James Keller, former head of "structured products" at UBS (UBS), writes a scathing review of Treasury Secretary Tim Geithner's plan to buy up toxic assets from banks in Barron's magazine this week. Well worth a read, considering Mr. Keller's background. He's played the game and knows its nuances.
Much of today's turmoil, he writes, stems from an overabundance of cheap financing that induced investors to overpay for financial assets. We know how that worked out. So what's the solution? To create a new overabundance of cheap financing, and reinflate the bubble.
Geithner and the interventionist crowd repeatedly claim that we are in the midst of genuine market failure with respect to toxic securities. Nothing is trading because nobody knows what anything is worth. According to many commentators, the securities are not tradeable because their value is unknowable.
One of the principal aims of Geithner's plan is to provide a market where none exists, so that these securities can be valued and traded. But it is not true that nothing is trading because nobody knows what things are worth. Nothing is trading because too many people know what things are really worth.
PPIP, the Public-Private Investment Program, purports to solve the problem by creating collateralized debt obligations (CDOs - you remember those?) out of bank debt - ironically the very structure that supposedly caused all the trouble. Bringing to mind Will Rogers, who asked, "If stupidity got us into this mess, why can't it get us out?"
Basically, the government and private investors will put up 8% each to snap up "toxic" assets. The other 84% will come from you - the taxpayer - "hereinafter known as Uncle Sugar." Asset managers nearly tripped over each other to sign up for the program, which amounts to them buying a cheap call option on the underlying asset, offering them enormous upside and limited downside. That's because under the "recovery" scenario, PPIP participants could reap gains of 625% - nearly 50% a year. Their risk, meanwhile, is limited to the 8% they put up. Uncle Sugar's return is unlikely to be much more than 10% - best case scenario.
It's reasonable to assume that Geithner will find ample participants, thereby artificially inflating asset prices. But that's a far cry from "price discovery" - and a rotten deal for taxpayers.
For other viewpoints, here's a brief selection of recent commentary on Geithner's PPIP:
- Promod Radhakrishnan: Making Sense of the PPIP
- Curious Investor: PPIP: The Creation of a U.S. Sovereign Wealth Fund
- Tom Lindmark: More Evidence the Banks Might Abuse PPIP
- Greg Feirman: Stiglitz: PPIP Assets = Call Options
- David Shvartsman: On PPIP and Geithner's Latest Power Grab
- Felix Salmon: The Least-Worst Option?