- FT Alphaville: At the heart of this complex plan is liquidity, which Geithner has identified as both the problem and the answer. Increase liquidity and assets price will rise towards fair value, banks’ capital ratios will improve and they will start lending again. What if value of assets is low because of reduced cash flow expectations--> see also 'Fire-Sale' Vs. 'Hold-to-Maturity' Prices: Is The FASB Yielding To Pressure From The Industry?
- Alea: The plan is good in theory as private investors have no incentive to overpay because they are in a first-loss position. However, there is likely to be a gap between the mtm value of the toxic assets and what a rational investor would pay, reducing or eliminating the incentive for banks to participate. Only the truly cash-starved banks will jump.
- Blog comments: private investors will take long positions in the selling banks’ stocks (or other long positions in derivatives) and will then have an incentive to grossly overpay for the securities in this program. They’ll gladly take some losses in this program to boost their other positions outside the program.
- Krugman: Huge taxpayer subsidies to the private sector are involved: Suppose that there’s an asset with an uncertain value: there’s an equal chance that it will be worth either 150 or 50. So the expected value is 100. But suppose that I can buy this asset with a non-recourse loan equal to 85 percent of the purchase price. How much would I be willing to pay for the asset? The answer is, slightly over 130 [in a competitive auction.] Why? All I have to put up is 15 percent of the price — 19.5, if the asset costs 130. That’s the most I can lose. On the other hand, if the asset turns out to be worth 150, I gain 20. So it’s a good deal for me.
- cont.: Another way to say this is that by financing a large part of the purchase with a non-recourse loan , the government is in effect giving investors a put option to sweeten the deal.
- John Mauldin (via TechTicker): I'm in the hedge fund business myself but as a taxpayer I don't believe Treasury should subsidize hedge funds.
“My gut reaction is that this is an excellent plan. This plan will go a long way toward getting banks in better position to lend more aggressively and break the deleveraging feedback loop that is now in place."I think this is a myth that banks will lend "more aggressively" once the toxic assets are off their balance sheets. To whom? Perhaps Anderson is making the moral hazard argument here - maybe he is saying since the banks (and their investors) are being bailed out with above market prices for toxic assets that they will once again engage in risky lending. I hope that isn't his argument.
Scott Anderson, senior economist, Wells Fargo
The key problem with the Geithner plan is that it incentivizes investors to pay more than market value for toxic assets by providing a non-recourse loan and with below market interest rates. (See Krugman on the price impact of a non-recourse loan). The investors do not receive this incentive, the banks do. And the taxpayers pay it, so this is a transfer of wealth from taxpayers to the shareholders of the banks.
March 23, 2009
The PPIP: It's NOT the Liquidity, Stupid. It's the Marks.
You can say something about the current Administration: they are really trying. The recently released Public-Private Investment Program ("Program") details show both a lot of thought and some really good ideas. Unfortunately, the essence of the Program and its messaging are still missing the boat on a few important fronts. The main issue: the Government perceives the problem to be one of investor liquidity and the ability to finance broken asset portfolios. The problem is that they are wrong. It is all about banks not wanting to own up to inflated balance sheet values. But here are some other problems with the Program and its positioning:
- Still enamored with short-term stock market movements. Larry Summers stated that the Administration is "gratified" by the stock market's reaction to the Program. Why, oh, why, do Senior Government officials, especially those with ostensibly high IQs, say such stupid things? Guys, the focus should be on doing the right thing for the long-term, not on what will goose the market for a day or two. And while Summers et al claim to be all about the long term, then why do they keep on talking about stock market reactions to policy decisions? If there is one thing we know for sure, it's that the market is very, very jittery and volatile, and is apt to make sharp moves in response to almost any news. While the Dow could rally 500 points today, it could just as easily fall 500 points if liquidity fears rear their ugly head, another bank runs into trouble, populist rantings by Congress spook the markets, Pandit is given a long-term employment contract, etc. Bottom line: the Administration needs to stop talking about and caring about short-term stock prices. Stock prices are not unlike the Treasury yield curve: easy to manipulate on the short-end, difficult if not impossible to impact for a sustained period on the long end.
- Forgetting the appetite of the supply side. The Program, with all the benefits provided to approved buyers - equity matching funds, cheap leverage, etc. - lists only a single line when addressing a key weakness: Participant Banks don't actually have to participate. Participant Banks can submit portfolios for auction, Approved buyers can line up, valuation firms can estimate the worth of portfolios submitted for auction, buyers can submit their bids and Participant Banks can say: no. I fail to see how the Program is a material departure from the current landscape, except for the fact that the Government is providing cheap financing. The buyers are still running equity risk regardless of the 1-1 Government match (as they should), and will only submit bids that reflect their assessment of risk and return. This may result in prices that are still far out-of-line with current bank carrying values, causing banks to reject the highest bids in a move to avoid further asset write-downs. So even a protracted auction process could result in a whole lot of nothing. What does Larry Summers think a failed auction will do to stock prices? I shudder to think.
- Perpetuating entrenched and failed managements. The Program is a vehicle for helping broken firms liquify broken asset portfolios. What it doesn't do is help broken firms get rid of broken managements that got us into these problems in the first place. In the rush to protect major lenders from going out of business (and protecting stockholders and debtholders in the process), the US taxpayer is given scant protection from the cadre of poor leadership teams that led firms into troubled waters. Why is AIG the sole whipping boy for the Government when plenty of other firms were complicit in damaging the financial system? While legacy AIG management deserves much of the scorn they've received, most broken bank executives have gotten off with nary a scratch. This I do not understand.
- Not reflecting the true magnitude of the Government's involvement in the numbers. If I read the materials properly, it seems as if the only money being counted against TARP are the equity matching funds being provided. What about the leverage being guaranteed by the FDIC? Depending upon the values realized for the purchased portfolios, those guarantees might come into play, increasing costs well beyond the equity commitments. This is more an issue of truth-in-advertising. While yes, having the private sector side-by-side is a good thing, the Government via the FDIC is providing the debt guarantee. If this isn't incremental exposure to the US taxpayer, then I don't know what it is. This needs to be clearly factored in as an explicit cost of the Program.