Public-Private Investment Program for Dummies: How does the new Treasury Plan Impact Housing and the Market? Poorly Planned Investment Program (PPIP).
The much-awaited Public-Private Investment Program, curiously labeled “PPIP” was released on Monday creating a massive rally on Wall Street. Initially we were getting glimpses of the plan through cracks in the financial wall over the weekend and what I was seeing was disappointing. The confirmation was made when the plan was made public early on Monday. The public has a right to be outraged. Not so much for the bonuses to A.I.G., which are disturbing but the fact that our political system seems to be an extension of the Wall Street and banking elite. I remember when the $700 billion Troubled Asset Relief Program was released back in the fall on the pretense that it was going to buy toxic assets. Remember the storm that created? The public was appalled and that initial gut reaction was proven to be right. Ultimately the first $350 billion of the TARP went directly to banks as capital injections and did absolutely nothing for the health of our economy and ultimately was a major safety net for the banks. Yet the bad assets remained. No credit lending to average Americans. Bad assets still there. TARP 1 was a gift to banks and Wall Street. Which brings us to the PPIP.
The problem with the PPIP is that it is designed to provide a major subsidy to so-called private investors to buy up toxic assets. This is a misnomer. Why is that? Language is important in any legislation and especially when presenting a money grab like this one. First, there is very little about this plan that encourages the “private sector” in buying these toxic assets. At least it isn’t private in the sense that you and 95 percent of Americans would like to think of it as private. That is to say, if you had some capital laying around and wanted to buy up some toxic assets yourself, you would not be able to do so? Why? Well let us take a look at the application for this PPIP on the Financial Stability website:
I’ll get into the details of the plan later in this article but this application pretty much sums up everything that is wrong with this program. First, participating institutions must have the capacity to raise $500 million of private capital. This is great for bailout participants that are deemed too big to fail since they’ll have that money easily accessible. Next, they’ll need a minimum of $10 billion in market value assets under management. This is important to keep out the riff raff of “small time investors” since only the big boys know how to mange money. Finally, the deadline for the PPIP application is get this, April 10, 2009 at 5:00pm Eastern Time. Bwahahaha! They already know who is going to get the bids! So much for that “open” market place notion. They spent such a long time devising this plan and now they expect solid plans to come out in a little over 2 weeks? The Treasury already has an idea who is going to play in this game on taxpayer funds and it is the same institutions that created this mess.
If you want a sense of who stands to benefit just look who posted massive rallies today:
Even though the market posted a “broad” 7 percent rally, many of these firms tripled that in the same day. And don’t think this rally was somehow spurred by the retail investor sitting on the sideline. You mean the unemployed ran back in to gamble in the stock market? You mean to tell me that 50 percent of those in our country that are 1 or 2 paychecks away from financial trouble knew to invest in these firms that stand to benefit the most from this poorly planned investment program (the real PPIP)? Amazing isn’t it? This was a major gift to Wall Street.
This plan was being built over time while Americans were kept in the dark. Remember on March 6 when word was spreading that the FDIC was going to go to the Senate for $500 billion?
“WASHINGTON — Senate Banking Committee Chairman Christopher Dodd is moving to allow the Federal Deposit Insurance Corp. to temporarily borrow as much as $500 billion from the Treasury Department.
The Connecticut Democrat’s effort — which comes in response to urging from FDIC Chairman Sheila Bair, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner — would give the FDIC access to more money to rebuild its fund that insures consumers’ deposits, which have been hard hit by a string of bank failures.
Ms. Bair said a change in the law would give the FDIC more options to determine the best way to rebuild its depleted fund. In an interview, she stressed that all insured deposits were already backed by the “full faith and credit of the United States government.”
Scammed again! The subtle pretext here of course was that the funds were going to be used to protect consumer deposits, which of course, is something most Americans would back and did. Instead, that $500 billion which is now the amount the FDIC will insure is the amount we will be backing for Tim and Ben’s excellent adventure into converting the United States into a mega hedge fund. So this fund was being beefed up for the PPIP that was released on Monday.
Okay, let us start digging into the details of the PPIP:
“Despite these efforts, the financial system is still working against economic recovery. One major reason is the problem of “legacy assets” – both real estate loans held directly on the books of banks (“legacy loans”) and securities backed by loan portfolios (“legacy securities”). These assets create uncertainty around the balance sheets of these financial institutions, compromising their ability to raise capital and their willingness to increase lending.”
Now you may be wondering, what in the world is a “legacy loan” or a “legacy security?” Frankly it wasn’t going to sell if they called it “toxic-ninja-fog-a-mirror-no-pulse-zero-down-subprime-non-prime-alt-a-okay-smoldering-junk-pile” loan program. Didn’t have a nice ring like legacy loans. Using the word legacy tries to give this program some mythical powers. Calling this a legacy loan is tantamount to calling a pimple a beauty mark. So right off the bat, this is disingenuous. Also, the reason banks can’t raise capital or lend is because their business models were based on selling “legacy loans” in the first place! Let us read more:
“Creation of a Negative Economic Cycle: As a result, a negative cycle has developed where
declining asset prices have triggered further deleveraging, which has in turn led to further price
declines. The excessive discounts embedded in some legacy asset prices are now straining the
capital of U.S. financial institutions, limiting their ability to lend and increasing the cost of credit
throughout the financial system. The lack of clarity about the value of these legacy assets has also
made it difficult for some financial institutions to raise new private capital on their own.”
Believe it or not, the declining asset prices are the markets way of popping the bubble and trying to find a bottom. The assumption above is that these assets are now marked with “excessive discounts” and that assumption in fact is incorrect. As we have seen with over a hundred homes profiled here in Southern California, some loans are actually worthless. It is very possible that some mortgage portfolios are only worth 20 or 30 cents on the dollar. Is that so hard to believe with the rampant systemic fraud in the system? It is only hard to believe if you live in a Wall Street world so disconnected from Main Street that they forget how it really is to work for a living and the massive surges with unemployment are only a ticker on a Bloomberg Terminal. They forget that what is inconvenient in their models is many people are simply unable to pay these loans. There are now many sub-divisions that boomed that have no economic viability or sustainability. That is, we will see some areas become ghost towns. Now how much are those loans worth? There is “clarity” on these legacy loans just not the clarity Wall Street or banks would like to see.
Think like a bank for a minute. We’ll call you Bank X. You’ve made a ton of horrible Pay Option Adjustable Rate Mortgages during the boom. You have $1 billion of these bad loans. Yet many of them are still paying because they are set to recast in the next few years. Yet you know once they recast, they will start defaulting (you are already seeing signs of this). You also have a portfolio of $1 billion of fixed prime mortgages. These are paying like clockwork. You have another portfolio of Alt-A loans on fixed terms paying on time as well but defaults are rising. Take a wild guess which bundle is going to be put up for auction? It’ll be the $1 billion in Pay Option ARMs. You would be insane as a bank to let go of any of the actual good loans. So right off the bat the incentive is to get rid of the worst loans.
This was my entire point with temporarily nationalizing the banks. Banks are not going to lend until the bad assets are off their books. Someone is going to pay. If we nationalized, at least we shared on the upside potential. Plus, we get to eliminate management, wipe out shareholders, and spend the actual cash on getting lending going again with a new model. We are already paying through the nose but we are basically nationalizing the profits for the banks and “private partners” while socializing the massive losses. Is it any wonder that in a recent poll 41 percent of Americans are now saying, “let the banks fail” and are outraged? Philosophically the plan is horrible for the taxpayer as you can see but let us keep on reading:
“Three Basic Principles: Using $75 to $100 billion in TARP capital and capital from private investors, the Public-Private Investment Program will generate $500 billion in purchasing power to buy legacy assets – with the potential to expand to $1 trillion over time. The Public-Private Investment Program will be designed around three basic principles:
Maximizing the Impact of Each Taxpayer Dollar: First, by using government financing in
partnership with the FDIC and Federal Reserve and co-investment with private sector investors,
substantial purchasing power will be created, making the most of taxpayer resources.
Shared Risk and Profits With Private Sector Participants: Second, the Public-Private
Investment Program ensures that private sector participants invest alongside the taxpayer, with
the private sector investors standing to lose their entire investment in a downside scenario and the
taxpayer sharing in profitable returns.
Private Sector Price Discovery: Third, 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.”
Now we’re getting to the nuts and bolts of this thing. I’ve gotten a few e-mails of people asking, “well they still have to pass this right?” Nope. Remember that $500 billion FDIC bait and switch above? That money is good to go. The other $100 billion is coming from the craptastic TARP. There is a Monty Python skit in the fact that the TARP is funding the PPIP, which will get loans from the FDIC. Let us go through these three so-called basic principles. First, you are not maximizing each taxpayer dollar. The notion that we are sharing risk with private sector participants is absurd because they are hedged to the max as we will soon see. Finally, this price discovery notion is insane. By default we ARE GOING TO OVERPAY! That is the entire point of this exercise. The market has already discovered the price. It is 20 cents or 30 cents for each dollar. That doesn’t work for Wall Street or banks so therefore they need to juice up the game by subsidizing the adventure of more hedge funds, banks, or others that actually created this crony model of investing.
The irony here is that nationalization would have discovered the prices much quicker. And this would have been the truly private-public model. Why? Remember the notion of portfolios? Once the toxic assets were isolated, they would be sold off to the private market. I assure you that there are many private investors licking their chops to buy loans at 40 or 50 cents on the dollar. Remember we are already losing money here with the PPIP. And this would have been a much more open market because guess what? You already have the system in place to sell these loans. In fact, the FDIC could have then used the money to loan out to private investors, both big or small. That is truly opening it up to the market. Instead, we are setting up a system where large middlemen are going to buy these loans and then what? That is right, SELL THEM TO INVESTORS! Haven’t we learned that a toxic loan is a toxic loan no matter what you do or call it?
You have to love this logic:
“The Merits of This Approach: This approach is superior to the alternatives of either hoping for banks to gradually work these assets off their books or of the government purchasing the assets directly. Simply hoping for banks to work legacy assets off over time risks prolonging a financial crisis, as in the case of the Japanese experience. But if the government acts alone in directly purchasing legacy assets, taxpayers will take on all the risk of such purchases – along with the additional risk that taxpayers will overpay if government employees are setting the price for those assets.”
Bwahaha! By subsidizing large private investors we are already guaranteeing that we’ll be overpaying for these assets. By the way, as we’ll discuss soon, these private investors are only going to be putting in $6 for control of $84 which is basically leveraging up to 14 freaking times! Here we are beating up on banks and Wall Street for leveraging up 12:1 or 20:1 and we are designing a program with 14:1 leverage! And the downside is minimal for investors. All they risk is $6. 14 times on the upside and 1 time on the downside? Did Geithner consult with Mozilo for this plan? The premise of “the government will overpay if we take over” and the boogeyman of nationalization creeping to socialism has kept any sensible plan from being implemented. Now, we are assured a massive overpayment for these toxic assets. Geithner is right that we are not going to have a Japanese experience. Japan zombified banks. With this plan we just zombified the taxpayer. Here is the breakdown of the program:
It isn’t true that the leverage will be 6:1. It is looking more like 14:1. What they are assuming via the 6:1 ratio is they are counting the Treasury matching funds as actual equity and only looking at the FDIC loan as debt. That isn’t the case. Those Treasury funds are coming from the taxpayer TARP! Since when did the TARP become a private hedge fund?
When you see the math of this you really get a sense of how absurd this is going to play out:
I love the PR wording in this. Divest instead of dumping this crap onto taxpayers. Legacy loans instead of toxic assets. So the above is a basic scenario. We have a $100 craptastic pool of loans. The highest private bid comes in at $84. It then breaks down as follows:
FDIC: $72 loan
Private Investor: $6
I love step 6 here. For $6, these private investors now fully control the entire pool of mortgages. And one more thing, the loan from the FDIC is NON-RECOURSE. It just doesn’t get better for these private investors and frankly, the banks. Who will suffer? The taxpayer.
What the government is doing is creating a musical chair game once again. The first investor will want to sell this pool off for a premium and who really cares since the loan is non-recourse, creating another phony market. Eventually the last bag holder will realize that indeed, the loans are still crap and the full losses will fall flat on the taxpayer’s shoulders.
Of course this plan is being scrutinized by many people but take a look at this shady scenario. Say I am Bank X again. I have a loan portfolio on my books at $1 billion full of horrible loans. I’m the bank and have full access to documentation and verify that yes, these are some sweet smelling legacy loans. In fact, some preliminary bids are at 20 cents on the dollar and even I think that is overpriced. What do I do? Well say I am a big player and apply for the PPIP. What is to stop me from being a bidder here? After all, if I sell this portfolio on the market I will only get $200 million and recognize a mega loss of $800 million. That would sink my bank. So we get ready and go bidding. Let us assume we use that 84 mark used in the Treasury example:
FDIC: $720 million loan
Treasury $60 million
Private Investor: $60 million
Total: $840 million
This is a freaking no brainer as the bank! And remember, many of these banks have been sitting on those capital injections since they sure as hell aren’t lending so they have some of our cash stashed away to play with. So as the bank, we can them limit our downside here for a mere $60 million on a $1 billion portfolio. Sure beats an $800 million loss. In fact, we can even overbid:
Face value: $1 billion
FDIC: $1,080 million
Treasury: $90 million
Private investor: $90 million
Total: $1.26 billion
The FDIC better have measures against gaming of this sort. Think about it. As a big bank $90 million for unloading a $1 billion toxic portfolio is worth it. It would be a perfect hedge for these banks. An excellent out. PIMCO and Blackrock must be itching to go for these things.
Bottom line? This is one gigantic put option for private investors. If you lose, so what. You only lose the premium put in since the loan is non-recourse. If you hit the pot of gold, then you make out like a bandit gambling with the taxpayer money. That isn’t going to happen. What is going to happen is short term gaming, Pollyanna thinking, and a stealth cleansing of the books which eventually will zombify the taxpayer. At a certain point these assets will hit the market. Who is going to buy these homes at inflated prices? The only reason home sales are bouncing up recently is because of nearly 50 percent of the homes being sold are foreclosure re-sales at rock bottom prices.
This plan runs along the same vein of the initial Paulson TARP. That somehow, the only reason banks aren’t lending is because of these stubborn toxic loans. That premise is false. The reason banks have pulled back on lending is because there is a limited pool of qualified borrowers. This plan fails to address that. How do you get a qualified pool of borrowers? By having a strong middle class that is employed. Finance should be the grease that keeps the engine going. Yet in our last decade, finance became the actual engine. That is the root of the problem. This kind of inside the box thinking shows how entrenched this mentality is. In fact, there is little room in the plan to acknowledge, “maybe these toxic assets are worth what the current bids are.” No, of course that cannot be. We need to make up all these convoluted programs with acronyms like PPIP, TARP, ABCP, etc and hope the average American blanks out or fails to do the math. 6 months after TARP, we are in a worse position. Where will we be 6 months after PPIP?
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