Making Sense of the PPIP

Tim Geithner unveiled a good amount of detail on the much-awaited financial sector resuscitation package over the last week. Apart from addressing the core issue of unfreezing the credit market and hence imrpoving liquidity, the Treasury also clearly articulated the broad guidelines of new financial sector regulation.

Let's try to make sense of the PPIP - the plan basically envisages the government putting its skin-in-the-game to push/incentivize private sector participants (read money managers) to take that elusive step forward - buy distressed assets and securities. The government's share of risk is through a mix of FDIC guarantees, direct Fed loans and Equity participation. To make sense of the program, let's look at the Legacy Assets and Legacy Securities program separately.

Legacy Assets PPIP program - This envisages private parties (meeting certain eligibility criteria) to bid for defined pools of troubled assets as made available by banks. Once the best bidder is decided for each pool, the government would match equity contribution. But the bigger piece of the puzzle here is the FDIC guarantee - FDIC would employ consultants to value each pool and provide debt guarantees up to 85% of the total bid value of the pool. The actual guarantee percentage for each pool (85% or lesser) would eventually determine total credit risk assumed by the government.

Assume a USD 100 million RMBS pool with a bid value of USD 80 million (to account for potential losses in the portfolio), if the FDIC provides a debt guarantee up to 85% of bid value, it basically means the government is taking a risk of USD 6.0 mn in Equity + additional losses if the actual realizable value of the asset pool is lesser than 68 million. This is fine in case the overall PPIP plan does turn back the market to normalcy; but it's a significant risk to the Treasury's balance sheet otherwise...another 12 million (15%) value drop on the portfolio is not beyond practicality! In a nut shell, there is enough risk sharing from the government to bring in private investment - but on the same note, an ineffective execution can expose the treasury balance sheet significantly. Considering the vary nature of the base asset (loans as against negotiable securities), initial participation is bound to be tepid, unless the securities PPIP program picks up speed and loosens the secondary market.

Legacy Securities PPIP program - The basic premise of the plan is similar to the assets program described above, but the modus operandi is a bit different. It starts with the treasury inviting bids from large assets managers (again, defined eligibility criteria) to select up to 5 asset managers to run the program. These managers would form distressed securities funds with disclosure on fund amount, investor mix, asset selection strategy, asset management strategy, fees etc. The treasury would commit an equal share of equity and on top of that, provide a matching share or in some cases (based on analysis of target investment pool, strategy etc) even twice the matching share in the form of senior debt. Assuming the maximum share of senior debt from the treasury/FDIC, this basically means there's an open risk beyond a value depletion of 25% on the base assesses value of the securities pool. Given the fact that several large global funds have already raised significant money targeted at distressed securities, this plan should drive active participation and free up liquidity in the market.

From the above, it's clear that this is a well-thought out plan from the Treasury, but it's no magic wand. As in any other solution, it does assume rational markets (and market participants) and hence does imply significant balance sheet risks to the treasury - up to 800+ billion, a large number considering the 9 trillion + balance sheet size. But, given the already-distressed value of the base assets and latent investor appetite for such assets, I would bet my money on the plan gradually unleashing liquidity over the next few quarters. The dark horse here is the impact that freshly unveiled regulatory changes (read registration, increased disclosures and hence constariend investment strategies) will have on the existence and volumes associated with critical participants like hedge funds, venture capital funds and private equity funds.

Stock position: None.

Comments

[CautiousInv...:]

It is not clear to me this is a well thought out plan.

The most fundamental issue is whether bids for troubled assets will be accepted by the seller. If the bids are low and the seller does not accept the bid, the toxic assets remain on the books and we delay resolution.

Realted to this is the delicate matter of timing. It would appear, now, that the most important of the two programs and the one dealing with legacy securities will not become operational until late June or July. During this span home prices are likley to continue falling at a 18% annual rate.........further depreciating the assets that the banks wish to sell and making it more likely bids will fail to clear.

Mar 29 07:49 AM

[Dave Wrixon:]

It is not clear to me that even trying to rationalize PPIP is a useful objective. It is a scam pure and simple. At the highest level it is trying to scam its way past a democratically elected congress, and at the lowest level it is trying create a fake in security market valuations. The objective is to convince the World that US banks are solvent when they are not, and they are attempting to do it by getting the taxpayer to act as the stooge. This could make Watergate look like a minor Faux Pas.

Mar 29 08:15 AM

[ed233:]

HERE IS THE SCARY PART. The government is trying to flog depressed valued instruments to prop up a few once big international banks; that if they fail could possibly topple the whole financial global markets which would spell double trouble for the emerging economies who have invested heavily in these toxic investments. The US government to protect their standing as the choice of currency for international transactions have placed the US taxpayer as the ultimate fall-guy by guaranteeing unnecessarily the future generations of their children's children. To make those investments more palpable it would have made more sense to protect the investments behind these toxic instruments rather than watch those(eg. housing investments) plummet month after month. But as they say you can always find a buyer if the price is right. The question is how sweet is the deal going to be for anyone to stick their toes in at the expense of joe public. It's the US currency as a currency of choice world wide that is at risk because when the US prints more money they'll be able to export most of their toxic instruments via the debasement of the dollar. The countries holding large amounts of the US dollar and bonds will pay the ultimate price at the expense of the wall street types and the federal government who move more US dollars globally.

Mar 29 11:55 AM

[Insiderman:]

Kudos to the insightful comment about banks accepting the bids, transferring risk from banks to taxpayers, and failing to punish excessive risk taking on virtually anyone's part. On that last note, why is it that CDS protection buyers (Goldman Sachs among others) emerge from this whole. Perhaps they should have split the losses between protection sellers and buyers and left the taxpayers out of it. A protection buyer that does business with a protection seller should bear the counterparty risk, eh? And that applies especially to those who bought naked (no underlying CDO risk).

Mar 29 12:25 PM

[Promod Radh...:]

There are only 2 options for the government - sit tight and let the market play itself out OR be an active participant to market revival. The first option might mean a continued economic freeze/down turn for another 12-18 months or more, with associated increase in umemployment rates. Does any of us want this to play through - at the current rate, unemployment would already hit 9.5-10% by Q2 end! I agree we can debate on the model used - can we put tax payer money at risk? But given the fact that the one who suffers the most from the fallout of a continued recession and liquidity freeze is the tax payer, I don't think this argument holds much water.

The tax payer didn't bring this market down - hence participants who caused this will/should be forced to play by stricter rules - through increased supervisory oversight, tighter regulations and disclosures etc. The outline of Geithner's plan already has heavy provisions for disclosures and reporting on many fronts - inluding those related to hedge funds, venture capital funds and private equity funds. As long as the government follows up with efficient execution on this front, we will gradually move towards sanity.


On Mar 29 11:55 AM ed233 wrote:

> HERE IS THE SCARY PART. The government is trying to flog depressed
> valued instruments to prop up a few once big international banks;
> that if they fail could possibly topple the whole financial global
> markets which would spell double trouble for the emerging economies
> who have invested heavily in these toxic investments. The US government
> to protect their standing as the choice of currency for international
> transactions have placed the US taxpayer as the ultimate fall-guy
> by guaranteeing unnecessarily the future generations of their children's
> children. To make those investments more palpable it would have made
> more sense to protect the investments behind these toxic instruments
> rather than watch those(eg. housing investments) plummet month after
> month. But as they say you can always find a buyer if the price is
> right. The question is how sweet is the deal going to be for anyone
> to stick their toes in at the expense of joe public. It's the US
> currency as a currency of choice world wide that is at risk because
> when the US prints more money they'll be able to export most of their
> toxic instruments via the debasement of the dollar. The countries
> holding large amounts of the US dollar and bonds will pay the ultimate
> price at the expense of the wall street types and the federal government
> who move more US dollars globally

Mar 29 12:33 PM

[Promod Radh...:]

I agree with your key point - the legacy securities program is indeed the lynch pin of the PPIP. But, 3 months is not too long considering the logistics involved (selection of Asset Managers, Raising capital, execution of investment strategy etc)...even if we assume home prices continued to fall (but at a lower rate), we shouldn't see much of a change in written-down value of these assets from current levels. As an indicator, CDS spreads haven't widened much beyond January levels in the last 8 weeks.

On your other point, the only reason sellers would hesitate to embrace the plan is if they feel assets are already written down below fair value/assets are worth more than what the market's valuing it at. In that case, the basic premise is that there's not much down side. Even in that case, wouldn't a competitive bidding scenario surely help determine true market value?


On Mar 29 07:49 AM CautiousInvestor wrote:

> It is not clear to me this is a well thought out plan.
>
> The most fundamental issue is whether bids for troubled assets will
> be accepted by the seller. If the bids are low and the seller does
> not accept the bid, the toxic assets remain on the books and we delay
> resolution.
>
> Realted to this is the delicate matter of timing. It would appear,
> now, that the most important of the two programs and the one dealing
> with legacy securities will not become operational until late June
> or July. During this span home prices are likley to continue falling
> at a 18% annual rate.........further depreciating the assets that
> the banks wish to sell and making it more likely bids will fail to
> clear.

Mar 29 12:49 PM

[Dave Wrixon:]

I got news for you. Unemployment is going to hit those kind of levels regardless. And if I where Obama, I would settle for 10% if I could cut a deal.


On Mar 29 12:33 PM Promod Radhakrishnan wrote:

> The first option might mean a continued economic freeze/down turn
> for another 12-18 months or more, with associated increase in umemployment
> rates. Does any of us want this to play through - at the current
> rate, unemployment would already hit 9.5-10% by Q2 end!

Mar 29 03:54 PM

[Prudent Man...:]

Once an institution gets a bid for an asset that is the market price. All institutions must mark to that market, which it is what it is and no one can complain.

When that is the case, those institutions on the cusp of failure will as they will no longer be able to hide behind failed assets that were not marked.

Mar 29 05:21 PM

[Insiderman:]

Sorry "Prudent Man." It is not a market price until you have a willing buyer and a willing seller. A willing buyer with a price does not a market make.

Also, isn't there some sort of prohibition against using the CFA designation without a comma after your "handle?"


On Mar 29 05:21 PM Prudent Man CFA wrote:

> Once an institution gets a bid for an asset that is the market price.
> All institutions must mark to that market, which it is what it is
> and no one can complain.
>
> When that is the case, those institutions on the cusp of failure
> will as they will no longer be able to hide behind failed assets
> that were not marked.

Mar 29 11:02 PM