Real Estate
PPIP and the Law of Unintended Consequences
By Dan Smith

PPIP and the Political Law of Unintended Consequences
Just as we went to press last month, the government announced the new Public-Private Investment Program (PPIP). This program is the long awaited “toxic asset” purchase program designed by Treasury Secretary Tim Geithner. Yes, I know the administration is only 100 days old. However, Mr. Geithner was the head of the Federal Reserve Bank of New York (the epicenter of this financial storm) since 2003. So one assumes he should have had some ideas about fixing this banking mess since he oversaw its formation. Is it just me, or does anyone else have a problem that the same bright lads that got us into this mess seem to always magically be in charge of fixing it? But I digress …

PPIP has one thing going for it and I’d like to start with a positive. The program provides a partnership with and aggressive financing for private capital (hedge funds and private equity companies mainly) to buy these toxic assets off of the bad bank’s balance sheets. The good news here is that this virtually guarantees that the government (us) won’t end up overpaying for these assets—and then end up with a big loss (still bigger national debt) later. So this part of the plan is well thought out, assuming you agree with the overall logic of buying toxic assets to begin with.

So what’s the downside, you ask? Well, let’s start with the selling side of this equation, namely the bad banks themselves. Why would a bank that has toxic assets want to sell them and establish a fair price? If they do so, they may well end up adding another nail to their own coffin. Once the real value of these credit swaps and derivatives is made public in this fashion, then “mark to market” accounting will require yet another round of potentially very large write downs. Since this plan contains absolutely no pricing mechanism to establish a fair value, many experts expect to see nothing more than a colossal log jam. In fact, one banking analyst recently reported that the average bank’s mark down so far is only 98 cents on the dollar for these assets. While I find that hard to fathom, imagine an auction where the bids come in at 30 cents and the bad banks refuse to take less than 90 cents. But the fun doesn’t end there.

The buying side of this equation is likewise flawed, but for different reasons. Remember when the administration went crazy over the AIG bonuses? Remember the bus tours to the homes of those executives and people waving signs and making death threats? And do you remember when President Obama fired the head of GM? Well, if you forgot, it appears the executives who run hedge funds and private equity companies haven’t. It turns out, they very much enjoy their bonuses—and their jobs for that matter. Consequently, Mr. Geithner has already had to postpone the registration deadline for PPIP and relax the qualifications. However, as I write this, there are still not nearly enough registrants to pull this auction off. So there’s that …

Then, of course, there is the whole idea of PPIP itself. I don’t know about you, but wouldn’t it be nice if we could have some public input before we waste another several trillion dollars on a program predestined to epic failure? By that, I mean what if the 30 cents on the dollar is the real market value? Well, surprise! Earlier this month two professors in finance from Harvard and Princeton issued a joint paper stating just that. Their extensive research lead them to three distinct conclusions:
1. These toxic assets are NOT being under valued because of a lack of liquidity, as the Treasury and the Administration have argued. This means that many banks are now legitimately insolvent. (Gee, you think so?)
2. Supporting (creating) a market for toxic assets has NO purpose other than to transfer money from taxpayers to banks. (Someone finally said it!)
3. We are making it worse. “… policies that attempt to prevent the widespread mark down in the value of (these) assets are likely to only delay—and perhaps worsen—the day of reckoning.” (So Virginia, you see there really is no such thing as “Too Big to Fail.”)

And finally, as a follow up to the Homeowner and Stability Plan I wrote about two months ago, I have this update. Congress passed this bill with the bankruptcy “cram down” in place. However, the good news is that at least one of our US Senators helped defeat this bill today (May 1). Mike Bennet(D) voted against this destructive measure, that would have raised rates on every home loan made in the future incrementally. Unfortunately, Mark Udall(D) apparently doesn’t understand the law of unintended consequences, or economics, or basic contract law for that matter. So it would appear many of you took my advice and contacted your representatives and helped send them this message. Perhaps the “silent majority” is beginning to realize silence isn’t golden any longer. Who knew…?