Main Street Needs a Smaller Deficit

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****The headline news this week is all about the Troubled Asset Relief Program (TARP) which Treasury Secretary Timothy Geithner has said will be extended until October 3, 2010.  This news is creating speculation over what the funds will be used for, what should be done with re-paid funds, and what the original purpose of the program was.

All this comes on the back of last weeks repayment of $45 billion by Bank of America (NYSE: BAC) and this week’s debate which pits Wells Fargo Bank (NYSE: WFC) and Citibank (NYSE: C) against government regulators.  It appears these banks are sparring over repayment terms – the government says they still don’t have enough common equity to meet capital requirements.  The banks want to get out from under the government’s wing – which really means they’d like to avoid public scrutiny over compensation packages. 

Many had feared that TARP funds, doled out to select banks by Uncle Sam to stave off another Great Depression, would never be returned - or that the borrowers would only pay back pennies on the dollar.  With Bank of America’s $45 billion re-payment, $116 of the $205 billion injected directly into banks has now been repaid, along with about $10 billion in dividends and interest.  Looks like the American taxpayers may in fact not get the raw end of this deal after all.  Or does it?

I am increasingly skeptical of the Obama Administration’s plans for repaid TARP funds.  The Treasury now estimates that TARP will lose $200 billion less than expected, and Washington fat cats are starting to get possessive over the ‘excess’ funds.

In his speech at the Brookings Institution on Tuesday, Obama outlined a number of initiatives that could be targets for redeployed TARP funds, including small business tax breaks, infrastructure spending, and consumer rebates of up to $12,000 for retro-fitting homes to use less energy.

Now, these are stimulus programs.  And I agree that economic stimulus is in order.  But this is a different need then saving financial institutions that were wandering through the Valley of Death.  While many Americans’ homes are ‘troubled assets’ given the plunge in property values, energy-efficiency retro fits are not the financial crisis that TARP funds were originally intended to address. 

Energy efficiency should be a national priority, and we do need infrastructure spending (small business tax breaks for new hires is a scam – if companies have an economic reason to add employees, they will).  But regardless of where you stand on these issues, the point is that this debate is separate from TARP.

Ben Bernanke summarized TARP’s purpose in a speech delivered shortly after TARP was passed in 2008:

“…Notably, the legislation establishes a new Troubled Asset Relief Program, or TARP, under which the Treasury is authorized to purchase as much as $700 billion of troubled mortgages, mortgage-related securities, and other financial instruments from financial firms…

…The TARP's purchases of illiquid assets from banks and other financial institutions will create liquidity and promote price discovery in the markets for these assets…

…The interests of taxpayers are carefully protected under this program. First, the Congress has required extensive controls and oversight to ensure that the allotted funds are used appropriately and effectively. Second, the $700 billion allocated by the legislation is not an authorization to spend but rather an authorization to purchase financial assets…”

Ultimately, the American taxpayer should be paid back in full, with interest and capital gains.  The TARP money grossly inflated our national deficit, and should now be used to pay that deficit down so that our children and grandchildren will not be on the hook for inherited problems.  Already, interest on the loans has accumulated and needs to be paid.    

If Congress really wants to restore faith in the financial system, it should send a check to every American taxpayer based on excess returns, if they materialize, from TARP investments.  That’s how investments are supposed to work.  And if Americans want to spend their capital gain on caulk and new windows, that’s great.  But those that don’t shouldn’t foot the bill through TARP.

Now don’t get me wrong, I agree that job creation is critical to get our economy back on track,  and that job creation needs to begin with small businesses – those that have created 65% of new jobs over the past 15 years.  But let’s not mince TARP and job creation.

****Last week was exceptionally good for small caps as evidenced by the significant out-performance in the Russell 2000.  Small-caps had been lagging the broader markets for several weeks as the Dow reached highs above 10,500, while the Russell has yet to return to mid-October levels above 620.  November’s drop in unemployment is evidence of a recovering economy and coupled with small-caps relative underperformance, seems to be igniting a rally in riskier stocks. 

I believe small-caps are staging a comeback, and will lead the market through the end of the year.  I hope you have had an opportunity to enjoy the ride with SmallCapInvestor Daily in 2009. 

And as we look to opportunities for 2010, I still have high expectations for small-caps, and Chinese small-caps in particular.  The Chinese government passed a $600 billion economic stimulus package in March of this year, and that program will help China’s economy reach the 8% GDP target for 2009.        

As you know, I’ve been extremely bullish on China for most of 2009. And that bullishness is paying off for my SmallCapInvestor PRO members. We have several Chinese companies in the SmallCapInvestor PRO portfolio posting gains like 122%, 80%, and 30%. And recent news that China will grow at 10.5% this quarter makes me confident that there’s a lot more upside ahead for our Chinese stocks.

One of my favorite stocks in the portfolio is China Green Agriculture (NYSE: CGA).  This little gem has recently made the switch from the AMEX to the NYSE and is continuing to fire on all cylinders.  This is just one high potential small-cap stock that you will receive research and updates on when you subscribe to my SmallCapInvestor PRO advisory.

Until Tomorrow,