|
We intended to write today to address the provisions of the Treasury’s Troubled Asset Relief Program (TARP), which we have done below. However, with the market’s reaction to the passing of this legislation on Friday, we will also address the dramatic market declines of the past three trading days and of the past three weeks.
The global equity markets have sold off more than 10% over the past three trading days, more than 20% over the past three weeks and close to 35% for the year. The panic in the markets has reached an historic high, as indicated both by measures of volatility and by the media coverage that has been purely negative. During this year, not a single equity asset class has shown a positive return. Bear markets of this breadth and severity are not unprecedented, but are quite rare.
On Friday, the U.S. House of Representatives approved the Treasury’s Troubled Asset Relief Program (TARP), and it has subsequently been signed into law. TARP will have the authority to purchase or guarantee up to $700 billion of illiquid and distressed assets currently held on the balance sheets of financial institutions. The funding will occur in three phases: $250 billion immediately, $100 billion more after the President reports to Congress on the progress of the program, and an additional $350 billion upon Congress’ approval.
The purpose of TARP is to provide cash to banks in exchange for mortgage assets for which there is currently no market. In theory, the government will be purchasing these assets at a price that is at or above the current “fire sale” prices, but less than the intrinsic value of the securities. The banks will then be able to replace illiquid assets with cash holdings, allowing them to start making loans again, and the government will own securities that they can hopefully profit from. Only time will determine if the implementation of the plan will live up to the theory.
The program will use three mechanisms to facilitate liquidity in the market. First, auctions or reverse auctions will be held by the Treasury. Second, in situations where a market-based approach is not feasible, direct purchases of assets by the Treasury can be made. These auctions and direct purchases are likely to commence in approximately one month. Finally, the Treasury will offer an insurance program under which it will guarantee the principal and interest of the distressed assets in return for a premium paid by the participating institutions.
TARP requires that the Treasury receive warrants or other compensation from participants in the program. It also places restrictions on executive compensation at financial institutions that participate in the program, but these restrictions apply only to compensation agreements signed after a firm’s participation in the program.
In addition to the wide array of “pork” that was added to the bill (including an excise tax exemption for children’s archery arrows), TARP temporarily increases the FDIC deposit insurance limit to $250,000 from $100,000 and provides the FDIC with unlimited borrowing authority from the Treasury. These measures were intended to help bolster the public’s confidence in the security of bank deposits.
Since the passage of TARP on Friday, the global markets have declined over 10%. Concerns over the efficacy of the program in the U.S. and about the health of banks overseas have led to a violent selloff in both credit and equity markets. This is undoubtedly the most trying time to be an investor in over thirty years. While maintaining discipline in the face of panic, chaos and great uncertainty is difficult, it is critical to long term success. We are confident that capitalism is not dead, and we are here to respond to any of your questions and concerns.
|
