Krugman vs. Sachs on PPIP Loopholes

Apr. 6.09 | About: Citigroup Inc. (C)

Paul Krugman links to Jeff Sachs worrying about PPIP loopholes, and both have a good long handwring about all this. Sachs says:

Suppose, however, that [[Citibank]] itself sets up a Citibank Public-Private Investment Fund (CPPIF) under the Geithner-Summers plan. The CPPIF will bid the full face value of $1 million for the worthless asset, because it can borrow $850K from the FDIC, and get $75K from the Treasury, to make the purchase! Citibank will only have to put in $75K of the total.

Citibank thereby receives $1 million for the worthless asset, while the CPPIF ends up with an utterly worthless asset against $850K in debt to the FDIC. The CPPIF therefore quietly declares bankruptcy, while Citibank walks away with a cool $1 million. Citibank’s net profit on the transaction is $925K (remember that the bank invested $75K in the CPPIF) and the taxpayers lose $925K. Since the total of toxic assets in the banking system exceeds $1 trillion, and perhaps reaches $2-3 trillion, the amount of potential rip-off in the Geithner-Summers plan is unconscionably large.

And Krugman adds:

As Jeff says, a bank can create an off-balance-sheet entity that buys bad assets for far more than they’re worth, using money borrowed from taxpayers, then defaults — in effect a straight transfer from taxpayers to stockholders.

If there’s a mechanism to police such deals, it isn’t clear. And the sense that the administration is just too close to Wall Street continues to grow.

Am I just being dense? Treasury’s FAQ on the PPIP plan contains these words:

A Fund Manager may not, directly or indirectly, acquire Eligible Assets from or sell Eligible Assets to its affiliates, any other Fund Manager or any private investor that has committed at least 10% of the aggregate private capital raised by such Fund Manager.

It sure looks to me like Sachs’ scenario is specifically disallowed; he’s postulating an example in which Citi contributes 100% of the private capital to a fund bidding on Citi assets. Did Sachs simply not read the Treasury documentation? What’s going on here?