A few days ago we wrote our top suggestion for President-Elect Obama. Several blogging colleagues took up the theme, and we sincerely thank them for their interest and for stimulating discussion. We plan a more complete review of opinion, but events have, once again, overtaken the schedule. The current Administration is moving in the opposite direction.
Secretary Paulson announced that the TARP program would not purchase troubled securities, at least not in the way originally envisioned. He stated that direct investment in financial institutions was a better use of TARP funds with more impact.
A Discouraging Turn of Events
Here at "A Dash" we try to analyze markets rather than to offer prescriptive advice. The "Letter to Obama" was a rare excursion for us. While others stray far from their expertise, we like to stick to our "happy zone."
Here are two takes on the wrong turn in TARP.
Market Take. Market participants, rightly or wrongly, now see the program as a funding source for anyone who claims a need. They see it as socialism. Most importantly, they interpret the failure to purchase distressed securities as an acknowledgment that these holdings are worthless. Briefly put, the Treasury has undermined the very assets they hoped to support, and the leadership has lost the confidence of investors.
Political Take. The decision to invest in preferred stock instead of troubled assets is an easy course. It sounds great to the taxpayer. The companies are held by private investors, so there is an inference of value for preferred shares. This is better than buying what is perceived as "toxic waste." It has an easily-understood causal mechanism -- a direct injection of capital. The downside is that it has eliminated an clear public-interest distinction, inviting nearly anyone to apply for TARP funding. It fails to address root causes.
Public Policy Take
Quite frankly, the investment and political types are not doing clear-headed public policy analysis. This involves understanding the following points:
- Focusing on the cause of the problem. The cause was originally troubled housing loans. We could have addressed this directly at less cost than the current plan. Instead, we have allowed mortgage securities to have an ever-decreasing mark-to-market value, and now face similar issues with Alt-A loans, student loans, and securitized credit card debt. As long as this spiral continues, the need for additional government investment will continue.
- Recognizing the error of using a club instead of incentives. The government is now instructing financial institutions to do more lending. We are not learning the lesson of Fannie and Freddie, where the government tried to combine public interest with a private company. It did not work there, because the government asked private companies to behave more aggressively than their financial statements warranted. We are going down the same road. If you were a bank manager with TARP funds, would you choose to strengthen your balance sheet in the face of declining assets, or make more loans? Simply instructing them will not work.
- Failure to develop and implement a coherent plan. The current "plan" seems to change weekly. Everyone sees this, so confidence is lost. It is the country's misfortune that our leadership was far too slow to address the relevant issues. We hope that the Obama Administration will carefully develop and implement an incentive-based approach, but the President-Elect does not yet have control. Our tradition of transition in government is being tested in a way that has no historical precedent.
The best hope for investors is that the new administration will quickly develop and announce proposals that get to the root of problems. Their key appointments should reflect this. The Bush Administration should cooperate during the transition.
It is a major burden for an incoming President. Never before has a President-Elect had such a responsibility before actually gaining the reins of power.