Saturday, November 28, 2009

PPIP Deathwatch, November Edition

The Geithner plan (PPIP), for public-private partnerships to buy up toxic assets saddling banks in the U.S. financial system, has been roundly attacked from the start. For my part, early on, I predicted PPIP would fail for a simple reason: the banks wouldn't offer up any toxic assets for sale (for fear of revealing themselves insolvent) and the U.S. government wouldn't have the stomach (or balls) to compel them to.

So I offer up this article in US Banker (a little late, but it's been a hectic month): PPIP Finally Ready, But Who's Selling?

For me, the impact paragraph comes at the very end (bold mine):
Ron Glancz, a partner at Venable LLP who has clients with toxic assets, agreed. "It's not created a lot of stir," he says. "We have banks that have a lot of toxic assets, and they are not selling to PPIP. It doesn't deal with the fundamental problem that banks can't book these losses, because that's a depletion of capital."
The official storyline is something rather different though. The Treasury Department claims that PPIP is no longer needed, as the economy has improved and major banks have been posting profits. But what's the truth? Here's a quick and dirty rundown:

1. Bank profitability: Well, duh. Banks were given much greater leeway in valuing their assets, back in April. If you can claim multiple pieces of junk worth 40 cents on the dollar are actually worth 80, that's going to boost profits considerably. That, and if you're a major bank, you get to borrow super-cheap from the Fed through an alphabet soup of lending facilities.

2. The economy has improved: The meaningful indicators, such as the rates for unemployment and foreclosures, as well as gauges of consumer sentiment, still look pretty grim. A less meaningful indicator -- the stock market -- of course shows an impressive little runup. Quarterly GDP made an expansionary spurt, but how much of that is temporary stimulus (Cash for Clunkers etc.)?

Which brings us to ...

3. Have the Fed's "cash for trash" emergency backstop programs sopped up a lot of the toxic securities: To me this is a really intriguing question. We know that "Helicopter Ben" is eager to flood the financial system with easy money. The Fed takes collateral from the major banks, and in exchange hands out good ol' dollar bills, usable anywhere. Talk about a jolt of liquidity!

Of course the Fed won't take any ol' piece of crap as collateral. It has to be rated AAA. But ... oops ... weren't Moody's et al rating practically everything AAA, even if it stunk to high heaven? Well, yeah. So one might wonder: how much "AAA" collateral is at the Federal Reserve, and what kind of assets does it represent, and who is it from? The answer: we don't know. The reason: the Fed refuses to tell us. We know that because Bloomberg is chasing the agency through the U.S. court system right now, seeking some details. And the Fed is stonewalling like crazy.

But here's an interesting question: How does the bank that has posted collateral at the Fed account for the value of that security on its books? Because, when you come right down to it, if "A" (the value of that security, as parked at the Fed and exchanged for good hard cash) exceeds "B" (what the bank can get for that security through a PPIP auction, even assuming there will be a little overpaying by the PPIP buyer), the bank will prefer to stick the money with the Fed. And PPIP will fail.

Of course the irony -- which one can spot from a good ways off -- is that the Fed, eager to restore liquidity and restart markets, is actually hampering the necessary clearing activity and proper restarting of the securities markets for dodgy assets, thanks to all its meddling. But then again, what's a good financial crisis without an abundance of irony?

Update: To be fair, I should note that lesser quality securities (below AAA) can be submitted for the PPIP auctions. So, obviously, a bank holding these lower-rated assets can't weigh "what is their value as collateral through the Fed vs. what is their value sold through PPIP"? The Fed, after all, only takes triple A (well, for what that's worth, and it would be interesting to know how much AAA the Fed has scooped up that has then been downgraded). But dodgier securities may not be great candidates for PPIP either, because they can be harder to value, and a bank may want to exploit this uncertainty by carrying them at inflated prices on its books (and conversely, because of the problem of adverse selection, PPIP bidders may penalize such securities, so it's a lose-lose for the bank). That may convince the bank to hold onto these assets and not risk having to do a writedown.