07 April 2009

PPIP, Geithner, and the Great Bail-Out

Why are people so surprised about the PPIP (for those not in the know, this stands for public-private investment program) that Geithner is proposing?

Here is a good article. But it's a little off. Jeff Sachs postulates it will turn into a profit scam that the banks can "game".

Of course it's a scam. We knew that the day the plan was announced. Anytime you get to sell something worth nothing for near face-value it's a scam. The investors get to borrow 85% of the purchase price from the FDIC, Treasury kicks in half of the remaining 15% needed and the investor puts in the rest, a whopping 7.5%.

But it's not a profit scam....it's a loss-reduction scam, er uh, "program".

We will use Jeff Sachs' example from the article cited above. Citi forms a little PPIP, bids the face value, $1 million, on an asset that Citi owns, and only has to put in $75,000. The PPIP defaults on the federally guaranteed FDIC loan and Citi is sitting pretty with $925,000 profit.

The problem is, it really isn't profit. If Citi had originally paid any more than $925,000 for the security that gets sold to the PPIP then they are net zero. They just recouped any potential loss of the security really turns out to be worthless. Profits would only materialize if the PPIP is buying the security for more than what Citi originally paid for it (which is possible and likely to happen if these auctions aren't held in check...but why would they be held in check? the point of this plan is that the federal government doesn't know how to value the assets, so they're going to let the "experts" figure out the value and then bid that value with taxpayer dollars. Adverse selection anyone?).

The whole PPIP program is really just an indirect bail-out. The government is buying assets for more than what they're worth. Period. End of story. The Geithner plan is merely creating the illusion of price discovery through market transactions. People aren't cool with the government just writing a check to the banks. To circumvent public scorn and discipline they have to make it look like an "investment program". But really, we're just giving the banks money for assets with unknown and likely inflated values.

Don't get irate. If the plan goes through and this actually happens then we will have achieved what we wanted to: saving the banks. Nobody wanted to let them fail. Well, that's fine and dandy, but if you don't want them to fail then this is the only option--reimbursing them the lost value of bad assets. There's now way around it. So don't think Geithner is pulling the wool over our eyes. He's doing what he's been charged to do, and just making it seem less like what it actually is.

UPDATE - APRIL 7, 2009 - 7:00PM:
Via Calculated Risk.

The FDIC thinks there will be no losses on the loans it insures to investors participating in the PPIP. Seriously. This is no joke.

So my question is, if the FDIC is so confident that there will be zero losses on loans made to purchase assets of questionable value, then why do the loans need to be guaranteed? There's obviously no risk in purchasing these assets if the investors who choose to buy them are able to make the loan payments. So if they're so safe, how come nobody wants them?

Oh, and the FDIC has some stipulations on the loans it insures. It says it will carefully vet each loan and require borrower's to pay loan fees and post collateral. No risk loans, but they are to be collateralized and vetted carefully? Something smells fishy.

Aside from that, who the hell is going to post collateral that actually has value for a loan to make a gamble on some obscure and mysterious asset of unknown value? Some investors might be pretty risk tolerant, but this ain't the craps table on the strip--these are businessmen looking for a handout. They're not going to post good collateral. The point of PPIP is to encourage investors to buy these "toxic assets" (I hate that term) by minimizing the risk of loss, ie giving you 92.5% of the money, no strings attached, to purchase them, with no recourse and no collateral needed. The strings are going to discourage anybody from borrowing to buy the damn things, leaving us in the same situation that we are in now.

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