivatives) and the CMBX (an index of commercial mortgage credit derivatives) went into cardiac arrest when Paulson announced the change in TARP focus (using CR’s preferred term, “cliff diving”):
.I have to believe there i … pain in funds that switched their bets when TARP was announced.
From a Reuters story:
A key subprime mortgage derivatives index fell one to three points on Wednesday after U.S. Treasury Secretary Henry Paulson said he was backing away from buying troubled mortgage assets using a $700 billion bailout fund, in favor of more capital injections, market sources said.
The top “AAA” layer of the ABX 07-1 index, which reflects troubled mortgage loans made during the first half of 2007, sank nearly three points to 38 from 40.96 at Monday’s close, market sources said. The “PENAAA” 07-1 sub-index fell one point to 50.50, versus 51.54 at the prior close, market sources said.
Three points on 41 is 7%, and if you were levered, might get hit. Now the question is whether anyone did try bottom-fishing in enough size to make a difference.
The other more obvious source of pain may be for those who went long financials, as Ken Heebner reportedly did recently.
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This just hot of the press! The Australian Security’s Agency has ceased all naked short selling wheeeee!
Skippy
In my opinion the correct interventions are being made. The problem however is that the timing is completely wrong. To expand on the nuclear reactor analogy, the reason every measure backfires is because they try to keep it running rather then shutting it down first and then restarting it.
Finance is about trust. And trust will not be restored until a vast majority feels the bottom has been reached. It is then and only then that stimulants and other interventions are actually going to do what they are supposed to do. This whole “keeping the boat afloat” state of affairs is just keeping uncertainty firmly entrenched in everyone.
I went to markit.com, and looked at the abx.bb prices. I don’t see that abx went from 90 to 4 today. More like from 6 to 4.
I hear that markets are dropping because hedge funds are liquidating a lot. It is probably true, but the statement is becoming such a truism (like growing money supply will cause inflation) that people are being less rigorous with their analysis.
There are large interconnected non-linear factors at play beyond hedge funds as the world is deleveraging and the velocity of money is dropping, and savings are rising.
Is the dog-chasing-its-tail nature of using taxpayer money to buy securities backed by taxpayer (consumer) debt not immediately and effortlessly obvious? It took almost no imagination for me to realize how absurd and self-defeating that is.
You can say this about almost any fiscal stimulus. The success of any such intervention relies on people having absolutely no imagination.
bg,
I have not looked at the ABX since they quit providing charts and was not certain whether the highs listed were contract highs or daily highs. The table labels say they are, but the MarkIt site is surprisingly poorly documented.
Steve wrote to say he misread the tables. Note that CR had deemed the moves to be “cliff diving”. I have revised the post using a news story from Reuters. Thanks for the catch.
ndk,
The key for fiscal stimulus is to get the dough into the hands of people with a high propensity to spend. Giving money to banks who may lend to people isn’t a very good way of going about it. Too much leeches out in salaries to bankers who are well enough paid that they are trying to pay down debt, and a lot goes directly to the bank paying down its own debt.
And direct payments to consumers have to be targeted. Various analyses of the tax rebate found that about 80% was saved.
So the next stimulus package should consist of Wal-Mart gift cards?
Funny, but people could save them for emergencies or gifts. In fact, if distributed in enough scale, they could become an alternative currency.
I know it’s fashionable to criticize Paulson no matter what he does, but IMO directly re-capitalizing banks (though I’d make it more onerous for current management and shareholders and give taxpayers more upside) is an infinitely better solution than simply buying up rotten assets at uncertain prices.
On the other hand, Congress really needs to get to work and put some real boundaries and real oversight on this stuff. It can’t justbe Paulson deciding to do whatever he wants on a day to day basis.
“can’t just be Paulson deciding to do whatever he wants on a day to day basis”
Paulson may be completely wrong… or worse. IMO, he is trying to support the value of a payment stream backed by deflated financial (MBS) and physical (homes) assets. The object of the bailout approach seems to be to create another synthetic market by hiding the true value of the cash flow from market price discovery. For the moment, sufficient cash is made available from the government but no one will buy the defective assets because they know that, ultimately, the synthetic market is unlikely too continue.
At some point, the market price discovery process will determine the bottom. The housing market will begin to stabilize when the overall cash flow price of owning the home (price and interest rate) is within the means of the income of the average bloke. This will be at a drop of 40 % at 7 pct interest or 20 pct at 3 pct interest.
The government would be better off to intervene legally in the name of national security,to modify the terms of MBS issues and flawed mortgages (CDS and CC debt ?), splitting the pain between the the financial parties and home owners.
It is in the interest of the nation that the terms of defective mortgages and MBS be changed to provide interest rates that are low enough on overpriced housing to compete with new housing selling prices in the open market.
The banks and the security owners would agree to subsidize thirty year, assumable, fixed rate financing at rates that will clear the market of their defective capital. They must also accept a cram down of the defective housing price. The government money should be reserved to help with a guarantee, reserving the right to reject any guarantee and transferring the loan terms to new buyers if a home defaults.
All parties involved will share in any future capital gains. The program will be limited to only those homes built prior too some prior date in 2008.
This would be the only way I can think of to support the defective housing prices above current market prices and allow the housing market to equilibrate.
The more these fools do, the worse this will get, the longer it will last, and the more damage they will inflict.
Better late than never. The new targeting is better than the old. Sure there’s a pain of transition, but I’m still glad they appearing to doing the right thing (or closer to it.)
So some of this is being caused by Hedge Funds with new bets? While I dont like the government changing tactcs like this, although I think this is a better direction lets pray its the last tack. But why are these guys still placing huge leveraged bets?
If highly leveraged bets is what is making the system so unstable then what the heck is going on? So, should the government not do the right thing because it will cause Hedge Fund margin calls? Who is continuing to lend money to those guys anyway, I thought we were in a credit crunch?
Forgive my ignorance but it strikes me as these guys will play poker till the table and the cards burn, and even then they will continue based on memory of the last hand. How do you isolate these groups from the system now, besides making it illegal (unenforceable I suspect)
Maybe I am missing the point though.
The key for fiscal stimulus is to get the dough into the hands of people with a high propensity to spend. Giving money to banks who may lend to people isn’t a very good way of going about it. Too much leeches out in salaries to bankers who are well enough paid that they are trying to pay down debt, and a lot goes directly to the bank paying down its own debt.
Yves, I would have agreed with you wholeheartedly 6 months ago. Today, I'm not nearly so sure, for three reasons:
1) The absolute scale of rebates that can be given to those with a high marginal propensity to spend is not that great. Food stamp and unemployment benefits could never be very large relative to GDP as it stands today, and I hope it stays that way.
2) People who are terrified will try to save the money, as they did with the first rebate. It was very poorly targeted, but it's not clear to me that the results would have been dramatically different if it weren't.
3) This sort of assistance is purely consumptive, and doesn't really lay the groundwork for true further economic development.
I still think it's incredibly important to get help to the poor and laid off for humanitarian reasons, and I totally agree that giving it to the banks is either really dumb or really mendacious, and knowing your background, it makes me cheer that you say the same thing.
I would much, much rather see the government dumping its money on things that the private sector is bad at that do lay the framework for future growth: infrastructure, and basic R&D.
I think it is extraordinarily simplistic to say:
“Needless to say, the nasty selloff in Asia overnight says they are not very impressed with this move either”
It’s quite an extraordinary leap to claim that all of Asia ONLY reacted to this statement last night. What about the Intel news? That had zero effect?
Asian markets are reacting to a HOST of factors, including but BY NO MEANS limited to Paulson’s statement.
The Shanghai bourse was up. How is that accounted for in your statement? Shanghai is not trivial.
Matt Dubuque
Matt Dunsel: The overall trend is down, Intel confirms it. Markets searching for a bottom. Real Estate is correcting as necessary. Another world currency meeting as the situation appears dire. The Treasury has money to give to the desperate but no one likes the strings that are attached. And still they create derivatives OTC.
You can’t force consumers to spend. (as they hoard their walmart gift cards)
QUOTE OF THE DAY:
The Fed is unable to buy tier-two companies’ commercial paper because the “law requires we be adequately secured,” Bernanke said during an Oct. 20 House Budget Committee hearing.
Don’t panic – all fed lending is on adequately secured assests. That’s a relief!
November 13, 2008
I’m really surprised that someone on this blog hasn’t yet figured out why Hank baby had to switch from buying “troubled assets” (bad mortgages) to “investing in bank preferred stock”.
Answer:
Benny already has all of the really rotten “troubled assets” moldering away in the basement of the FED (Fetid?) as he keeps playing ever new versions of “Roll Over Beethoven”” Over night, 28 days, 180 days , and finally for now, “Ah hell guys whenever.” to the present estimated total of $2 trillion plus.
Earl L. Crockett
Santa Cruz, CA
“Banks have increased their reserve holdings on deposit with the Fed from $8 billion to $494 billion. This is $488 billion more than the Fed estimates they would ordinarily need to hold for payment clearing and prudential purposes.
Increased reserve holdings have absorbed perhaps half of the liquidity placed into the banking system from the Fed. Much of the rest has almost certainly been invested into the mountain of Treasury bills the U.S Treasury has been issuing. Only a very small proportion is left for re-lending to the real economy.”
That’s a quote from John Kemp’s good article today on “Tarp and Fed facilities unravel” at Reuters. It’s a great read:
http://blogs.reuters.com/great-debate/2008/11/13/tarp-and-fed-facilities-unravel/
Matt,
I am getting sick of your preening. I saw Asia open, and Paulson’s comments WERE a big factor in the market action.
Get over yourself.
You are not the expert you pretend to be, and I am tired of your need to pipe up whether you have anything useful to say or not.