PPIP: Now You Don’t See It, Now You Do

Apparently, the Treasury is close to naming the nine fund managers who will operate the PPIP, the Public-Private Investment Plan.  The program will value the “toxic assets” on banks books through an auction mechanism, whereby approved private investors bid on the “illiquid” real estate assets. Winning bidders receive matching US government capital as well as a non-recourse loan, with the government assuming any losses beyond the investors’ equity invested.  Lately, some have claimed the PPIP is dead, but it seems that its enactment is now imminent. 

The administration’s view is that the “toxic assets” on the banks’ books are incorrectly priced due to illiquidity – that is, that they are “bad” because the market doesn’t understand what they are really worth.  The banks are reluctant to mark them to market, even though housing prices have declined as much as 54% in some places (http://tinyurl.com/mhcro8), and residential real estate alone is showing losses of more than $5 trillion nationwide. 

The PPIP would establish prices for these assets by subsidizing toxic asset buyers (talk about leverage!) and guaranteeing their investments using taxpayer dollars – and thus recapitalize the banks (at the taxpayers’ expense – if the banks sell).  If there is a profit, the fund managers split it with the taxpayers – that is, if the assets recover value over time, which is obviously a fundamental underlying assumption of this plan.  But, if there is a loss, the taxpayers reimburse the investors (net of the investors’ relatively small initial investment). 

Some banks have been reluctant to participate – unwilling to sell these assets at “fire sale” prices.  With the relaxing of FAS 157, (the rule requiring banks to mark assets to market, http://tinyurl.com/nlu6n7), first quarter profits showing improvement, and recent success in raising additional capital from the public markets, banks will be even more interested in keeping these assets on the books (“holding to maturity”), as they are no longer compelled to mark them down and their balance sheets show improvement (be it based on unrealistic valuations or not).

While some smaller, local banks with portfolios of commercial real estate loans are hesitant to sell at the low prices investors are willing to pay, fearing the impact it will have on their capital, other small banks are interested in participating, but are thinking that they will be locked out by the FDIC’s requirement that they participate above a minimum threshold, which may prove too high for them.  Regional banks provide the bulk of small business lending, and small firms have long been the largest source of job creation in the U.S.  If the small banks don’t participate in this program, there is a danger that we will not see a restarting of the small business / job creation engine, and also that these banks will fail and head for receivership, (though these banks hardly represent the systemic risk regulators are seeking to mitigate).

Will the PPIP really help?  The initial idea was to help banks raise new capital and lend money again.  The truth of the matter is that there is a price at which investors would buy these assets (their current market value) – and the banks do not want to sell the assets at that market value, which would force them to recognize a loss. 

It is hoped that the leverage and downside protection offered by the government will help investors bid high enough that banks sell.  If there is a way to entice the banks to sell – (and why wouldn’t bidders overpay – they assume very little risk) – and we thereby create banks healthy enough to lend once again, will they even do so?  The economy’s woes are far from over – and banks are hoarding cash, not putting it to work.  This past weekend, The Washington Post reported on the shrinking credit market – and quoted Citigroup CEO Vikram Pandit as saying that “…borrowers should accept a new world of tighter credit as financial institutions recover from months of bad loans and failed banks…” (http://tinyurl.com/koa6ms).

If the banks are not lending – helping businesses grow and create jobs, is the PPIP missing the mark?  In enacting the PPIP, the risk assumed by the taxpayer is huge, and the upside to the taxpayer is very unclear.

Tags: finance, PPIP, The economy