Death of the original TARP program

Sort of old news by now but for those who may not have heard, the Bush administration is abandoning its original TARP bailout program, which called for buying financial assets (mostly mortgage-related,) and is shifting it focus to capital injections and to the consumer:

The Treasury Department on Wednesday officially abandoned the original strategy behind its $700 billion effort to rescue the financial system, as administration officials acknowledged that banks and financial institutions were as unwilling as ever to lend to consumers.

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The program, still in the planning stages, would for the first time use bailout funds specifically to help consumers instead of banks, savings and loans and Wall Street firms.

Treasury officials said they hoped to invest about $50 billion from the bailout fund into the new loan facility, with the aim of helping companies that issue credit cards, make student loans and finance car purchases.

As envisioned, the Treasury would put up about 5 percent of the money that a company would use for lending and private investors would put up perhaps 20 times that much by buying bonds issued by the new program.

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The Treasury has already committed about $290 billion. It has allocated $125 billion to the nation’s nine biggest banks and investment banks; another $125 billion for publicly traded regional banks; and $40 billion to expand the existing bailout of American International Group, the insurance conglomerate that collapsed in September.

This is bad news for Ambac and other financial institutions but it's the right thing for the country in my opinion (I'm Canadian but speaking as if I was living in the US.) The original TARP program had a whole hoard of problems including the following:

• No guarantee of any direct impact on the economy: There was no reason to expect that any financial institution would lend even if they sold the assets to the government. In fact, looking from a shareholder perspective, I'm pretty sure the companies would buy back stock than lend (the fastest way to increase shareholder weatlth right now for financial institutions is to buy back shares since they are very depressed.) Recall how money handed out to airlines after 9/11 due to security burden and terrorist threat were mostly used to buy back shares.
  
• Almost impossible to value securities: The original plan to buy assets at purposely-inflated values met some criticism so the final plan was to buy assets at market values. However, since these are illiquid securities, and it was very difficult to value them, it would have been almost impossible to come up with a reasonable price. Even if you came up with a price close to market value, the financial institutions may not want to sell at what they, rightly IMO, view as irrationally low prices.
  

The focus now seems to be the consumer, which should directly help the economy. This will probably involve bailing out GM (I'm not sure how though.) It will also help companies like American Express (AXP), which suddenly seems to be facing huge problems. Problems at Amex are a surprise to me because some highly conservative value investors, such as Warren Buffett and Jean-Marie Eveilard own shares and thought the risk was manageable as recently as late last year. The story out of Amex does not look pretty at all, with some recent story (rumour?) that it badly needs at least $3 billion (stock price is off around 70% this year, and down 50% within 3 months.)

The way I look at all this, what is happening is the following. So far the Federal Reserve has been leveraging up, while financial institutions and investors (particularly hedge funds) lower their leverage. Going forward, the government is attempting to leverage up, while the consumer (and related businesses) decrease their leverage. The government can't compensate fully and they shouldn't (that's not their goal.) The goal here is to dampen any blows. For instance, it is highly likely that American savings rate will go up roughly 8% over the next, say, 20 years (here is a historical chart of savings; I'm assuming we will go back to the 60's/70's level.) Conversely, this means debt will decline by some number (let's say 10%.) The question is whether the de-leveraging will happen quickly, with a 10% decline in 2 years, or whether it will happen in 10 years. What governments can attempt to do is to smooth this so that the consumer lowers their debt by 1% per year over 10 years, instead of 10% in 2 years.

Anyway, the Bush administration is just trying to buy time until the Democrat-dominated government takes full control. From a macro point of view, what really matters is the first 30 days of January, at which time we will have a good idea of the economic strategy of the Obama administration. I wouldn't invest blindly based on what the government does or does not do, but if you are macro-inclined, it is important to consider it.