PPIF: A Step in the Right Direction - But Not a Cure-All

On Monday, Treasury secretary Geithner finally fleshed out the government’s plan to create more liquidity for the toxic (sorry, now they’re called “legacy”) loans and securities on banks’ balance sheets. The program is complicated, and important details have yet to be filled in. But from what I can see, the plan should help close, if not eliminate, the gap between the assets’ lowball “market” values and their carrying values on banks’ books. That’s a good thing—but it may not be the panacea that many people think.

I’ll spare you the details of the plan, called the Public-Private Investment Fund, PPIF. (If you can’t help yourself, they are here.) Let me say up front, though, that while I’m not a huge fan of the program, I do believe it will accelerate the clean-up of some banks’ balance sheets.

No one can tell how big a success the plan will be until its final details emerge, of course. But it will almost certainly help liquidity, since the government will provide ample low-cost financing to private-sector buyers. And it will help pricing, as well, since buyers will be able to use leverage that would otherwise be unavailable.

A big question, though is whether banks will be willing to sell at the prices prospective buyers will want to pay. Take Bank of New York Mellon (BK), for example. Last year, after marking its securities to market per FAS 157, the company took $1.6 billion pre-tax charge on its on mortgage-related securities. Management says the expected credit-related loss on the paper comes to just $535 million; the remainder, $1.1 billion, was due to spread-widening, and has nothing to do with the credit quality of the underlying mortgages.

Perhaps Bank of New York will simply want to get this part of the cycle behind it, and will be willing to sells the MBS into the PPIF at its carrying price. But if the company really believes the paper’s true impairment is just $535 million, rather than $1.6 billion, should it really consider giving up an extra $1 billion in value? I would be very hesitant to do that, and I expect many bank managements in similar situations would be, as well.

So even if under the PPIF, an investor’s required return would be equal to a selling bank’s carrying value, will the bank sell? I’m not sure. I hope not, in many cases.

I believe it’s fairly obvious the assets most likely to be sold via the PPIF are those (be they loans or securities) that banks are carrying at “market” rather than the assets they’re carrying at accrual values. This means, in particular, assets that were acquired and marked to market in the past year, such as the Wachovia assets acquired by Wells Fargo (WFC), Washington Mutual assets acquired by JPMorgan Chase (JPM), and National City assets acquired by PNC.

So, in my view, the PPIF can do no harm. Potential investors will be in a position to make fair (but I assume not generous) offers for bank assets, which banks will be able to either to accept or decline. That is a good thing, but it won’t cleanse bank balance sheets in a single stroke.

Still, economist and New York Times columnist Paul Krugman declared the Treasury program dead on arrival Monday morning; as you might guess, Krugman, a Roubini-ite, believes the assets to be “toxic.” If the banks marked them down to their true value, he believes, the system would be insolvent. All PPIF will do is exacerbate the banking industry’s ongoing vicious cycle: banks will continue mark down their assets, the markdowns will exacerbate losses, capital will then continue to shrink, so lending will keep on contracting, and the recession will thus never, ever end. Krugman’s solution: nationalize the banks, and the sooner, the better, to get credit creation started again.

As Krugman writes in his column: “The common element to the Paulson and Geithner plan is the insistence that the bad assets on banks’ books are really worth much, much more than anyone is currently willing to pay for them. In fact, their true value is so high that, if properly priced, banks wouldn’t be in trouble.”

He goes on to say that, because of the government subsidy on financing, the PPIF might lead to transaction prices that might be higher than “real” market prices. But he doesn’t believe that’s the real problem.

“The real problem with this plan," he writes, "is that it won’t work. Yes, troubled assets may be somewhat undervalued.” [Emphasis added]

I doubt it, professor! In the very same column you say a) that these assets are so toxic that, if their true values were recognized, the banking system would be insolvent, and b) these same assets “somewhat undervalued” on banks’ balance sheets? You can choose one or the other. But you can’t choose both!

As I see it, the PPIF can only be a positive to create a more liquid market for banks’ “toxic” assets and, in turn, to move us to the day when Cassandras like Krugman have to stop calling the banks insolvent and urging that they be nationalized.

Comments

[Steven Hansen:]

one problem i have with this toxic purchase program is that it will suck up investor dollars which may have a better use elsewhere.

of course i am wrong if you believe a healthy bank will create a healthy economy (versus a healthy economy will create a healthy bank).

Mar 25 04:51 AM

[Amouna:]

I doubt the plan. The PPIF aims at creating liquidity for ILLIQUID assets by forcing investors to pay a higher price for toxic assets than the market forces dictate. We all know by now that we can't rule against market forces.

Mar 25 05:01 AM

[ebschor:]

When Krugman won the Nobel Prize in Economics it demonstrated that the Nobel Prize is nothing more than a political posturing award rather than an award for a lifetime of achievement. If Krugman isn't enough proof, take a look at Carter, Arafat, and Gore.

Krugman deserved a Nobel Prize in Economics as much as the leader of the Taliban deserves a Nobel Peace Prize.

Mar 25 07:30 AM

[flashrob:]

all this LIQUIDITY CRISIS talk...

all kinds of EFFORT TO IMPROVE LIQUIDITY IN THE CREDIT MARKETS...

the problem I have with this: "WHO THE HELL NEEDS TO BORROW ALL THIS MONEY?" which is supposed to return the finanacial sector to profitability....

THE ABOVE IS THE QUESTION THAT NEEDS TO BE ADDRESSED...I am still waiting for the Obama Administration which is "severely focused on restoring liquidity to big financials" TO TELL ME WHY THEY ARE "PUTTING SO MUCH EFFORT IN THIS ACTIVITY!

IF WE ARE IN A WORLD WIDE RECESSION AND WORLD ECONOMIES "ARE CONTINUING TO CONTRACT" ...

biz needs CREDIT/LIQUIDITY in an EXPANDING MARKET/ECONOMY...

PUMPING THE BANKS "FULL OF MONEY" IS LIKE "FILLING THE SHELVES OF A RETAIL STORE WITH GOODS"...

IF THE CONSUMER IS "OUT OF MONEY" and THESE BANKS have Obama "pumped in full money"...they still WILL NOT LEND TO THOSE WHO NEED CREDIT...BIZ DOESN'T...they are not EXPANDING...but the consumer needs "credit" to buy the stuff in our stores...

Obama and company...ARE MERELY "FILLING UP THE STORE SHELVES" (supply side economic theory)...BUT HE IS OVERLOOKING THE FACT THAT "A CONSUMER WHO LOST HIS JOB...even if he is "temporarily" subsidized by "unemployment...like at 60% of his former pay...and not even that if he was making big bucks...

WHERE IS THE "DEMAND" and the credit extended to those in THE POTENTIAL DEMAND "SIDE OF THE ECONOMY"...

will SOMEONE PLEASE "GRILL OBAMA ON "DEMAND" and how he will accomplish THAT!

everyone is IGNORING THAT FUNDAMENTAL ISSUE.

President Obama: ADDRESS "DEMAND"

no DEMAND, and banks "FULL OF LIQUIDITY" mean VIRTUALLY NOTHING TO RESTART ECONOMIC RECOVERY!

flashrob

Mar 25 10:13 AM

[It Figures:]

A possible problem I see is the regulators forcing the banks to accept better but still uneconomic bids for their assets. Using the BNY-Mellon example, suppose they get a bid reflecting a $1 billion discount - above carrying value (-$1.6 bil) but still below the bank's estimate of hold-to maturity economic value(-$535 mil). It is not beyond imagination to see the feds "suggest" they take the bid, thereby enhancing the "optics" of the balance sheet/capital structure but in fact destroying the economics.

Bair mentioned the other day that such desicions would be made "in consultation" with regulators. Being that bank and regulator objectives and motivations differ significantly, and that the regulators hold all the power in the relationship at the moment(via the "stress test"), this could be a bad thing for banks seen to be vulnerable - whether they actually are or not.

Mar 25 11:35 AM

[flashrob:]

were we FOOLED AGAIN, BY "BIG MONEY!" have they INSTALLED "ANOTHER PUPPET!" beginning to look like THEY FOOLED US AGAIN...as usual!!!

Now, if Mr. Obama, wants TO PROVE OTHERWISE... here's a JUMPSTART THE ECONOMY CLUE FOR HIM!

HELP "main st" instead of "wall st."

illusion NUMBER ONE: you keep hearing that we have to prevent the "big investment type banks and financials" from failing TO PREVENT A WORLDWIDE LIQUIDITY CRISIS.

THIS IS FALSE because PUMPING THOSE BANKS FULL OF LIQUIDITY WILL NOT "GET THEM LENDING!" It only "bails out formerly rich investors!"

Think: Who is going to be borrowing IF YOU FLOOD THE BANKS WITH MONEY ...that could be used BETTER ELSEWHERE!

We are in a "global recession" and STILL GOING DOWN with continued FURTHER JOB CUTS. WORLDWIDE BIZ is CONTRACTING, DELEVERAGING, AND LAYING OFF PEOPLE.

BIZ NEEDS LARGE AMOUNTS OF LIQUIDITY AND FREE FLOWING CREDIT when THEY ARE EXPANDING "NOT CONTRACTING."

using the "trillion bailout" IS LIKE PUSHING A STRING...

those that NEED CREDIT, like the consumer WILL NOT GET IT, AND "big biz" does not need it IN CONTRACTION.

they are just BAILING OUT WALL ST. "AS USUAL!"

I voted for O'bama thinking CHANGE... but it appears the FOXES have surrounded him... and are taking care of "foxes" and not "us chickens!"

SOLUTION: we have 600 or so regional and local banks and SOME BIG ONES that are not using "mark to mkt" accounting and are in relatively GOOD FINANCIAL SHAPE.

LET THE BIG INVESTMENT BANKS GO DOWN...flooding them with credit that few need is WASTING TAXPAYER DOLLARS!

while there is STILL TIME... give the CONSUMER (who won't qualify for the credit reliquification anyway) A
HUGE IMMEDIATE TAX REFUND for last year.

the "individual" consumer could be given a "treasury refund coupon book"
with options to spend the tax refund in "certain timeframes" and on certain biz and sector purchases. This way he can't "salt away the money, etc."

say: one coupon of 20% could be used to purchase a "new or used car" or make a mortgage or credit card payment" but not pay off all credit card debt in one shot...like make double the minimum payment, etc. ...get the idea!

Congress would have to work out the specifics of the plan, but the effect WOULD BE TO IMMEDIATELY PUMP "HUNDREDS OF BILLIONS" OF DOLLARS into ALL SECTORS OF BIZ AND THE ECONOMY (instead of wasting this money to liquefy credit in world banks...where it will help few who "need and quality" for that type of credit).

JUMPSTARTING the "consumer sector" of the economy is WHAT IS NEEDED IMMEDIATELY...not bailing out Wall St. fiascos...

if you don't jumpstart the "consumer economy" immediately...more jobs WILL BE LOST, MORE PEOPLE WILL BE FORECLOSED AND LOSE THEIR HOUSES. These jobs will not return easily or quickly once they are lost.

Get with it Obama. Forget Wall St. ...BACK "MAINSTREET!"

FLASHROB

Mar 25 12:00 PM

[Mad Hedge F...:]

It certainly will suck in some serious money. “I said a few months ago that Washington was all in. We are now all in squared. The FDIC, Fed, and the Treasury are making a concerted effort to turn deflationary swamp water in inflationary wine.” Ah, Paul McCulley, man of Virginia, you have such a way with words. PIMCO must love you. I agree.

Mar 25 01:53 PM

[Stone Fox C...:]

The cross information provided by the Roubini/Krugman side could almost be seen as slander. This talk about nationalizing banks that have over marked assets seems absured. Whats really astounishing is the disconnect between guys like Bove/Brown and Whitney/Roubini. One camp thinks assets are market to ridiculous levels and one thinks banks are insolvent b/c they haven't taken any marks. I'm sure the reality is in the middle which is great for the stocks b/c they took Whitney and Roubini to be accurate when we hit bottom.

I'm not convinced that the plan will work either

Mar 25 06:38 PM

[flashrob:]

the assets ARE SOMEWHERE IN THE MIDDLE... I agree...

problem is: they are going to continue to GO DOWN...with more high-paying job losses, more foreclosures as "mainstream mortgage payers" lose their jobs...

the future is "no recovery FOR MANY YEARS" FOR "big financials!"

the market is in denial listening to "recovery hoopla!"

what we need is REALITY to even have a chance at weathering this catastrophic economic storm.

MAIN ST. needs to be bailed out with a "huge and immediate" tax refund to GET THE CONSUMER ECONOMY jumpstarted...

forget the bondholders at the "big financials" ...they and friends are trying to "rally mkt up" so they can UNLOAD THEIR DECLINING ASSETS TO suckers...WHO THINK THESE PHONY STOCK MKT RALLIES will continue...

underlying fundamentals SPELL no "quick fix" to the world wide economy ...LIKE THOSE by Whitney/Roubini...who are giving
us the "unpleasant but real numbers and forecasts!"

flashrob

Mar 26 06:22 PM

[DUNIT:]

The writer of this post clearly hasn't gone through the numbers. Yes, you are correct, the Geithner/Bernanke plan cant do any harm, but Krugman is right, the banks are technically insolvent. There are currently $1T worth of securities and $8T worth of legacy loans on bank balance sheets. The loans are the problem, since a high percentage of them are marked at 97.5 cents on the dollar (banks arent forced to mark these to market, and they normally take a 2.5c loss provision on the loan at inception and carrry it to maturity). If you assume a modest loan loss severity of 12c, the banking system is insolvent. No amount of financing boost will provide enough pick-up to get investors to buy the loans anywhere near where the banks will sell them (or could sell them without taking massive losses and forcing themselves into bankruptcy). Ultimately, the final result is that the program will end up functioning as a liquidation vehicle for the assets of failed banks.

D-Unit

Apr 14 09:16 PM