Let’s say RIP to PPIP

September 24, 2009

Remember PPIP? The Public-Private Investment Program was to provide cheap government financing to encourage investors to overbid for banks’ toxic assets.

Investors would overbid, it was thought, because they were being offered a free put option. If the toxic assets they bought fell further in value, taxpayers would be left holding the bag.

The program has been largely left for dead, but the FDIC still sees some life in its part of the plan. Last week, the agency had a pilot sale, offering loans out of the estate of failed Franklin Bank, whose assets are in FDIC receivership.

Sure enough, the winning bidder elected nearly the maximum available amount of non-recourse leverage, resulting in a 22 percent premium for the assets over bids that didn’t take advantage of leverage.

On the surface, this seems like a good thing for taxpayers, since the higher purchase price accrues to the FDIC’s Deposit Insurance Fund.

But in a new paper, Linus Wilson of the University of Louisiana at Lafayette argues that while the auction prices are increased by leverage, the increase is offset by the loan guarantee the FDIC makes as part of the deal.

So at best it’s a wash and at worst the “subsidized leverage discourages the winning bidder from maximizing the value of loan portfolios.”

If true, this last part is problematic. The point of getting assets back into private hands is that private investors are supposed to be better than the FDIC at managing them. But if the structure of the sale discourages investors from maximizing value, then FDIC may be short-changing itself in the long run.

At least in this case, the 22 percent purchase premium was captured by the Deposit Insurance Fund, since the pilot sale was for assets already in FDIC receivership.

But FDIC conducted the test with an eye toward using it on living banks. If it does so, shareholders and creditors of those banks will capture any increased value that results from government leverage, while taxpayers will be left holding most of the risk.

Another potential problem according to Wilson: Inflated prices from PPIP auctions may give other banks an excuse to mark up their own assets, reducing their incentive to raise necessary capital.

A better idea is to let asset prices fall to levels that don’t require government support. Shareholders and bank creditors should eat those losses. Such a recapitalization will put the financial system on firm footing again, providing a strong foundation for sustainable growth.

Comments

I agree with Linus Wilson. There is a certain smell to the excessive leverage offered through TALF-PPIP that ought to worry everyone. Simply: the investor can model for a statistical default-loss that is hugely buffered by the non-recourse taxpayer provided leverage. It seems very similar to how we all got here: use someone else’s money, make big bets, risk little, make fees. We really like distressed asset opportunities, we really like CMBS, but we approach CMBS investment as real estate lending, not heavily leveraged bets on securitized asset pools. So we don’t buy the bond if we wouldn’t make the loans today. This is conservative, but nevertheless offers good risk adjusted returns as we reduce risk through thorough re-underwriting to todays standards and performance. The problem with PPIP might well be that it encourages a statistical approach, based on assumptions and a model that goes light on underwriting. Frankly, some of the Fed’s accepted CMBS would not meet our criteria for investment. So, on top of introducing moral hazard, the TALF-PPIP probably inflates CMBS values artificially by creating demand for underpriced risk investments. “Dumb money” always inflates values which subsequently fall as reality sets in.

 

Your kidding aren’t you. ” Let assest prices fall to levels that don’t require government support.”
The Dow at 2000
citibank, BOA, 1 cent
GM well I’d hate to think
house prices back at 1997 levels ( another 50% to fall)

I’m not sure the government would survive. Best they keep acting as a cheerleader for the markets and the bankers that are still making millions from the US taxpayer.

Posted by gd | Report as abusive
 

A Radical Solution for America’s Insolvent Financial System

Please follow link:

http://seekingalpha.com/article/160269-a -radical-solution-for-america-s-insolven t-financial-system

Posted by Mansoor H. Khan | Report as abusive
 

“May give other banks an excuse to mark up their own assets!” I’m afraid that is exactly the point of this business. The FDIC is almost certainly getting pressure to “put makeup on these pigs” while continuing to retire the weakest. Expect more of this nonsense.

Clearly this administration is no more willing to take tough action against big business than the last. Kick the can down the street and spend future dollars — the “leadership” that is steadily ruining this country.

Posted by Ron | Report as abusive
 

Any money Mr Obama will be letting the bankers make subprime liar loans to poor blacks and hispanics in less than 12 months.
On a totally different topic could any one tell me what an “uncle tom” is?

Posted by gd | Report as abusive
 

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An sin el espaol David Silva en su centro del campo debido a una lesin, los “citizens” tenan el baln aunque no lograban definir ante el guardameta estadounidense Brad Guzan.

 

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