John Hussman: However It's Written, TARP Is a Bad Idea

Excerpt from the Hussman Funds' Weekly Market Comment (9/29/08):

However the final legislation is written, the Troubled Assets Relief Program (TARP) being rushed through Congress will evidently be built around its single worst provision, which is that the Treasury will have authority to purchase distressed mortgage securities from U.S. financials.

...

What the financial system has needed most has been for Congress to streamline the bankruptcy process for investment banks, so that in the event of failure, the good bank (assets and liabilities, ex the debt to bondholders) could be cut away quickly and liquidated to an acquirer, leaving the proceeds as a residual for the bondholders. Indeed, that's exactly how it works for regulated banks. What investors overlooked in last week's panic was that we actually saw the largest bank failure in history  Washington Mutual  with absolutely no losses to customers or the U.S. government, precisely because the good bank was seamlessly cut away and sold to J.P. Morgan, wiping out shareholder equity, preferred equity, and subordinated debt, with partial repayment to the bondholders. Snap  just like that.

...

A better approach would be for the government to provide capital directly, in the form of a super-bond, in an amount no greater than the debt to bondholders. The super-bond would be subordinate to customer liabilities, so it could be counted as capital for the purpose of capital requirements, and would be seen by customers as a legitimate cushion of protection. However, in the event of bankruptcy, it would have a senior claim in front of both stockholders and even senior bondholders. Do that, and you've actually got a mechanism to protect the financial system while at the same time protecting customers and taxpayers. Ideally, the super-bond accrues a relatively high rate of interest so that financials have an incentive to shift to private financing as soon as possible, but you would also defer the interest until the bank meets a minimal level of profitability to make sure that the financing doesn't strain the institution's liquidity.

Comments

[whidbey:]

why fight over what should be done? The deal has been cut and the proceeds are soon to be cut up (using god knows what criterion) to acquire some mortgages. Meanwhile back in the forest the fire has broken through the stops and is now eating into the industrial system players, like GE, and there will be others are getting scorched. Will they burn? We can not see their hole card, but I would think they are not diversified - too many airplanes and trains etc, so maybe the fire has jumped into new sectors.

What we must do is think about recovery, give up on stopping the decline.

Things will turn when the energy is spent and since that involves the whole world, it will be a while. But the recovery will come from a set of reformed currencies backed by metals, attention to food, water, public safety, basic services and disposal of the trash from the last party. I know it is horrific to say, but we need to think clearly and productively to have a future. Z

2008 Oct 02 04:15 PM

[Robot:]

I like this better than what Dave wrote a few days ago! He was pleading with everyone to accept the Tarp. Let's just say, I didn't find his reasoning very convincing. Generally speaking, this article seems to makes some sense. A lot is being left out though, so the idea hardly leaves me spell-bound. Oh and Zooey, are you headed to the bomb shelter in the backyard or something? Armageddon is upon us and you emerge after it has taken place? Haha, I hope you get this, but I'm curious to know what you think it entails to have currency once again backed by metals. Are you referring to a new standard? Please give me a clue.

2008 Oct 02 05:58 PM

[Robot:]

I'm thinking my comment was to Whidbey, but something goofy is happening on SA (Seeking Alpha). If my post applies to your post then my questions were directed at you. Thanks all.

2008 Oct 02 06:30 PM

[Urbane Gori...:]

"Everybody Knows" by Leonard Cohen.

Everybody knows that the dice are loaded
Everybody rolls with their fingers crossed
Everybody knows that the war is over
Everybody knows the good guys lost

Everybody knows the fight was fixed
The poor stay poor, the rich get rich
That's how it goes
Everybody knows

Everybody knows that the boat is leaking
Everybody knows that the captain lied
Everybody got this broken feeling
Like their father or their dog just died

Everybody talking to their pockets
Everybody wants a box of chocolates
And a long stem rose
Everybody knows

Everybody knows that you love me baby
Everybody knows that you really do
Everybody knows that you've been faithful
Ah give or take a night or two
Everybody knows you've been discreet
But there were so many people you just had to meet
Without your clothes
And everybody knows

He just sums it up so well, doesn't he? jegan ;-)

2008 Oct 03 10:09 PM

[vince v:]

I'm curious, Mr. Hussman ... did you have an opportunity to offer an opinion to the decision makers of TARP, or was this view even considered (to your knowledge)? They stated that they looked at alternatives. Did they?

2008 Oct 04 11:00 PM