Jeeyum

Krugman vs. Sachs on PPIP Loopholes

Amateur?'s comment captures the essence of the PPIP loophole problem.


On Apr 06 07:03 PM Amateur? wrote:

> Krugman and Sachs are just stating the obvious - there are a number
> of ways around this inconvenient 10% direct or indirect rule. <br/>
>
> How about a little course in Financial Engineering 101?
>
> Bank A and Bank B working together. Using the example above, Bank
> A puts in $75k and buys $1m of Bank B's toxic assets. Bank B, ever
> thankful, reciprocates and puts in a small $75k to buy $1m of Bank
> A toxic assets. Assume same defaults and both banks win, taxpayer
> loses. Easy.
>
> Something more complex? Bank A lends $75k to the equity investor
> in the Fund on a limited recourse basis to the value of the equity
> in the Fund. If the equity in the Fund is worthless, the equity
> investor doesn't have to repay the loan to Bank A. Of course Bank
> A doesn't care since they've just stuffed the taxpayer with $925k
> of losses.
>
> Something with less linkage? Bank A has a portfolio of subprime
> loans which it wants to sell (but not take losses). There are subprime
> indexes which may not have perfect correlation to Bank A's portfolio
> but will be very close. Investor puts in $75k equity into the Fund
> to buy the $1m subprime portfolio from Bank A. Investor acquires
> a credit derivative based on the subprime index (not based on the
> actual Bank A portfolio) from Bank A which economically shifts most
> of the risk on the $75k investment from the Equity investor to Bank
> A. If needed, Bank A and Bank B can play the same game as described
> above to mix it up a little. In general, if subprime tanks, both
> the index and the Bank A portfolio are likely to go down in value
> by a similar amount. The equity investor is flat, Bank A loses $75k
> and the taxpayer loses $925k.
>
> I could give you some more clever ideas which which I'm sure the
> banks are working on right now, but hopefully you get the idea.
> In short, the system will be gamed unless very strict rules, penalties
> and oversight is put in place.