Paulson's TARP Pulls An Audible

A: To be honest with you, I like this call. I know that it adds uncertainty, and that is the last thing that the market needs right now, but the fact that Paulson changed the play because the original plan was thought to be less effective, is progress! Good decisions can't be rushed! $350Bln of the TARP was already used to inject capital into the banks and another portion of funds may be put to work in the auto sector. That leaves only $300Bln or so left to buy distressed securities. What the heck is that going to accomplish? Citigroup alone has about $1.18Trln of off-balance sheet holdings, just to put the numbers into perspective! If anything, expect the TARP funds to be used for more bank injections so that the capital raising required is not done on desperate terms from the private sector or through further share dilution. This does NOT mean that is not in the cards for later on though!

Originally, the TARP was going to be used to buy distressed mortgage backed securities from the balance sheets of banks. Non-agency MBS bounced a bit on news of the rescue plan, making some of us wonder what the point is going to be using TARP funds to pay marks much higher than market value! I mean, if you found out $500Bln+ is about to be poured into this market, it should artificially prop up the market from previous lows! Now that the plan has changed, the ABX's are selling of again and making fresh, new lows. This comes as other credit indicators have come in significantly since the launch of the Fed's CP facility and the TARP rescue plan. Here is a chart of the ABX-HE-AAA via Markit.com:

Bloomberg reports in the story, "Mortgage Bonds Fall to New Lows as Paulson Scraps U.S. Buying":

Residential and commercial-mortgage backed bonds tumbled after Treasury Secretary Henry Paulson said the government no longer plans to buy devalued mortgage assets, credit-default swap indexes suggest.

All 24 of the ABX indexes tied to subprime mortgage bonds fell to new lows, according to Markit Group Ltd. The second half of the program will be used to help relieve consumer credit, not buy mortgages and related bonds, Paulson said today in a speech. Treasury and Federal Reserve officials are exploring a new "facility" aimed at bolstering the market for securities backed by assets other than mortgages, he said.

I think it is almost a given that a 2nd TARP-like stimulus program will be announced. I mean, what is going to happen to the toxic stuff on the balance sheets if there is no RTC-like vehicle to buy the distressed junk? We know $320Bln+ of alt-a MBS are on review possibly to be downgraded!

Or is Paulson's play a bluff? Doubtful. If the gov't were to buy distressed securities, a few things come to mind, which kind of cancel each other out:

1) the taxpayers will want attractive marks so as to increase the potential for profit, and decrease the risk of losses
2) to succeed and recapitalize, marks must not be too low as to destroy the banks anyway
3) its best if the market doesn't know how much distressed MBS may be purchased and when the buy will occur, so that valuations reflect the actual market for these securities without any expectations of a BIG BUY ORDER coming in, canceling out #1

Maybe Paulson did this to take out the premium for MBS priced in because of the TARP funds about to come in. Maybe the job proved too difficult to pull off. Maybe the remaining funds were deemed insignificant to have any effect. Who knows. One thing is for sure, anyone that is not respecting this credit crisis and the deflationary environment that resulted from it, will be hit the head by a 2x4 in the near future!

Paulson's move today tells me that actual decisions are being made to adapt to the situation as it evolves! That's a good thing and a sign of leadership even if adds to near term uncertainty. Don't mis-interpret this to mean all is well now, its not, and I think a 2nd TARP-like program is coming.

We are entering the dark stages of this process where corporate warnings (INTEL After the bell, Best Buy this morning) come in fast, and macro economic data deteriorates noticeably. Stocks react making the pain hit home for average investors as they avoid checking their portfolio's for fear of being scared at the exact losses taken so far.

My "Sometimes We Get Lost In The Dark" piece back in February stated:

The stock market is the stars, and is the tool that most use to figure out where they are when confused, or lost. But in this unchartered world where we don't know what lies ahead, this widely used, widely publicized vehicle is not a very good navigator for one real reason. Stocks trade on information available and investor sentiment for the near term, lets say the next six months. If the world around us slows and earnings come down, then the entire valuation model of equities (p/e) will have to re-adjust to the weaker times that we know are about to come. Here is a great recent example:

APPLE (NASDAQ: aapl), was trading at a higher price/earnings ratio only 4 weeks ago when shares were hovering near $160 a share and off its high of $200; lets say 31 although I don't have the exact #. Then something happened. On JAN 23rd, the earnings forecast disappointed. The stock fell 11% as investors re-adjusted the share price to be more in line with the lowered earnings forecast. As with most earnings disappointments, the adjusting stock slowly slipped over the following few weeks to a current trading price of $118.

This very dynamic, is why stocks CAN'T be used as an accurate gauge to our current situation.

Oh, almost forgot. Former Goldman Sachs Chairman John Whitehead thinks (via CalcRisk):

"I think it would be worse than the depression," Whitehead said. "We're talking about reducing the credit of the United States of America, which is the backbone of the economic system. ... I see nothing but large increases in the deficit, all of which are serving to decrease the credit standing of America. ... I just want to get people thinking about this, and to realize this is a road to disaster. I've always been a positive person and optimistic, but I don't see a solution here."

"Before I go to sleep at night, I wonder if tomorrow is the day Moody's and S&P will announce a downgrade of U.S. government bonds," he said. "Eventually U.S. government bonds would no longer be the triple-A credit that they've always been."

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