TARP Running Dry

First the WSJ details:

The U.S. Treasury Department said it expects to have about $134.5 billion left in its financial-rescue fund, giving the Obama administration a cushion as it implements a range of expensive programs aimed at unlocking the credit market and boosting ailing industries.

If you think $134.5 billion left sounds like the well is running dry, then take a look at what Keith Hennessey (former director of the National Economic Council) believes that figure is closer to:

When President Obama took office, $387 B of the $700 B of available TARP funds had already been publicly committed. Here’s the breakdown.

This meant that the Obama team had $313 B left to commit before reaching the $700 B limit.

Since January 20th, Keith estimates that the Obama administration has committed as much as an additional $280.



If this is correct, we have less than $35 billion remaining in the TARP. Back to Keith:

Uh-oh.

There’s some uncertainty around the $80 B figure to further expand TALF, because the Administration has been ambiguous about how big the new TALF would be in total. I’ll bet they’re scrambling this week trying to figure out what they actually meant.

They can create some wiggle room for themselves if they say that the $15 B for small businesses and the $5 B for auto parts suppliers are a subset of the $100 B (in total) for “consumer credit.” This uncertainty and ambiguity should not obscure the critical point: they’re almost out of money.

Government Spending on the Move

Expect this figure to fly in coming quarters / years...



Source: BEA

I Thought it was Democrats that were "Big" Government???

While I knew the budget deficit decreased during Clinton's presidency and did a 180 degree turn under Bush, charting spending / revenues of the U.S. during these times one can see why. What surprised me was that during Clinton's presidency, spending decreased 3.7% from 22.1% to 18.4% of GDP, along with a similar increase in revenues.

On the other hand, the budget deficit under the first 7 years of Bush was caused as much by an increase in spending, as it was from a decrease in revenues. In fact, had interest income not decreased over that time (financing the debt has been done at historically low levels due to historically low Treasury Bill / Note / Bond rates), this number would have been closer to 2.5%.

And this doesn't include the record deficit expected in 2008 BEFORE this weekend's Fannie / Freddie bailout.

Source: CBO

IN A PERFECT WORLD: BAILOUT = END OF CREDIT CRISIS

Over the past few weeks there has been much criticism over the potential (now actual) Government Sponsored Agency “GSE” bailout due to the potential cost to taxpayers, the moral hazard it would encourage, etc... I do not disagree with most of these criticisms, but the cost of NOT doing anything would be much greater. To show the potential benefits of the bailout on both housing and credit markets, which in turn will benefit the economy, below is how the bailout will unfold in a “best case” scenario. While I do not believe it will solve all of the problems detailed below (or even a fraction of them) in this manner, I do believe it is important to look at the bail-out in terms of a "glass half full" and how it can help alleviate the liquidity problems associated with today’s credit markets.

I) BAILOUT DETAILS
Specific features of the bailout that impact the outcome to the credit market include the Feds new liquidity facility, the goal to increase Fannie and Freddie's mortgage-backed security portfolios through the end of 2009, the right for the Treasury to actively purchase MBS in the open market to reduce spread (and cost to future homeowners), and the future goal to reduce the GSE balance sheet by 10% annually starting in 2010. In the first part of my "perfect world" analysis, I predict that these features (and others – go here for 10 key features) will help put a floor on housing prices.

II) RATES MATTER

Homeowners that already qualify for high quality prime loans will not be as impacted directly by the new moves by the Fed. Why? Agency spreads are near historic wides, but absolute levels are already near historic lows.

HOWEVER, borrowers that do not currently qualify for these low rates should see their rates drop dramatically. Why is this important? If a homeowner that qualified for a 9.5% rate can access a 7% government “subsidized” loan, their buying power increases by almost 25% (all else equal).

These “subsidized” loans will prop up the housing market as the size of the payment made is what truly matters for a homeowner (specifically one that intends to live in that home for the foreseeable future). Importantly, these rates are not “teaser” rates that reset, but more manageable fixed rates for the life of the mortgage.

III) THE IMPORTANCE OF ATTRACTING THE MARGINAL BUYER TO THE MARKET
The goal is to entice the marginal buyer to come to the market / have “bad loans” refinance at more manageable rates. In the past 6-12 months potential homeowners have been sitting on the sideline as prices continue to make new lows (nobody wants to catch a falling knife). With the new “bailout” limited time horizon (increasing balance sheet through 2009), this SHOULD bring a sense of urgency for new homeowners (expect emphasis on the "limited time offer" aspect).

If these low rates do put a floor on home prices sooner than later, this should benefit the owners of subprime / Alt-A securities that have priced down as delinquencies have risen at historic levels. If the market bottoms and these owners are able to refinance at the new lower rates, get who gets off the hook? THE EXISTING MORTGAGE OWNERS who get paid back at PAR for all loans refinanced.

IV) BANKS FINALLY ABLE TO DELEVER AND MAKE NEW LOANS
Banks own a lot of these mortgage securities that have priced down and in response, over the past 6-9 months banks have attempted to delever as their equity has been written down / capital has been so difficult to come by. This system wide delevering only caused these entities to be more levered. How is this possible?

Well, if one bank attempted to delever, they’d be successful. When every bank attempts to do so at the same time, it only makes the problem worse! Let’s take a look…

As these banks all sold off assets at the same time, these assets sold priced down in value as the entire market was selling into a distressed AND illiquid market. This in turn reduced the price of assets remaining at the banks. When that happened, they were forced to write down even more assets / equity, resulting in leverage HIGHER THAN WHEN THEY INITIALLY BEGAN.

If these assets snap back even partially in value, the reverse happens. In fact, I expect a portion (maybe a tiny portion) of the underlying mortgages in securities marked as low as 60 cents on the dollar to repay at PAR when homeowners sell to new owners at the “subsidized” rate or are able to refinance themselves. In addition, liquidity injected into the market through the Treasury’s outright purchase of mortgages should bump up the price. The result will be improved leverage ratios at banks, which will slow the asset selling process we've seen from banks. In fact, expect well funded banks to actively buy securities in the market in the coming weeks / months.

It's also important that the bailout makes banks much more attractive for outside investment (think Sovereign Wealth Funds). Once new capital is injected and their balance sheets are improved, new loans can be made. This should result in improved (lower) rates for non-government mortgages.

V) THE CREDIT CRISIS ENDS?
If this all works out as I detailed in the above best case scenario, a functioning credit market at no cost to taxpayers results. What likely will happen? After everything that has transpired over the past 12+ months, I have no idea though I do expect credit markets to more accurately reflect the actual economy and not the lack of liquidity in markets. The result of which might scare investors just the same...

United States Balance Sheet / Dependence on Foreign Capital

Ben Bittrolff points us to an interesting take on the fragility of the current International Financial system via Bloomberg:

"A failure of U.S. mortgage finance companies Fannie Mae and Freddie Mac could be a catastrophe for the global financial system, said Yu Yongding, a former adviser to China's central bank.

"If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,'' Yu said in e-mailed answers to questions yesterday. "If it is not the end of the world, it is the end of the current international financial system."

"The Chinese are getting a little feisty as their losses continue to mount.

"China's $376 billion of long-term U.S. agency debt is mostly in Fannie and Freddie assets, according to James McCormack, head of Asian sovereign ratings at Fitch Ratings Ltd. in Hong Kong. The Chinese government probably holds the bulk of that amount, according to McCormack."

Lets take a look at just how large the U.S. dependence on foreign investors is:

Source: Federal Reserve