Monday, April 6, 2009

"Gaming" the PPIP

Paul Krugman says that Jeff Sachs's worries "need to be taken seriously." I think people need to stop taking academics seriously on the bank rescue. Sachs claims that banks like Citi can game the PPIP by partnering with the government to buy their own toxic securities at inflated prices. No, professor, they can't. The terms of the PPIP explicitly prohibit this:

A Fund Manager may not, directly or indirectly, acquire Eligible Assets from or sell Eligible Assets to its affiliates, any other Fund or any private investor that has committed 10% or more of the aggregate private capital raised by the Fund.
All the hoopla over the banks possibly "gaming" the PPIP is overblown. It's true that some of the investment banks (e.g., Morgan Stanley, Goldman) have explored the possibility of buying toxic securities under the PPIP, and repackaging them for sale to new investors—in effect creating a new CDO market. But this will never happen. If it ever got that far, Treasury would kill the idea. Regulators have repeatedly stated that "healthy banks" will be able to buy toxic assets in the PPIP program. That obviously doesn't include Citi or BofA, and there's no way regulators would let either of them participate on the investment side. The reason Treasury hasn't ruled out TARP recipients en masse is that hundreds upon hundreds of banks have received TARP money, and their degree of health varies considerably. Some regional banks that received TARP money are no doubt healthy enough at this point to participate in the PPIP. These determinations are best made on a case-by-case basis, which is why Treasury hasn't issued a blanket prohibition on TARP recipients participating in the PPIP on the investment side.

20 comments:

Robert said...

I share your opinion that critics of the Geithner plan clearly haven't read the published descriptions.

They are finding loop holes in an imaginary plan which is vaguely similar to the Geithner plan.

To a certain extent the argument is that if the Treasury wants to give money to banks by paying (along with private partners enticed by a Geithner put) more for assets then their hold to maturity value, the rules in the Geithner plan won't prevent it. This is obviously true. If the Treasury wants to give money to banks, it can, since it has broad authority under TARP.

It does not follow that the Treasury clearly wants to give money to banks -- the evidence is that it has said (in the details of the Geithner plan) that it doesn't but not all claims are honest.

It certainly does not follow that the Treasury can force the FDIC to give money to banks.

All this doesn't imply that it is a good plan. Does imply that Sachs didn't do his homework.

Anonymous said...

You should note that the text you quote is from an updated version of the term sheet. The original read: "Each Fund Manager may only purchase Eligible Assets from sellers that
are not affiliates of such Fund Manager, any other Fund Manager or
their respective affiliates or any private investor that has committed at
least 10% of the aggregate private capital raised by such Fund Manager."

Adding the text "or indirectly" is a significant change -- possibly driven by criticism of people like Sachs.

Economics of Contempt said...

The language from the original term sheet would still have explicitly prohibited Sachs's scenario. Citigroup would unquestionably be an "affiliate" of a Citigroup PPIF, so under the original language, a Citigroup PPIF would be prohibited from buying toxic assets from Citigroup (which is what Sachs envisions). Regardless of whether the addition of "or indirectly" was significant, at no point would Sachs's scenario have been permissible.

Economics of Contempt said...

"All this doesn't imply that it is a good plan. Does imply that Sachs didn't do his homework."

Agreed. I'd like to have a debate about the merits of the Geithner plan, but we don't have nearly enough information yet to have that debate. We don't even know the cost of funds or the haircuts yet, not to mention the leverage ratio that will be applied to the different asset classes!

I'm a fan of most of Sachs's scholarly work on development economics, but structured finance ain't development economics, and his motives in critiquing the Geithner plan are obviously less than scholarly.

Anonymous said...

"It's true that some of the investment banks (e.g., Morgan Stanley, Goldman) have explored the possibility of buying toxic securities under the PPIP, and repackaging them for sale to new investors—in effect creating a new CDO market. But this will never happen. If it ever got that far, Treasury would kill the idea."


Wrong again. Not only have banks openly stated that they intend to buy toxic assets, but Treasury is defending the idea. See http://www.nakedcapitalism.com/2009/04/treasury-trying-to-defend-bank-gaming.html

Wake up.

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