The markets in the US did not take at all well to Henry Paulson’s announcement that he wanted to get his hands on the rest of the TARP allotment (a remaining $350 billion) and spend it so as to help consumers go to the mall again. As one correspondend, Andrew, noted:
1) Is the dog-chasing-its-tail nature of using taxpayer money to buy securities backed by taxpayer (consumer) debt not immediately and effortlessly obvious? It took almost no imagination for me to realize how absurd and self-defeating that is.
2) Do you think that Paulson and his cadre are completely aware of how absurd it is, and laughed and slapped each other five when they came up with it? Or are they incredibly dense?
Needless to say, the nasty selloff in Asia overnight says they are not very impressed with this move either.
As we have noted before, intervening in a tightly-coupled system like a nuclear reactor or our financial system, as Richard Bookstaber said, often makes matters worse (the system is so tightly integrated that any move will create diffcult to predict and often destabilizing knock-on effects. We have discussed these unintended consequences in the past.
One is that, particularly with stock prices low and trading in equity and other markets thin, forced selling by hedge funds is even more disruptive than at normal times. And with hedge funds deleveraging for a whole bunch of reasons (margin calls, investor redemptions, tougher standards at prime brokers), distress in one market leads to margin calls, which can lead hedge funds to sell not the asset subject to the margin call (if that market is tanking, you will get a terrible price and would make any similar positions worse) but one that is less impaired, which could be in a completely different market.
As reader Steve pointed out, courtesy Calculated Risk, the ABX (an index of asset backed securities derivatives) and the CMBX (an index of commercial mortgage credit derivatives) went into cardiac arrest when Paulson announced the change in TARP focus (using CR’s preferred term, “cliff diving”):
.I have to believe there i … pain in funds that switched their bets when TARP was announced.
From a Reuters story:
A key subprime mortgage derivatives index fell one to three points on Wednesday after U.S. Treasury Secretary Henry Paulson said he was backing away from buying troubled mortgage assets using a $700 billion bailout fund, in favor of more capital injections, market sources said.
The top “AAA” layer of the ABX 07-1 index, which reflects troubled mortgage loans made during the first half of 2007, sank nearly three points to 38 from 40.96 at Monday’s close, market sources said. The “PENAAA” 07-1 sub-index fell one point to 50.50, versus 51.54 at the prior close, market sources said.
Three points on 41 is 7%, and if you were levered, might get hit. Now the question is whether anyone did try bottom-fishing in enough size to make a difference.
The other more obvious source of pain may be for those who went long financials, as Ken Heebner reportedly did recently.