PPIP: Will banks just end up selling to each other?

By Felix Salmon
April 3, 2009

There’s been a lot of speculation about banks gaming the PPIP system by setting themselves up as investment funds and buying the very assets they’re meant to be selling, only this time with lots of government subsidy. I thought such worries were laid to rest with the explanation that very few people would be allowed to bid on the toxic assets. But now here comes the FT, reporting:

US banks that have received government aid, including Citigroup, Goldman Sachs, Morgan Stanley and JPMorgan Chase, are considering buying toxic assets to be sold by rivals under the Treasury’s $1,000bn (£680bn) plan to revive the financial system…
Spencer Bachus, the top Republican on the House financial services committee, vowed after being told of the plans by the FT to introduce legislation to stop financial institutions ”gaming the system to reap taxpayer-subsidised windfalls”.
Mr Bachus added it would mark ”a new level of absurdity” if financial institutions were ”colluding to swap assets at inflated prices using taxpayers’ dollars.” …
Public opinion may not tolerate the idea of banks selling each other their bad assets. Critics say that would leave the same amount of toxic assets in the system as before, but with the government now liable for most of the losses through its provision of non-recourse loans.
Administration officials reject the criticism because banking is part of a financial system, in which the owners of bank equity – such as pension funds – are the same entitites that will be investing in toxic assets anyway. Seen this way, the plan simply helps to rearrange the location of these assets in the system in a way that is more transparent and acceptable to markets.

I’m particularly disappointed at the way this issue seems to have become politicized already, with Baucus (rightly) calling the idea of banks swapping their toxic assets at inflated prices absurd, and “Administration officials” going so far as to actively defend the idea.
The administration defense seems extremely thin to me: for one thing, there’s still a big disconnect between bond investors and equity investors, so it’s really not true that the owners of bank equity — especially the owners of common stock — are the same people who are going to be investing in toxic assets anyway.

But insofar as it is true, then that only serves to ratify the dark musings of Steve Waldman, who reckons that the biggest fund managers will be perfectly happy to deliberately overpay for toxic assets so long as that prevents them from having to take large losses on all the bank debt (and even equity) that they own.

Looked at this way, the combination of letting banks bid on each others’ toxic assets, along with the weakening of mark-to-market rules, will serve to maximize opacity, minimize the chances that insolvent banks will be revealed as such, and render the government’s stress tests an exercise in rubber-stamping utterly unrealistic balance sheets. The risks of a Japan-style lost decade seem higher than ever.

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