Here’s one, rather immediate, consequence from Paulson’s changing of the Tarp yesterday.
The decision not to use taxpayer funds to mop up illiquid mortgage assets resulted in this market reaction: ABX indices (based on CDS for tranches of subprime mortgage-backed securities) unsurprisingly cliff-diving, meaning a lower value for MBS — Figure 1, from Bank of America below. CMBX, which moves inversely to the value of CMBS, rose as you can see in Figure 2.
(You can see charts of all the ABX.HE and CMBX series and indices here and here.)
It’s not much of a surprise, at least not to Bank of America, given Paulson and assistant treasury secretary Neel Kashkari’s reluctance to supply details of the original plan and the general criticisms of the scheme from the start (how would you price the illiquid assets, etc.) — but it does hint at a further consequence: more writedowns.
ABX, even if illiquid, is still used as an input in many banks FAS 157 level 3 asset valuation models for their mortgage assets, so further writedowns could be on the way — though they likely won’t matter much since the Treasury intends to recapitalise them anyway. Here’s BoA’s take:
Mortgage prices in credit products appear to have come to this conclusion for some time as ABX, for example, having rallied 10 pts on TARP announcement has declined to below pre-TARP levels and fell a further 4 pts today. AAA CMBS widened nearly 70 bps, to 780 bps. The consequence is further asset writedowns to be offset by capital from the Treasury’s CPP program.
The spread on the CMBX is implying an equally catastrophic collapse underway in commercial mortgage-backed securities.
Which lends some credence to commentator reactions like this, from John Carney at Clusterstock:
Congressional opponents of the the bailout were more or less mocked for proposing alternate plans. More than once supporters of the Troubled Assets Relief Program emphasized that banks weren’t lending to each other because of the toxic assets on their balance sheet. Critics argued that there was no good way to price the assets, that the Treasury would probably overpay in an effort to secretly recapitalize banks and that it would be better to openly recapitalize them if that’s what was necessary. And now the Treasury is admitting it was wrong, the critics were right and the TARP won’t be used.
Related links:
The TERP - FT Alphaville
Paulson’s oversight - FT Alphaville
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