The stock market falls through holes in the TARP

In a press conference Wednesday, Treasury Secretary Hank Paulson announced a change in the federal “Troubled Asset Relief Program” (“TARP”), saying that the plan would now center around capital injections into banks rather than the purchase of distressed assets.

While the change in focus may or may not be an improvement (I think not, actually), the fact that these big changes are happening and the handling of the TARP seems so chaotic gives very little confidence in our nation’s – indeed the world’s – short term financial future.

It was that apparent confusion at the highest levels of government, more than the particulars of what the TARP will be used for, which I blame for the market’s more than 400 point drop on Wednesday.

A process which seemed somewhat insulated from political pressures for its first few days became more politicized since then – and how could it not when Congress puts a $750 billion pot of money – starting with an early emphasis on forestalling foreclosures, despite the fact that the long-term success of capitalism requires financial punishment of people who make bad decisions.

The TARP’s purchase of preferred stock in financial institutions is a double-edged sword at best. We’ve already seen, with Fannie Mae and Freddie Mac, what can happen when government is given both motive and opportunity to influence the behavior of a corporation. The motive and opportunity for political shenanigans such as legislation favoring one company or group of companies (such as those in which the government owns stock) over other companies (such as those who either didn’t qualify for the preferred stock plan or who ran their businesses well enough that they didn’t need it) will dwarf the Fannie and Freddie conflicts of interest.

I don’t want to sound like a conspiracy theorist, but what is one to make of a government which has been dominated in financial positions by Goldman Sachs for years allowing their competitor, Lehman Brothers, to fail when Paulson and friends were bailing out everyone else in sight? From the most powerful financial position on earth, the former head of Goldman allowed a possibly-preventable rescue of Lehman, something which might even have been accomplished without putting taxpayers on the hook if Treasury had been more helpful in negotiations with suitors or offered a shred of financial support which would have been unnoticeable within the scale of the Fannie Mae, Freddie Mac, AIG, and even Bear Stearns rescues.

Separately, if a company feels that an investment by the government will then make it fall automatically “too big to fail”, the company would likely lose much of the discipline that fear of (corporate) death would impart. And why should they not feel that way? Look at the ever-increasing numbers being pumped into AIG. Look at the auto makers: Given a $25 billion loan, they just came back for another $25 billion…and the Democrats are giving them every reason to believe the money is coming.

The automaker bailout is an obvious sop to unions for their support of Democrats, just like the participation of the clearly unqualified Michigan Governor Jennifer Granholm on President-Elect Barack Obama’s economic advisory team.

But won’t that be as good an excuse as any once the precedent has been set that it’s OK for the government to bail out – or own – private companies?

At least, for the moment, Hank Paulson made clear that the TARP would only be used for financial companies and that automakers would not be participating. It must have occurred to the auto companies within the first 30 seconds of the announcement of the TARP that they all have their own struggling finance divisions. Indeed, GMAC, which is 49 percent owned by General Motors and 51 percent owned by Cerberus (they must be kicking themselves after doubling down by buying 80% of Chrysler 18 months ago, just a year after buying 51% of GMAC), is (or was) a very large player in the mortgage business, as if the car loan business wasn’t bad enough. So I presume the auto companies are looking for a way to claim qualification under the TARP if Barney Frank can send them $25 billion of taxpayer money some other way.

It’s no surprise to me that the stock market has been tanking for the past few days. I’ve predicted as much among friends and family. The TARP is getting holes poked in it. It might be incompetence or politics. But to be fair, it might also be that the situation is so chaotic and complicated that even the best minds in finance have to adapt quickly to changing circumstances and new information. Even if it is that best-case scenario, the prospect of a never-ending bailout combined with our having just elected a far-left government which will do everything possible to support unions even at great peril to taxpayers leaves no reason to expect the market to have any significant recovery for months. Add to that the deep recession we’re likely to have, and I expect the stock market (DJIA) to remain under 11,000 for at least two years, and probably under 10,000 for most of that time.

Maybe they can come bail out us shareholders. After all, we’re suffering losses that aren’t our fault. Isn’t that reason enough these days?