Reply #18: Is the Switch of the TARP Away From Troubled Assets Going to Create More Hedge Fund Forced Sales? [View All]

[ozymandius]

The markets in the US did not take at all well to Henry Paulson's announcement that he wanted to get his hands on the rest of the TARP allotment (a remaining $350 billion) and spend it so as to help consumers go to the mall again. As one correspondend, Andrew, noted:

1) Is the dog-chasing-its-tail nature of using taxpayer money to buy securities backed by taxpayer (consumer) debt not immediately and effortlessly obvious? It took almost no imagination for me to realize how absurd and self-defeating that is.

2) Do you think that Paulson and his cadre are completely aware of how absurd it is, and laughed and slapped each other five when they came up with it? Or are they incredibly dense?

Needless to say, the nasty selloff in Asia overnight says they are not very impressed with this move either.

As we have noted before, intervening in a tightly-coupled system like a nuclear reactor or our financial system, as Richard Bookstaber said, often makes matters worse (the system is so tightly integrated that any move will create diffcult to predict and often destabilizing knock-on effects. We have discussed these unintended consequences in the past.

One is that, particularly with stock prices low and trading in equity and other markets thin, forced selling by hedge funds is even more disruptive than at normal times. And with hedge funds deleveraging for a whole bunch of reasons (margin calls, investor redemptions, tougher standards at prime brokers), distress in one market leads to margin calls, which can lead hedge funds to sell not the asset subject to the margin call (if that market is tanking, you will get a terrible price and would make any similar positions worse) but one that is less impaired, which could be in a completely different market.

http://www.nakedcapitalism.com/2008/11/is-switch-of-tarp-away-from-troubled.html