Macro Tsimmis

intelligently hedged investment

Bank of America (BAC) update #6—TARP funds distributed

Posted by intelledgement on Wed, 29 Oct 08

The Federal Reserve effected their $125 billion TARP fund preferred share purchases yesterday, and so as of now, with our short positions in Bank of America (BAC), Goldman Sachs (GS), HSBC Holdings (HBC), and Wells Fargo (WFC), we are officially betting directly against the Fed. (Well, actually with HBC, it is an unofficial bet as the Fed did not buy any stock in that one. And technically, we are not directly betting against the Fed because they have purchased preferred shares and we are short common shares.) So far, on that score it is Fed 1, ISOP 0, as yesterday saw another round of dramatic gains in share prices: BAC +12%, GS +1%, HBC +9%, WFC +12%.

But now the good news (which, of course, considering we are discussing short positions, is really bad news). Even with yesterday’s big share price gains (except for GS who are beset by concerns about their true level of toxic asset exposure), we are still ahead of where we were at the last spike, two weeks ago, as the price per share of all four stocks had dropped off since then. Systemic risk is still evident, and we believe the odds still favor opportunities to exit these positions at lower price levels…plus, of course, they continue to serve as insurance against a meltdown so long as we hold them.

Having said that, we do need to begin thinking about an exit strategy. None of these banks are likely to fail anytime soon with the Fed backing them up. For that to happen now, the Fed would essentially have to fail and that is not in the cards. With the outcome of the election next week pretty much a foregone conclusion, we are likely to have a spasm of optimism that the new administration will do better, and that could engender a stock market rally of unknowable duration.

Which raises a key question: will the Obama administration break with the disastrous Bush-Clinton policies of weak dollar-low interest-deficit spending-pro bubble that got us here? If so, it will require a lot of immediate pain—which can be blamed on W—and cutting loose a lot of deadweight banks…in the short run, bad news for the stock market in general and good news for our shorts in particular. (And potentially great news for the USA, as it means a reversal of our drive towards disaster.)

On the other hand, if the new administration does the expedient thing and decides (as has every administration since Nixon took us off the gold standard) to kick the can down the road again, then the Fed will elect to keep interest rates low to encourage lending and stave off deflation, and that should result in a boost for equities. In effect, we will be getting sugar pills for our illness, which will taste good, and may even make us feel better temporarily, but will do nothing for our illness. If this happens, however, we will probably need to cover our shorts.

Unfortunately for the USA (and our short positions), the odds favor the can-kicking scenario. Obama has made huge spending promises to his constituencies in the course of the campaign and the Democrats in Congress were more supportive of the Wall Street bailout than the Republicans. It will be elucidating to see whom he nominates/appoints to key financial posts in the coming weeks. Stay tuned.

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