A CAP to Replace the TARP

--What is it with these acronyms? The Troubled Asset Relief Program (TARP) is giving way to the Capital Assistance Program (CAP). A tarp covers up a mess in your back yard. A cap covers up bed head. Both involve cover ups. More on the details of the CAP in a moment.

--Here in Australia, bad news rolls on in the labor market. Pacific Brands is sacking 1,850 jobs in Australia in a bid to boost its fortunes. Profits got to shareholders, and shareholders are Australians who also wear underwear. Thus a dilemma, what if what's good for Australian shareholder s in general is bad for the 1,850 workers of Pacific Brands who won't be making jocks any longer? Which group should be favoured?

--Discuss. Our answer tomorrow. Hint: even if we all went out and bought a pair of bright pink Bonds today, it wouldn't solve the company's problem.

--The share market is digesting the ambitious speech Barrack Obama gave to the U.S. Congress. He's going to cut the U.S deficit in half, increase spending, provide universal health care, improve education, replace oil with alternative energy, introduce a carbon cap and trading scheme...and that's just before lunch!

--You have to wonder what kind of Kool Aid the folks in Washington are drinking. Do they not realize that the nation which they claim to represent is actually going bankrupt? The U.S. government has already made too many promises it can't keep. Making more isn't going to improve things.

--But in a democracy, the people demand action and handouts and a plan! So give it to them good and hard, as H.L. Mencken would say. They're going to get a plan alright. And it's going to involve borrowing lots of money.

--It's no wonder the stock market is depressed. You half expect Mr. Market to take sickie and spend the day at the pokies. Or drinking gin.

--It's optimistic, but there's a chance the status quo could be maintained for about six months. You'd have a directionless market, a range-bound gold price (between US$900-$1,000) and a steady drip of negative economic news. Why six months?

--That brings us to the Capital Assistance Plan (CAP) announced yesterday by the U.S. Treasury. The CAP is designed to solve the problems in the U.S. banking sector. It aims to do this by given the appearance of thorough audit of bank assets and capital requirements (under different scenarios) and then giving the banks six months to raise additional required capital in the private markets, or, to sell convertible preferred shares to the government at a yield of 9%.

--The first part of the plan makes plenty of sense. Behind closed doors, regulators want to meet with the banks and take a good hard look at the books-ALL the books-and see if the banks have adequate capital to survive if the economy contracts by another five percent this year.

--In its white paper on the program, Treasury states that, "In their assessments, regulators will incorporate off- balance-sheet commitments, earnings projections, risks of the banks' business activities and the composition and quality of their capital." Once that's done, the banks, the Treasury, and most importantly, private investors should have a reasonable idea of how much capital the banks need.

--You can see what the Treasury is trying to do. And it's headed in the right direction. Treasury believes that if the banks can provide the marketplace with an audited and accurate statement of their risk going forward, cashed-up private investors might be more than willing to provide capital. Transparency leads to freer flowing investment.

--That's what they must be hoping anyway. One problem we can think of right away is that there are two scenarios used to determine capital requirements and adequacy, a "baseline" scenario and a "more adverse" scenario. The "baseline" scenario reckons on a 2% contraction in U.S. GDP this year and 2.1% growth next year. The "more adverse" scenario reckons on a 3.3% contraction this year and a 0.5% expansion in 2010.

--Does this make sense, though? GDP could expand this year by virtue of the government stimulus package. You'd have the illusion of more economic activity without any actual improvement in the quality of banks assets (which remains the core issue).

--Besides, maybe Treasury should include a "really adverse" scenario in which GDP contracts by 5-10% this year. After all, all over Asia GDP is falling like a stone as exports decline and industrial production cliff dives. America is not going to export its way out of a slump when its trading partners are faring even worse.

--And another thing. U.S. existing home sales were down 5.3% in January. Median prices are down 14.8% year over year to a suddenly intriguing US$170,300. Now, if people could just get a loan! Seriously. Prices are reaching that "clearing" level where you might see an uptick in demand.

--But the Treasury plan probably does not include a contingency where house price fall another 10%. If that's the case, the banks will need more capital than you can imagine. And remember, it's not going to come from savings. It's going to come from money the Treasury gets by borrowing, raising taxes, or from the Fed.

--Inflation. Get ready for it. Now or in six months. It's the only real way to grow GDP, although it will be bogus growth. Six months. IN the meantime, maybe the market will buy this plan. Or maybe it will be left in a state of uncertainty. That gives you time to execute your own plan. More on that tomorrow.

--Finally, our apologies to the alligator fruit! We had no idea...really...very sorry. Eat more!

--Dear Folks,

Offering a fellow who's dying of coronary artery disease a cheeseburger with bacon certainly wouldn't help, but you got it WRONG about the AVOCADO!

There are "good fats" and "bad fats". The bad fats clog your arteries and cause clots to form, resulting in heart attacks, strokes, and other nasty things. The good fats prevent these things.

Saturated fats such as are found in beef fat and cheese are bad fats. Trans fats, such as are found in lard and the oil used for deep frying French fries are even worse - as they cause inflammation of the clogged arteries - clots tend to form on areas of inflammation. It's the clot which completely blocks blood flow in the artery - which does you in - not the hardening of the artery.

Medium chain triglycerides are good fats - they do not harden arteries and decrease arterial inflammation. They are found in plants - mostly in seeds. Examples of medium chain triglycerides are - ta da! - avocados, most nuts, sunflower seeds, canola (formerly called rapeseed but that was deemed politically incorrect - I couldn't make this up!) oil, olive oil and flaxseed oil.

So there you are - go forth and eat your avocados!

Best -

John D. Foster, M.D.
Atlantic Beach, Florida
U.S.A.

Dan Denning
for The Daily Reckoning Australia

P.S. to get The Daily Reckoning direct to your inbox sign up to our free e-mail newsletter or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.

Related Articles:

• Slipstream Trader: How to find small cap gains from large cap stocks
• U.S. Government Takes Over the Economy
• Fannie and Freddie Say Goodbye to Veto
• China Stepping Up Purchases of U.S. Treasury Debt
• The Disturbing Facts About Paulson, Fannie, Freddie and Friends