Jul 9

The Great Expectations of PPIP

In one of Charles Dickens’ greatest works, Great Expectations, the protagonist, Pip begins life as an orphan, slowly rising in social standing towards what many consider a successful end.
In one of the Adminstration’s most ballyhooed efforts to cure the current financial and economic crisis, it established its own PPIP (Public Private Investment Partnership) program. 
PPIP was designed to basically act as a sort of ‘off balance sheet RTC’ that would get toxic assets (loans and securities) off of banks’ books.  As you may remember, the RTC was designed in the 1980s to do the same and it worked quite well, although the costs were large and did indeed seep onto the Federales’ books.  And, therein lies the reason we have PPIP instead of an RTC II.  PPIP’s creation did not require Congress to act.
Someday someone will be able to explain to me why the government of the world’s largest economy requires decisions made by people with little or no economic or financial background, unless you count Congress’ ability to count their campaign commissions (I mean, contributions).
Be that as it may, PPIP’s Great Expectations were really split in two:  A ‘legacy loan’ program and a ‘legacy securities’ program.  However, as Dicken’s Pip had to learn the ways of the world, so did the Fed and US Treasury.
You see, no bank in its right mind would sell loans held at near book value at a sufficient discount to make the PPIP ‘legacy loan’ program work. It would crush their capital levels, which were already being supported by the Federales’ TARP program. Even though some banks have paid back their TARP money, the last thing bankers need are more capital hits….especially if it would cause them to return to the TARP window. Thus, the ‘legacy loan’ program will undoubtedly soon be used as a dumping ground for banks that have no choice but to participate: those taken over by the FDIC.
Now, PPIP’s Great Expectations have been tempered by that reality and the size of the program has been toned down, but still with plenty of leverage supplied by one of our most overlevered institutions, the Federal Reserve (take a look at their latest balance sheet and you’ll see assets only about 2% greater than liabilities…physician, heal thyself). 
It begins with the Treasury choosing nine investment managers to be involved in managing PPIP assets. The nine then become cheerleaders for PPIP (much like Pip’s supporters in the book), raising funds to invest in ‘legacy securities’. Such securities were at one time AAA rated (but just don’t look at their rating today) or are currently AAA rated. They are to be non-agency residential and commercial mortgage backed securities.
These securities would come from any institution ready to unload them…at market prices. But, what are market prices? In reality, the most troubled of these securities are undoubtedly being ‘marked to model’, a standard now embraced for ‘illiquid’ markets by both GAAP and STAT accounting. And, most institutions’ models may be quite a bit sunnier than the models used to determine the price that the nine cheerleading managers will pay for them.  This pricing crevasse may or may not be bridged by all that cheap Federal loan money, but this has yet to be proved.
Alas, as Dickens’ Pip would undoubtedly realize, timing is everything. Until the accounting poobah’s were forced to change from ‘mark to market’ to ‘mark to model’ by Congressional pressure (i.e. bank and other financial institution lobbyists), PPIP’s ‘legacy securities’ program had a much better chance of being successful. Thus, PPIP’s Great Expectations may be further tempered by the reality of accounting rules that have made it easier to hold these securities instead of sell through PPIP.
You will hear the cheerleading nine telling us that the revised PPIP will provide pricing support to nearly all similarly rated non-agency RMBS and CMBS in the short term. And, this may very well be true. However, it is obvious that PPIP must have many other changes in its future in order to be successful, just ask Mr. Dicken’s Pip.