Lots of virtual ink being spilled on the PPIP. Nobel-winning economist Michael Spence thinks the critics are off the mark. The Economist thinks we need to wait for more details before passing judgment. Mike at Rortybomb whips up four ways off the top of his head that the banks could game the system. And Interfluidity, as usual, gives us food for thought:
It is worth noting that overcoming coordination problems so that diverse parties can collaborate on profitable ventures is precisely what the financial sector is supposed to be good at doing.
All good stuff. But as is my custom, I want to boil things down for those, like myself, who have the attention span of a slightly overripe kumquat. (Or who simply do not have the time.)
Anyone who is neutral or favorable toward this plan, including the Treasury itself, needs to answer one simple question:
Why are the loans non-recourse?
Suppose I called my niece and said, “I want you to go to Vegas and have a great time. Make as many bets as you like, keep all of the winners, and on every bet where you lose more than $10, I will make up the difference.”
A child could see that this offers money to my niece. But limiting the downside on multiple independent instruments is the definition of non-recourse loans. Anybody who wants to argue that PPIP is (or “might be”) a good idea needs to do one of two things:
- Just admit up front that the entire purpose is to transfer hundreds of billions of dollars to private equity and the banks without Congressional appropriation; or
- explain how my analogy is false, and provide some other rationale for making the loans non-recourse.
Good luck.
This is an easy question. You see, everyone is afraid that the legacy assets are not actually worth all that much (as evidenced by the results of the FDIC auctions from failed banks). But the Treasury (which knows better) realizes that they have already provided a lot of stimulus for the economy, so everyone just needs to let this cycle play out. (Green shoots, etc.) Once the economy recovers, the legacy assets will be worth something, probably even a lot more than investors paid for them. So the non-recourse bit is just to help allay investors’ fears a little in the meantime. It won’t actually generate losses for the government (and therefore taxpayers). Have a little faith. Nothing will go wrong.
OK….here goes.
You analogy is more like telling someone that they can go to Vegas and bet their own money. If they lose their money, they can have a free loan of 5x the original loan, and either win back their losses, or else they lose everything.
Not a bad deal, but they have to lose their money first. Which means not everyone would be interested.
Why non recourse? I think you are reading too much into a word. There is recourse to the assets. If people borrow and have to guarantee the financed portion of the loan, then it isn’t really a loan. They are self financing.
If money is lent on a recourse basis, then the borrower needs to be able to fully fund any loss. Which means that they need the full amount of the loan as either liquid assets or duration matched with the loan liability. Which means that they really don’t have leverage.
There is clearly recourse to the assets. I don’t know what else there would be recourse to. These deals would be some sort of special purpose entity and wouldn’t have earnings or assets outside of the specific deal.
Now, if you are suggesting that a single entity or fund could set up a bunch of entities — say one for each loan, and default on the losers, then that would be like your analogy. I don’t think thats what the term sheets specify.
The vultures put their money in a first loss position. They borrow more at very favorable interest rates. With the subsidized loans, they can pay more for the expected cash flows and still make high returns on their investment.
There is a lot not to like, but subsidization of interest rates is about the only thing in Treasury’s play book. Conforming mortgages are HEAVILY subsidized via the GSE’s and FHA. The fed is intervening in markets to push down longer term interest rates and mortgage interest rates.
I am assuming that this wasn’t just a rhetorical question. Interest rates are as important to asset valuation as default rates. if you don’t like interest rate subsidization in TARP, then I want to know how this is any different than other Treasury and Fed market interventions to manipulate interest rates.
I’m sure it was obvious, but I was being sarcastic above. The problem with the non-recourse language is that it is not a matter of pushing potential investors over the edge as to whether to invest or not invest (with the legacy loan portion of the program, which is the more significant), as it has been portrayed. The legacy loans have not been written down hardly at all. They might attract investors that are very confident in their ability to determine the value of assets that so far have defied generalizations, but even then, the chance of the government being stuck with the assets seems relatively high. What is the big deal there, the government at least has the assets, right? It is a very big deal if the assets are not performing at all.
CapVandal —
In my analogy, my niece is in “first loss” position on each bet. It is equivalent to telling her she has to put up $10 and can borrow the rest from me, but only has to repay me when she wins.
The key point is this one:
Now, if you are suggesting that a single entity or fund could set up a bunch of entities — say one for each loan, and default on the losers, then that would be like your analogy. I don’t think thats what the term sheets specify.
1) Find where it says one investor cannot invest in multiple public-private investment funds.
2) The non-recourse TALF loans are quite explicit… The same entity can obtain multiple loans against multiple assets, each one non-recourse (i.e., with recourse only to that asset).
The loans could be made like normal loans in the real world, where you cannot just set up multiple “funds” and get separate loans for each without any recourse to you. If the problem were just “liquidity”, ordinary lending would be sufficient. But the problem, of course, is solvency, and the Treasury’s problem is how to move the losses from the banks onto the taxpayers. The PPIP is part of their solution.
I have problems with all the interest rate manipulation, too, but that is a topic for another time. I stand by my analogy.
i don’t see the problem. the PPIP ensures that net losses (encompassinig all assets) accrue to the government. the functioning asset pools presumably stay with the banks, or recover and are resold; the shit ends up at the treasury … forever (add ital).
Is it possible Treasury understands that the PPIP program may help to raise the marginal price, creating some liquidity and limiting the need to make those billions in loans? Or that the program itself may support prices long enough for fundamentals overtake technicals (This makes an assumption about fundamental value.) Observe the price rally in CMBS since the announcement of PPIP and the spread tightening in the “quality” ABS market (auto loans, cards) since the TALF program got going. Maybe that’s wishful thinking given the higher level of toxicity. Otherwise, you’re analogy is right on.
Bond Girl,
It was perfectly obvious even to me that you were PROBABLY being sarcastic, and I have never worked in the financial “industry” or “markets” and can’t really follow many of these discussions.
The problem is there are people who say the same thing who aren’t being sarcastic. We live in strange times.
I thought it was nicely said. Kudos.