As the S&P 500 Index has improved by 38 percent since its low point on March 6th, it seems to be a reasonable moment to pause and ask, "What next?" Is there any reason that the market should continue to rally? So it seems timely to review an aspect of the government spending that hasn't gotten much focus and may be a tsunami of stimulus. A 189-page summary is available from the Special Inspector General's report, "Troubled Asset Relief Program " (TARP) but I'll hit the high points here.
Within the TARP program, what has caught my attention is the Public-Private Investment Program (PPIP). The Federal Reserve created this program which allows for the government to lend up to $1 trillion to programs that will use the funds to buy up asset-backed debt -- meaning loans that have collateral, or the collateral assets themselves if the borrower has defaulted or given them up.
This is pretty dry stuff, but it is worth understanding. PPIP is designed to draw private capital into markets. Five large investment firms will work with the government and go out and find investors who will invest alongside government money. The investors will do it because the government will have taken most of the risk. To give you a sense of scale, PPIP will be able to borrow on a 6:1 basis and use the money to buy "legacy" (once called toxic) loans. On top of that, PPIP managers will be able to leverage up to a 2:1 ratio to buy equity, the forsaken collateral.
Treasury has announced that some PPIP projects will be eligible for Term Asset-Backed Securities Loan Facility (TALF) funds. This is yet another program with yet another $1 trillion available to it. It doesn't take much to see that we may be talking about $4 trillion going into buying legacies, and we certainly are talking about a very significant sum.
Now I get to why I see some real upside potential to the stock market. I quote from the Special Inspector General's report, "Treasury, the Federal Reserve, and FDIC have announced the creation of PPIP to facilitate the purchase of certain real estate-related (the emphasis is mine) legacy assets." This fund is supposed to buy bad real estate holdings. You may recall that real estate is what got us into this pickle. Most pundits claim that until the real estate starts returning to normal, the economy will be in a holding pattern.
So we have something on the scale of eight to twenty percent of total annual GDP added to the picture, much of it to purchase real estate. That represents a tidal wave of new money, and it is supposed to hit in about six weeks. Yet the headlines are largely silent on this aspect of federal funding. Opinions abound with the left arguing that this amounts to a hidden subsidy of asset managers (it does) and those on the right saying the Obama administration cheated by using Treasury funds and not going to Congress (it did). Opinions abound on whether this will create inflation, plunge the nation into greater debt, or make the rich richer, but not much is written about how enormously important it will be to stabilize real estate.
Large investors will doubtless snap up the first tranche of these pooled PPIP offerings, but the administration is clear that it expects managers to design some products available to smaller investors. It shouldn't be hard to attract all sorts of investors. Early assumptions are very promising. One firm (would not let me use their name) is estimating returns of between 10 and 30 percent per year on AAA-rated equity assets. What are equity assets? They include office buildings, hotels, hospitals, retail space, industrial facilities, and rental apartments. Each and every purchase will lead to jobs for the construction industry, lawyers, insurance, leasing agents, and so forth. This is enormously simulative.
In other news that has piqued my interest of late, there is a growing body of literature suggesting that we tax sugar products such as soft drinks in order to pay the cost of health care. The prestigious New England Journal of Medicine has taken on the cause. According to David Leonhardt in today's New York Times, "the authors were Kelly Brownell, a longtime obesity researcher at Yale, and Thomas Frieden, the New York City health commissioner. Since the article appeared, President Obama appointed Dr. Frieden to lead the Centers for Disease Control and Prevention." That tells me the idea may have some traction.
Also, in today's papers, there was a story featuring a photograph of my new favorite person, Secretary of State Hillary Clinton. She is releasing funds for tents, food, and human needs to Pakistan's many new refugees in the quasi Taliban-controlled areas. In a notable departure from the past, the funds are being released to the United Nations and not to the government in Pakistan. This strikes me for three reasons. The first is that the United Nations may finally be gaining respect and support from the American government. The second is that the government of Pakistan has been a shaky ally at best, rift with corruption and quickly adding to its nuclear arsenal, so perhaps we are distancing ourselves. Third, who would you trust to be effective in getting aid to the camps? The United Nations would beat the government of Pakistan in my book.
A more discouraging bit of news is that the Securities Exchange Commission seems to be increasingly likely to lose powers and transfer roles to the Federal Reserve. The agency has been an effective protector of investors for 75 years with the only exception being the recent eight. To dismantle it and replace functions with the Federal Reserve seems to lose the mandate in the maze.
Still, all in all government continues to be surprisingly effective in fighting the economic battle, in creatively looking at ways to tax, to incentivize good behavior, and in raising America's reputation abroad. These are good, and with a potential $4 trillion buying binge ahead, I remain optimistic.