Toxic asset profits, public liability
Hedge funds sponsored by the U.S. Treasury are reporting eye-popping returns, but the costs to taxpayers and households could end up being massive.
Funds created under the Public-Private Investment Program reported annualized net internal rates of return averaging 36 percent through Sept. 30, the Treasury announced on Friday, a figure that could encourage the belief that the banking bailout was a shrewd investment rather than a transfer of wealth.
The PPIP was created in 2009 to allow private investors to partner with the public purse to purchase distressed assets from the banking system, using cheap loans from the government for leverage.
Eight of these funds were created, with the Treasury having a 50 percent equity stake in each but providing all of the debt funding at extremely low rates averaging just over 1 percent a year.
It’s hard to know which to debunk first: the returns of the PPIP, which are the outputs of the “models” we’ve come to know and love; the structure, which privatizes profits and retains for the public the bulk of the risks; or the conception of the whole enterprise, which is aimed at propping up asset values to avoid more direct subsidies to banks.
First off, the return figures. The 36 percent is an average, and an annualized one at that. For the taxpayer, who is earning a leveraged return on half of the equity but who is saddled with all of the debt, the overall return thus far is more like 5.6 percent, according to Linus Wilson, professor of finance at the University of Louisiana in Lafayette.
Also note that the returns are based on opaque mark-to-model calculations by the Treasury, estimates which could turn out to be, as they were for Bear Stearns and so many others, highly optimistic.
While the returns are putative, the dividends the funds are paying to their shareholders are all too real, meaning there may be less capital available to make whole the taxpayer if the things turn sour later.
“These are mark-to-model returns. The U.S. Treasury so far has allowed the investment funds to pay $159 million in dividends based on mark-to-model profits,” Wilson said in an email exchange.
“This is irresponsible when taxpayers will be lending $14.7 billion of extremely low interest loans. Dividends should not be paid out until the private investors’ debt to taxpayers is paid in full.”
So, it may well be good to be an equity-only investor in the PPIP, but success is far less assured for the rest of us.
WHO IS THE CLIENT?
Even if the returns end up being accurate, they in no way reflect the total costs of a policy of which the PPIP is only a small part: a decision to support asset prices, particularly housing, at all costs. This has allowed the U.S. to avoid having to take over or massively and nakedly subsidize large insolvent banks, but done so by distorting the economy and channeling funds from households and taxpayers.
The support of house prices, by tax breaks, by loans via the Federal Housing Administration and especially via wards-of-the-state lenders Fannie Mae and Freddie Mac, has been huge.
If you want a taste of the long-term costs of this, just a taste, look at the report last week from the Federal Housing Finance Agency which is projecting Fannie and Freddie may need anywhere from $142 billion to $363 billion through 2013.
Any way you slice it, the taxpayer will be on the hook for hundreds of billions in support of the housing market, money that means higher taxes or diminished services in the years to come.
Almost worse is the fact that homeowners, or renters for that matter, are going to have to continue to pay a relatively higher percentage of their income for housing in order to keep prices inflated. This is especially true for the many people getting mortgage modifications that, truth be told, are not in their own best interests. These modifications commit them to continuing to pay too much of their income to lenders, income that could otherwise stimulate the economy in the form of consumption, or be invested, perhaps even in the type of export-oriented businesses that ultimately must be the solution for the U.S. economy.
Narrowly defined, the PPIP is a success, as is TARP. A government with a fiat currency and a printing press can always successfully support its banking industry.
The larger question remains unanswered: is the government there to support the banks, or are the banks there to support the economy?
At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.