NorCalSavant

Treasury Secretary Geithner unveiled the new Public-Private Investment Program for Legacy Assets (PPIP) on Monday to a huge applause by the Wall Street and many questions from the skeptics.  PPIP is the Obama Administration’s plan to purchase the toxic assets off the banks’ balance sheets.  What is involved in the Public-Private Investment Program?  Will it do the job?  Is it a clever plan?  How does it affect personal finances?

The prevailing theory for some time has been that once the toxic assets are off the banks balance sheets, banks would be lending again.  The credit squeeze will ease, and the economy will begin to recover.

In fact, Bush’s Treasury Secretary Paulson was supposed to do just that under the authority of the Troubled Asset Relief Program (TARP) passed by Congress.  However, Paulson changed course and pumped cash into banks instead of purchasing the toxic assets.  Paulson had cited two reasons for this change of course – speed and bang for the buck.

We apparently didn’t get any bang for the bucks he pumped into the banks because bank lending did not improve.  And time wise, Geithner took about two months to come out with a toxic asset purchase program, less than the time available to Paulson after Bush signed the Emergency Economic Stabilization Act of 2008 authorizing TARP on October 3, 2008.

Treasury in conjunction with the Federal Deposit Insurance Corporation, Federal Reserve, and private investors will generate $500 billion to $1 trillion in capital to purchase toxic legacy loans and securities on banks’ balance sheets.  It is estimated that these toxic legacy assets on the books may amount to as much as $2 trillion.

The Public-Private Investment Program includes two components – Legacy Loans, and Legacy Securities.

Legacy Loans Program

Legacy loans are the toxic real estate loans held directly on the books of the banks.  Under the Legacy Loans Program, the Legacy loans will be auctioned off to private bidders with matching funds by Treasury and loan guarantees by FDIC.

On any pool of loans, FDIC will provide a leverage of up to 6-to-1 debt to equity.  Of the total purchase price, the equity will be shared equally between the private investor and Treasury.  The debt would be provided for by loan guarantees by FDIC.

For example, suppose that FDIC has decided to leverage a pool of legacy loans at a 6-to-1 debt-to-equity ratio, and the purchase price is $84.  In this case, the private investor and Treasury will invest $6 each for a total $12 in equity with a $72 financing from FDIC.

Legacy Securities Program

Legacy securities are the toxic securities backed by loan portfolios held by banks and other financial institutions.  Under the Legacy Securities Program, Treasury will match dollar for dollar private capital raised for an investment fund to purchase legacy securities.  In addition, Treasury will loan to the investment fund an amount equal to up to two times the private capital raised for the fund.

The investment fund would be managed by the Fund Manager responsible for raising the private capital with the strategic long term goal of buy and hold.  As an example, a Fund Manager able to raise $100 of private capital will have access to $300-$400 for purchasing legacy securities off the books of financial institutions.

A Clever Plan

The Internet and the blogosphere are abuzz with commentaries and critiques of the Program.  To me, it appears to be a cleverly designed plan to price and remove the toxic assets from the financial institutions’ books.

I remember when Tim Geithner was under consideration for the Secretary’s job, he had thrown around the idea of bringing private capital into purchasing the toxic assets.  The current plan does that and has two desirable features.

It is a good plan for the taxpayer because the asset pricing is accomplished by private control rather than by the government hand with the inherent risk of overpaying.  The plan also provides incentives to private parties to come to the table by providing them leverage.

In the absence of such government provided leverage, it is doubtful if the private parties would have taken the huge risk of purchasing these toxic assets.  As a matter of fact, they have not done it so far.  The private investors still have the downside risk of losing their entire capital, but because of leverage their upside gains could be multiplied — a classic capitalist market play able to attract the best and the brightest minds.  If these investors make money, the taxpayers make money.

Creative minds are already very busy figuring out how to game the rescue plan.  Only the future will tell if the program was abused, or if it was managed in a way so as to minimize the abuses.

According to Paul Krugman, Economics Professor and Nobel Laureate, this is a failed effort in moving banks, at least some big banks, from the brink of insolvency to healthy lending.  He fears the prices would be distorted because of taxpayer subsidy.  Even then, he expects these toxic assets to fetch very little on the dollar.  Of course, he expects investors to make a tidy bundle of money on the back of taxpayer subsidy.  He has advocated nationalization of banks to get the banks solvent and lending again.

Nouriel Roubini, aka “Dr. Doom,” likes the market-based approach of the Treasury’s plan and believes it does not preclude nationalization at all.  He believes nationalization remains an option for the insolvent banks determined to be so by the Obama Administration’s stress test, especially given Tuesday’s Congressional testimony by the Federal Reserve chairman, Ben S. Bernanke, and Treasury Secretary Timothy F. Geithner.

The Treasury plan is basically betting on private money rushing into the newly solvent financial institutions sans the toxic assets.  I don’t see why it won’t be so once the toxic assets are off the books.  America, after all, is the favorite capital destination of the world.

PPIP and Personal Finance

Lastly, how does the Program affect personal finances?  Apart from providing macro benefits realized in improved credit flow and economy, PPIP also provides for a lucrative opportunity to profit as an investor in the Legacy Loan Program.  According to the Treasury’s web page here:

Private market equity investors (“Private Investors’) are expected to include but are not limited to financial institutions, individuals, insurance companies, mutual funds, publicly managed investment funds, pension funds, foreign investors with a headquarters in the United States, private equity funds, and hedge funds.

According to this article in New York Times, Goldman Sachs is trying to whip up investor interest in the government’s rescue plans.  And, BlackRock is looking into the practicalities of starting a mutual fund so everyday investors could buy into banks’ toxic assets.  Such plans, when they materialize, could be the vehicle for individual investors to profit from PPIP.

What do you think?

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