Monday, March 23, 2009

The Key Question Remains!

The most important “principle” in the Geithner Public/Private Investment Program (PPIP) is the “private sector price discovery” mechanism. The Treasury Fact sheet says that in order to “reduce the likelihood that the government will overpay for these assets, private sector investors competing with one another will establish the price of the loans and securities purchased under the program.” Pundits on both the left and right are furiously arguing that the plan is going to be a huge giveaway to the banks at the taxpayer expense. But, this assumption is based on the PPIP overpaying for the toxic assets. Of course, the government could rig the PPIP auctions for the benefit of the banks but the pundits (and many traders long the financial stocks) are just speculating on this score.

Paul Krugman argues that the Geithner plan is “just an indirect, disguised way to subsidize purchases of bad assets” at inflated prices. But, Krugman’s statement is far too definitive without the benefit of the pricing data. The ultra-cheap financing and attractive terms will enable the public/private to “pay up” for the toxic assets. The key question is how much? Market participants will not know if the PPIP is a taxpayer giveaway until the asset auctions begin and the prices are disseminated.

Also, keep in mind that the “uniform stress test” results are expected by the end of the April and the PPIP is going to be launched within the next 45 days. Will any banks fail the stress test? And, if so, will banks that fail the stress test be forced to sell assets into the PPIP in order to receive additional capital? The uniform stress test may be the trigger that forces banks to recognize their true unrealized losses and the PPIP may be the venue where the unrealized losses are finally realized. The uniform stress test and the PPIP may be a way for the Obama Administration to force the point and provide political cover if a “too big to fail” institution needs to be nationalized and liquidated.

In terms of strategy, the rally appears extended here despite the solid move above the 50- day moving average and the 800-level on the S&P 500. Traders that are still aggressively long should be paring back exposure into this advance. The speculation that this program is going to be a windfall for the banking sector seems misplaced and overdone.

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