Treasury released details concerning the Public Private Investment Program (PPIP), the Administration's approach to dealing with "legacy assets", or the real estate loans and securities that caused the current financial crisis.
The approach relies, in large part, on the market. Unfortunately, these are the same institutions that created the problem. The issue is this: as the Fact Sheet Treasury released describing the PPIP Program notes,
"the financial system is still working against economic recovery." (No kidding.) As we noted in April, 2008:
"With the development of toxic (derivative and subprime lending) financial products, the relationship between investment banks and the economy has turned parasitic."
Further, the solution outlined by the Administration relies heavily on the assumption that "these assets create uncertainty around the balance sheets of.. financial institutions." This is a false assumption: the behaviour of financial managers created the uncertainty. While we are not "in despair", as is, apparently, Paul Krugman, we recognize that any "solutions" that do not explicitly address the ethics and behaviour issues are, well, problematic.
The lack of recognition is problematic because it leads away from the long term solution. For example, the Fact Sheet states "excessive discounts embedded in some legacy asset prices." There are no excessive discounts. In this, Mr. Krugman is correct. Prices are what they are at a given point.
Further, we note a discussion about the "lack of clarity about the value of these legacy assets." There is no lack of clarity. Market participants are discounting asset values because of the fraudulent and highly unethical business practices used to create and distribute these assets.
Given the above, we can ask if the approach outlined by Treasury will, in fact, address the challenge. Three principals are outlined:
1. Private Sector Price Discovery
2. Shared Risk and Profits With Private Sector Participants.
3. Maximizing the Impact of Each Taxpayer Dollar
Private Sector Price Discovery is problematic. The fraudulent and unethical business practices used to create and distribute these assets will tend to interfere with price discovery. In addition, there is the asset selection problem: banks and investors will determine which assets to price. See our earlier comments. Better to have a regulatory agency do so.
Shared Risk and Profits With Private Sector Participants. The fact sheet notes that "Treasury and private capital will provide equity financing and the FDIC will provide a guarantee for debt financing issued by the Public-Private Investment Funds to fund asset purchases." This is fine, except that to participate you must have "capacity to raise at least $500 million of private capital, a minimum of $10 billion (market value) of Eligible Assets currently under management and experience investing in Eligible Assets." Sounds reasonable. It is not, since these requirements do nothing to address the core issue: fraudulent and unethical business practices. Better to have a solid ethics test that requires eligible firms to show that they testified in Federal Court on behalf of investors or perhaps that statistical models created by the firm signaled the probability (or even the possibility) of system-wide economic and market failure.
"Maximizing the Impact of Each Taxpayer Dollar" simply means that the Federal Government will multiply dollars provided by the private sector. In itself, this is appropriate.
All in all, we like this plan, and think it is another in a series of positive steps taken by the Obama Administration. This crisis will take time to work through. There will be a number of starts and stops. This is a bear market, and the best way to escape a bear is as follows:
"..do not run - slowly back away, always watching the bear, and do not turn your back on that bear. Make yourself look as large as possible, and as confident as possible."
We could not agree more.
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