Paulson's Commercial Paper Quandary

There's no such thing as fairness in the government's efforts to fix this crisis. Investors need to keep that in mind as the terms of the bailout evolve (for the most entertaining example witness Treasury Secretary Henry Paulson and bailout czar Neel Kashkari spending their day defending their decision to revise the TARP program against angry lawmakers today.)

Highlighting the unintended consequences of one part of the program, Sivaram Velauthapillai, who blogs at Can Turtles Fly?, makes a good point about how the Fed's decision to support only top-tier commercial paper in its financial sector backstopping efforts might be hurting companies that don't qualify for government  support. He points to this Bloomberg article for evidence. It says a group reportedly including Textron (TXT), Nissan (NSANY), American Electric Power (AEP), Home Depot (HD), Dow Chemical (DOW) and Honda (HMC) -- a collection of not-awful companies -- are pressing for the Fed to fund their second-tier commerical paper (right now, the Fed only buys top-rated paper). Velauthapillai writes:

It's a tough situation for the government. Do you expand the program and take on taxpayer risk (not to mention the possibility of the system being arbitraged by profit-seekers)? Or do you just limit it to the A-1/P-1 paper which means you are practicing an unfair system?

This is an example of an unintended consequence. I'm sure no one thought of Dow Chemical being put at a disadvantage compared to, say, G.E. (GE is a high quality issuer). I'm still in favour of the program but policymakers need to be cognizant of these side-effects. I think they should expand the program or give a firm date for the closure of the program (closing the program will likely put a lot of stress on non-financial companies.)

Now, it's worth mentioning that the government's efforts to keep commercial paper markets liquid continues to be one of the more overlooked success stories in this entire crisis. Remember, short-term financing is the real lifeblood of every big company, so extending help to more companies may not be a bad idea. But it's only one example of what we can collectively call the "Lehman effect": Picking and choosing who gets help from the government creates both winners and losers. Just look at Lehman vs. AIG, or companies left off the short-seller ban.

It's a tough reality, but with markets this weak and a recessionary economy hurting all sorts of companies, investors need to acknowledge that some of their investments may get hurt by what will be unavoidably arbitrary decisions handed down by Washington.