Saturday, November 15, 2008

TARP - Bait and Switch?

From the Desk of Joe Rollins

Some of you may know that when I was a freshman in college, I played on the University of Tennessee’s basketball team. The year was 1967 and coming from rural Tennessee, I had never before had an opportunity to play in front of more than the 400 people that could fit into the cracker-box gym at my high school.

The first significant freshman game that I played as a Tennessee Volunteer was against Vanderbilt University at Adelphia Coliseum. Our game was just prior to the nationally televised varsity game, which started at 3:00 p.m. In all the other junior varsity games I had played, the janitors were still getting the auditorium ready for the varsity game when we were on the court, but this particular game was different.

In 1967, the University of Tennessee was intensely hated by Vanderbilt University. In fact, since the Vols had gone to the Orange Bowl the previous year, it wasn’t unusual for Vanderbilt students to throw oranges from the upper balcony onto the court, causing them to explode with great force. Additionally, Adelphia Coliseum was unique in that the first three rows were actually situated below court level. For this reason, the players’ benches were placed on the ends of the court rather than on the sides.

When we first entered the court at 11:30 a.m. to practice for our noon tip-off, there were 15,000 Vanderbilt fans already seated in the bleachers – double the amount of people than in the two towns in which I grew up combined. We had brought only one ball onto the court to practice that day, and almost immediately, one of my teammates mistakenly dribbled it off the end of the court into the first three rows filled with Vanderbilt fans. They seized the ball and wouldn’t give it back, leaving us all looking stupefied while standing at mid-court without a ball to continue our pre-game warm-up. But that was only the beginning of the shenanigans we would face during that game…

The game became really intense sometime during the second half, making all of us somewhat fatigued from running up and down the court. At one point, we were on the far end of the court from our bench. I went up for a rebound, got hit by a player’s elbow, and knew immediately that I was injured. I reached for my mouth, and my hand was promptly covered in blood, leaving me to wonder if I had any teeth or not. By that time, all of the players had made their way to the other side of the court, leaving me by myself in the middle of the court with blood streaming down my face and onto my uniform. The hit left me dazed and disoriented, until I finally realized that the bench was on the far end of the court and started making my way to it. As I walked towards it with blood soaking my big orange jersey, I was greeted in a most interesting manner from the fans.

Almost in unison, 15,000 people jumped to their feet and gave a roaring standing ovation. I was struck by the good sportsmanship exhibited by the fans at that moment, but once I reached the bench, I realized they weren’t cheering for me but for the player that had elbowed me. Regardless, I must admit that it was the only standing ovation I’ve ever received – directly or indirectly – by 15,000 people.

This memory came flooding back to me when watching the news outlets discuss Treasury Secretary Hank Paulson’s announced changes to the $700 billion financial plan to more consumer assistance rather than bank assistance. It seemed that the entire world responded with a standing disapproval of jeers and sneers.

As I write this post, the stock market is actually about flat for this week. I know it feels worse than that due to the incredible volatility we have witnessed, but even with the first three down days of the week, Thursday’s significant gains left us with flat performance for the week. If you’re like me, then your head is likely spinning from trying to keep up with the extreme volatility in the market as of late.

I decided when I went home on Wednesday night that I would perform as much research as possible regarding the TARP to determine whether this program has worked to our benefit or our detriment. There is an enormous amount of information available on the Internet on the subject, but most of it is extraordinarily biased.

It’s nearly impossible to watch the news without hearing the commentators criticize the TARP, and likewise, it’s nearly impossible to find any pundits who are satisfied with what has taken place thus far. However, it’s important to keep in mind that virtually all of these analysts are biased in some way or another as it pertains to how the money from the TARP should be used. My only bias is that I want the economy to improve. In order to understand how that is possible, I wanted to find out exactly how the TARP will be used to improve the economy.

Treasury Secretary Paulson was on Bloomberg on Wednesday night, and for about two hours he discussed the progress of the financial plan and his goals for the TARP. Paulson is a brilliant man, and the fact that he is donating his time to deal with this political nightmare in Washington shows that he is a true patriot in every respect of the term. It should not be forgotten that two years ago, Henry Paulson was the highest paid executive on Wall Street, making in excess of $50 million in compensation alone (although many have said that he made closer to $1 billion in his final year as chairman of Goldman Sachs). For a man of this stature and intellect to go to Washington and take the grief and incredibly uninformed triviality of Representative Barney Frank and Senator Christopher Dodd reflects that he did it as an act of patriotism. I can honestly think of no other reason for him to do it considering what he’s being put through.

I want to give you some information that isn’t being provided by the media: THE TARP IS WORKING AND THE ECONOMY IS ALREADY GETTING BETTER. You may be wondering how I could make such a statement when it seems that everyone else is so negative on the TARP. My statement isn’t based on public opinion, but rather, on actual facts. The evidence is overwhelming that the TARP is working and those who argue otherwise are clearly uninformed.

The program was designed to purchase troubled assets from the banks. All of us originally wondered how that was going to work given the incredible complexity of purchasing the individual assets from public companies. While it would have benefited the original banks from which the assets were purchased, the effect would only be a benefit of $1 for every $1 of assets purchased. The multiplier effect simply would not have accomplished the goals as quickly as we need them to happen.

It was quickly realized that the original plan needed to be revised to give the greatest bang for the buck. By virtue of purchasing preferred stock in the banks, they were basically able to receive a positive benefit of 10 to one. Since banks can loan about 10 times their equity, rather than $250 billion of money being injected into the economy, they have injected $2.5 trillion with the leveraged effect of the banks.

As of Friday morning, $290 billion of the original money is committed. Approximately $180 billion of that $290 billion has already been funded. The remaining $60 billion on the first appropriation will probably not be used, except in emergency cases. Given that only approximately one-half of the original $350 billion has now been funded, and that is for only three weeks, the positive benefits are already being reflected in the economy.

Four major banks that received some of this money have already announced major mortgage refinancing programs. Bank of America, JP Morgan Chase, CitiBank and Wells Fargo have announced that they will be refinancing mortgages for consumers and taking losses up to $100 billion. These plans are already in motion and helping the public. Under no circumstances could the government have moved this quickly to benefit the consumers. In fact, Fannie Mae and Freddie Mac announced an inept plan to help refinance mortgages, but it has not been agreed upon or implemented. The private sector was the answer to this issue, and the TARP has been a success thus far.

As I have mentioned in prior posts, the three-month Libor has dropped by over 50% in a period of only three weeks. For the first time in months, major investment-grade debt is being issued at reasonable prices. Bonds issued during October have climbed as much as 10% in one month, reflecting the improved environment for debt.

The Federal Reserve, jointly with the Department of Treasury, has issued over $2 trillion in commercial paper instruments for major corporations. The actions by the Federal Reserve have freed-up the commercial debt market to allow for corporations to fund their short-term debt. Interest rates have fallen dramatically on this commercial paper, making the corporations more profitable and therefore, able to provide jobs for their employees. The commercial paper market has freed-up and is now working to the benefit of American corporations, and all of this is as a result of the TARP.

Also on Thursday, The Wall Street Journal printed a forecast by well-known economists, a majority of whom indicated that the U.S. is now in the midst of the worst part of a recession - Economists See No Growth Until 2nd Half of 2009. The overwhelming consensus was that economic growth would probably return by the second half of 2009. Even more interesting is that two-thirds of these economists indicated that the TARP was helping the economy and that the actions by the Department of Treasury had done much to free-up the debt markets for the use of corporations and stabilize the financial markets which were previously frozen.

On Wednesday, Treasury Secretary Paulson announced a major change in the direction of the TARP. There was an enormous negative outcry by the public, the journalists, and of course, the stock market. This is a complicated matter, and I believe that people are reacting before they really look into the positives associated with the changes Paulson is making to the TARP.

There were scathing comments being made in the news regarding Paulson’s proposed changes, and in fact, I saw many references to a supposed “bait and switch.” I have heard an inordinate number of uninformed Congressmen express the same opinion. However, none of us should sell Treasury Secretary Paulson short.

In reviewing the information about the TARP along with the data and analyses, it appears to me that Treasury Secretary Paulson has been absolutely correct in his decisions. Rather than criticize him and his colleagues, they should be praised. They quickly realized that the program in its original form would not be as effective as the one that was ultimately implemented. The one they did implement has worked well thus far, and will work even better once it is fully funded. In Paulson’s words, “I will never apologize for changing a strategy or an approach if the facts change.”

Paulson’s proposal mentioned on Thursday was even more intriguing to me. He indicated that for the second half of the TARP, the money would be used to fund loans for automobile purchases, student loans and credit card receivables. The public, the press and the financial networks missed the entire point: THE FIRST HALF OF THE TARP WAS FOR WALL STREET, AND THE SECOND HALF OF THE TARP IS FOR MAIN STREET!

By furnishing funding for consumer-type receivables, the Treasury will free-up the lack of credit extension to consumers. Who could argue that making more college loans available to kids is not beneficial? Who could argue that the extension of credit on credit cards is not beneficial to consumers who are literally frozen from fright? Certainly, we all need to be able to secure a loan to purchase a vehicle. Both of these actions were brilliantly conceived and planned.

It is highly unlikely that Treasury Secretary Paulson will be working for the government when the second half of the TARP is approved, but I can only hope that whoever is put in charge avoids political influence and does what’s right for the economy, as Paulson has done. Those who argue that Paulson did a “bait and switch” with the U.S. economy are clearly as uninformed as the Congressmen who are also making that assertion.

Many of my clients have expressed outrage regarding the proposed bail-out of the Detroit auto industry. Let’s not forget that the automobile industry in the United States is incredibly successful, but unfortunately, none of the successful companies have plants in Michigan. Secretary Treasurer Paulson and President Bush have acknowledged that the original TARP was not designed for the auto industry and should not be used for such. Having read the bill myself, I concur. If Congress wants to provide assistance to Michigan’s auto industry, then they should do so by separate legislation.

I am a diehard capitalist, but I do recognize that if Detroit’s auto industry is forced into bankruptcy, it would be seriously detrimental to the economy as a whole over the short-term. For the long-term, it would be fine and the economy would adapt, but over the short-term it would be devastating. The answer to this issue is short-term loans until Detroit’s auto industry turns profitable again. Then, they can compete with Toyota, Honda, BMW and Mercedes, and if they’re unable to compete on a fair and equal playing field, then they should cease to exist.

I find it incredibly interesting that the majority party, which will control all departments of government, is pushing an outrageous bill that supports the very unions that helped them get elected. Make no mistake; the reason that GM, Ford and Chrysler cannot compete with the other car companies manufacturing in the United States is because of the work restrictions the unions place upon those companies. Due to outdated work rules, excessive pay and extraordinary benefits, these car companies no longer have any ability to compete with the non-unionized car companies located in the South that don’t carry the legacy costs of the Michigan companies.

Congress now wants to force these companies to be unionized and make them as inefficient and incompetent as the ones in Detroit. I suppose the theory is that since Detroit cannot compete due to the unions’ control of their labor, we will just the force the other non-union companies to be as inefficient and incompetent so Detroit can compete. Obviously, the end result is that we will have overpriced cars that will not be as well-made or as inexpensive as we have today.

Again, the economy is on the mend. You may not hear that on TV or read it in your local paper, but it is definitely happening. If you spend time reviewing the facts, clearly the economy is improving and things are getting better. I urge those who are criticizing Treasury Secretary Paulson to take the time to review the data.

Sources: Bloomberg, The Wall Street Journal

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