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The debate

Thu, Sep 25 2008, 08:44 GMT
by Yapi Kredi Bank Economic Research Department

UniCredit Group

Markets are watching with growing anxiety as the political debate on Paulson’s Troubled Assets Relief Program (TARP) rapidly heats up— with money market tensions running high and growth weakening, the sense is that the plane is going down fast while policymakers wrestle for the controls. Criticism to the TARP has been levied from both sides of the aisle. Most US lawmakers are visibly uncomfortable with the scope of the envisaged government intervention, and while conscious of the urgency of the situation, they have strong reservations on some key aspects of the proposal: its overall size, whether it should be implemented through asset purchases or capital injections, and the proposed lack of oversight are among the most controversial. In his Testimony today Bernanke defended the idea of asset purchases, stressing that the essence of the proposed plan is to restore transparency and confidence in the balance sheets of financial institutions, thereby making it easier for them to attract new private capital, and hence enabling them to resume lending and support growth. He appeared open-minded on other proposals, notably on closer congressional oversight, and he dismissed concerns that the program might be inflationary. It seems less and less likely that the plan will be approved this week, as the government hoped for.

A delay, and the seriousness of the issues raised in the debate, will likely fuel market fears that the plan might not be approved quickly enough, or at all. The short term impact of these concerns would probably be negative for equities but might be paradoxically positive for the USD, which has suffered from the concerns about higher debt issuance and possible inflationary impact of the TARP. These concerns are already exacerbating tensions in money markets on both sides of the Atlantic, notwithstanding continuing liquidity injections—rates were extremely high at yesterday’s TAF by the Fed and at today’s 3-month auction by the ECB. The Fed meanwhile today launched a USD30bn swap line with central banks in Norway, Sweden, Denmark and Australia, a further sign that liquidity problems are widening and intensifying. Together with Bernanke’s gloomier assessment of the economic outlook today this confirms that time is of the essence, and I still think a modified version of the plan is likely to be approved by next week, bringing the dollar back under pressure in the short term.

One of the toughest and most controversial issues—as I flagged in my earlier notes—is determining the price at which illiquid assets would be purchased by the Treasury. The choice implies an uncomfortable trade-off: the lower the price, the smaller the risk to taxpayers, but the harder the impact on the balance sheet of financial institutions—and not only those involved directly in the transaction, as other institutions may be forced into further write-downs once a low price has been established.

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Published on  Thu, Sep 25 2008, 08:47 GMT