Beware, TARP-III is here!

Thu, 4 Nov Pre-Open

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Call it TARP or call it QE2, another US$ 600 bn worth of cheap money is set to immediately find its way into global markets. In its latest decision, the US central bank Federal Reserve has decided to make yet another attempt to salvage the US economy from the jaws of recession. And to do this it will totally pump in US$ 900 bn by the end of September 2011.

It may be recalled that TARP (Troubled Assets Relief Program) was put into place by the US government to bail out some of the largest banks in the country. It was the money given to the financial institutions at zero interest to avert insolvency. The total amount came upto US$ 787 bn. Although the banks did manage to pay off most of the loans, the loss to American taxpayers for the zero cost loans went unaccounted for. Bloomberg estimated that taxpayers had to forego US$ 350 bn worth of interest charges per year because of the low interest rate policy of the Fed.

In 2009, the second round of TARP came in. The Fed bought US$ 1.7 trillion in mortgage and Treasury bonds. Those purchases were expected to help lower long-term rates on home and corporate loans. However, that too failed to improve the rate of home purchases or consumption in the US.

The story this time around is not very different. Companies in the US are still finding few buyers for their wares. Unemployment remains at multi year highs. And in the Fed's own words, the US economy is moving at 'a snail's pace'.

Thus, if this round of stimulus fails to revive consumption, the US may soon be having severe deflationary pressures. This vicious cycle wherein consumption and production are deferred could lead the economy to a tailspin.

Given its short sightedness, for the time being atleast, markets are rejoicing over the fresh inflow of funds. The US markets closed higher yesterday, albeit marginally. Most Asian markets are up this morning. After all, most of the cheap money is expected to find its way into emerging markets. The search for better returns could well bring money out of the US rather than support US consumption. But that said, wherever it goes, the propensity of risk is bound to be higher. Although most Asian markets have already taken rate hikes to avert price rises, the same may have to continue. India in particular may have to do more than keeping its lending rates higher. Stock markets and housing prices have seen a fair share of FII money coming in so far this year. These may go even higher in the near term. But rationality warrants that investors do not get carried away by such myopic speculations. Instead they need to focus on the long term risk return scenario. And that is clearly giving out some warning signals.