March has been an extraordinary month from a historic market perspective. The volatility we have become accustomed to over the past 7 months did not disappoint, as the S&P500 lost nearly 5% on the first trading day of March and hit its 13 year low on March 3. After February resulted in more stock market losses, the operative word among government officials was changed to “the economy was fundamentally ok.” The Fed and Treasury then launched a new program to pump $200 billion into the asset backed security (ABS) market to spur lending for non-mortgage consumer loans. Ben Bernanke then made an unprecedented move for a sitting Fed Chairman, granting widely watched 60 Minutes an interview, to stress his belief that America has averted the risk of a depression and a recovery could begin next year if the financial sector stabilizes, which he believes is happening. It is our opinion that among existing government finance officials, Chairman Bernanke has the most credibility with market participants. During the interview, he was calm, knowledgeable, and reassuring. In almost all likelihood, that show earned him a second term as the Fed Chief. He provided the market a balm of reassurance that subsequently led to almost daily gains for the rest of the month. Amid the Bernanke balm, the government went to launch a monetary offensive on market and the economy. In all, $1.45 trillion will be slotted for infusion into the system, along with a new plan to move toxic assets off banks’ balance sheets with all vehicles essentially participating in the plan via a leveraged private/public hedge fund.
It is in every American’s interest to have a bull market and we are glad to see that investors can quickly regain their confidence. However, a long lasting stock market rally can only be built upon healthy and sustainable economic fundamentals and prospects. While we believe the initiatives announced in March will likely have a positive impact on the credit market in the near term future, we are wary of some “unintended” consequences that might occur out in the horizon, such as inflation. Further, the general tone Congress has adopted towards the business class is concerning. One reason for such a concern was evident with the rush to “Tax AIG Bonuses” retroactively. It is almost surreal how House of Representative members have casually discussed such a serious issue, essentially making it a bill of attainder.
Chief Justice Earl Warren wrote in US. v. Brown (1965) that the basic reason for a Bill of Attainder clause was to prevent “trial by legislature.” This is because “the legislative branch is not so well suited as politically independent judges and juries to the task of ruling upon the blameworthiness of, and levying appropriate punishment upon specific persons. (http://volokh.com/posts/1237734930.shtml)
Trial by legislature is exactly what took place during the entire sad spectacle. Such extreme actions on the part of Congress carry serious ramifications as the private sector has developed a very jaundiced eye towards working with the government to end this fiscal mess. Similarly concerning was how the government forced GM CEO Wagoner out for failing to deliver results, but did not attempt a similar move for Auto Workers Union Boss Gettelfinger. Wagoner’s effectiveness as a CEO warrants its own discussion, but clearly he could not reach a workable deal if the union did not feel any pressure as well.
Now, let us review some of the government’s actions in March.
Government’s Grand Plan to Spur Lending: The government, namely the Fed and Treasury will pump $1.45 trillion into the economy to kick start lending, assuming the resultant increase in lending will boost spending, which hopefully in turn will revive the economy.
1. The New $200 billion TALF program (Term Asset –Backed Securities Loan Facility) (3/3/2009): The Fed and Treasury launched a much-awaited new TALF program to provide up to $200 billion in financing for up to 3 years, to investors to buy up outstanding debt for autos, education, credit cards and other consumer loans. Before the financial crisis, banks relied on packaging such loans into securities and selling them to pay for additional lending. This process had financed about 25% of consumer loans in recent years until the credit markets froze in October. In the fourth quarter of 2008, credit card ABS issuances were $0, compared to $23 billion a year earlier, according to Dealogic.
TALF intends to recreate a market that has essentially collapsed. The logic is that providing the leverage previous ABS buyers have relied on to generate attractive returns, will hopefully jump start the moribund market. Based on a leverage ratio of 12 times, although TALF provides leverage up to 20 times, investors can borrow approximately $92 million to buy $100 million of bonds backed with prime auto loans, for example, and achieve annual returns of over 20%, assuming no credit impairments. In addition, the Fed, unlike banks, won't demand the investor post collateral if the ABS market value falls over the three-year life of the loan. In the Fed's defense, the TALF demands that collaterals pass heavy pre-screening, and is only eligible to securities receiving the highest-category credit ratings from at least two nationally recognized credit rating firms. The potentially massive return with limited risk will likely lure private investors back to the ABS market. Clearly, by subsidizing the returns investors obtain by lending to consumers, the government continues its policy of encouraging consumer borrowing through easy money. In regards to the end game for the TALF, the government hopes it will rekindle the broader securitization market, instead of trapping the Fed in the uncomfortable position of being the "prime broker" for years to come, which is a possibility. Currently, the Fed plans to keep the program running through December, but said it could be extended.
2. Fed to Pump $1.25 Trillion to Economy (3/18/2009): Through a number of new programs, the Fed will inject $1.25 trillion into the economy.
