TARP Troubles

Checklist of problems about TARP ( Troubled Asset Relief Program ) By the way, MLEC = Master Liquidity Enhancement Conduit:

1) Possible conflicts of interest with the administrators of the plan:

"Still, some investors are troubled by the government’s heavy reliance on private firms. They said it would be difficult to prevent firms from steering capital in ways that favor their private customers.

Inevitably, large asset management firms own, or are tied to banks that own, some of the same securities the government is seeking to sell. Pimco, for example, is owned by Allianz, one of Germany’s largest insurance companies. Merrill Lynch owns a stake in BlackRock.

“I can’t even fathom how I would manage that,” Mr. Siegel said. “How would I manage one side, where I’m seeking to maximize profit, and the other side, where I’m looking out for the social good?”

The law stipulates that the government must prevent conflicts of interest in the hiring of firms, the decision of which assets to buy, the management of those assets and even the jobs held by employees after they leave the program. But it leaves the details to the Treasury."

2) Overpaying for assets.

"Other than helping attract private capital by cleaning up the institutions' balance sheets, I'm not sure how this plan helps the financial system recapitalize. Hopefully Mr. Paulson doesn't intend to pay a premium, not just to the current market value, but to current book value, for the toxic assets. But how else could the plan help the financial system recapitalize? "

And:

"The bailout is not a way of preventing the loss of value. The loss (or transfer) of value occurred when people made bad mortgage loans. What happened more recently was the recognition of that loss. All the bailout can do is to shift the loss from some people to others, from the stockholders and creditors of firms that are now effectively bankrupt to the taxpayers."

And:

"And as with the MLEC, the big issue will be how to price the paper or at least some commentators treat that as an open question. But by foisting this on to chumps taxpayers, the problem goes away. It is clear now that the intent is to pay over whatever the book value of the paper is, both to recapitalize the banks and to generate high valuations that let other financial firms use these phony favorable prices for preparing their financial statements. "

3) Doesn't do enough to ease credit markets or makes it worse.

"The problem was that there was no price which would solve the basic conundrum: investors were not willing to pay above market prices, and the banks were unwilling to sell at market. Paulson & Co. wasted nearly two months trying to breathe life into this stillborn idea, then abandoned the effort."

And:

"Hopefully Mr. Paulson’s fiscal moves will provide enough fiscal laxative to unplug the banking sector and get money flowing again. Only time will tell if he’s done enough or if more will be required from the next Treasury secretary."

And:

"But the MLEC was designed to address the pressing problems of a year ago. The crisis has advanced considerably since then.

Remaining fixated on a solution that is badly out of date is tantamount to fortifying the Maginot Line when the blitzkrieg has rolled into the fields of France and the British are beating a retreat to Dunkirk. And I expect it will prove every bit as effective. "

And:

"Long after the crisis burst into the open, the Fed and Treasury downplayed it. It was, they insisted, "contained." Last week they asserted that, unless the House voted "yea," the wheels would come off this $14 trillion economy. President Bush himself has broadly hinted that the nation is on the cusp of disaster.

How can they be so sure? And how can they know that the unintended consequences of the radical policies they are pushing through won't be worse than the panic that they themselves are helping to foment? When the Fed insists it has no choice but to print up hundreds of billions of new dollars and when the keepers of accounting standards bend in the face of criticism that market prices hurt, what they are really saying is the that financial truth is too awful to bear. Heaven help us all if they're right."

4) When the assets are eventually sold, there is a huge and unanticipated loss.

"Today, the suits are saying that mortgage-backed securities are undervalued, and that if the government just holds them to maturity it will make a profit. But the geeks will tell you that we cannot be certain these securities are undervalued.

The valuation of mortgage-backed securities is marked by an enormous asymmetry. If house prices rise, the security holder gains little. He or she is happy to be relieved of the risk of default, but he or she cannot share in the homebuyer’s profit. On the other hand, each drop in house prices lowers the value of the security further.

Saying you will be just fine if you hold a mortgage-backed security to maturity is like saying you will be just fine if you don’t evacuate when Hurricane Ike is approaching. Depending on where it makes landfall, that strategy may cost you nothing—or you could be Galveston.

In terms of the bailout, a Galveston-like scenario would be a decline in the housing market that turns out to be steeper or more protracted than what financial markets currently expect. If such a hurricane makes landfall, almost the entire $700 billion could go down the drain. Under better scenarios, a small profit could materialize.

Main Street might prefer to have a choice about whether to take that risk. Instead, the choice is being made by politicians, who are gambling with other people’s money to advance their own agendas.

This bailout isn’t as bad as Main Street thinks. It’s worse."

5) Lobbying by hedge funds, etc.

"But hedge fund managers and other potential buyers are demanding that the government push for the much lower price, based on the current trading value of the assets. These potential buyers are hoping they can piggyback onto the Treasury program, perhaps even acquiring distressed assets alongside the Treasury in auctions."

6) Reverse auctions:

"The main mechanism for buying these assets will be reverse auctions, using the same principles that govern auctions of electricity or the wireless spectrum. In this case, the government will issue an offer to buy a class of assets — for example, subprime mortgage-backed securities — with the final price being determined by how many banks are willing to sell."

And:


"Here is the link. The article will soon be much longer. Here is a website devoted to summarizing the research against reverse auctions; it appears unrelated to critiques of Paulson and the Paulson plan. It seems to be fighting a personal war and so I doubt its objectivity:

The bottom line is BUYERS should not use reverse auctions because the amount of savings that can actually be achieved is greatly overstated. In addition, reverse auctions create numerous other problems for buyers. SELLERS should not participate in reverse auctions because there is nothing in it for them; especially incumbent suppliers. In almost every case, neither buyers nor sellers benefit from this purchasing tool because it is an unhealthy continuation of zero sum power-based bargaining that degrades the competitiveness of both parties. Reverse auctions are undeniably a bad purchasing practice and a wrong approach to spend management."