The AIG Bonuses, Part 11:
The Administration's program to clean up 'toxic assets' has failed
29 Jun 2009 in Regulatory Economics
We've blogged ten times about the "AIG bonus problem" and its sequelae, most specifically about the adverse effects that arise when the government signals its intentions not to honor contracts. Examples of these government signals include HR 1586, which the House of Representatives passed to confiscate legally awarded bonuses via the tax code and even punish those who returned them; HR 1664, which the House subsequently passed to force TARP recipients to break these contracts; and statements by the Administration indicating that it will decide after the fact whether investors made "too much" money.
It was in this setting tha the Administration announced a new Public-Private Investment Program (PPIP), the stated purpose of which was to provide a facility for banks to sell so-called 'toxic assets" and for investors to buy them at fire sale prices. An obvious deterrent to buyer participatin is the Treasury Department's decision to impose on buyers TARP-like restrictions on employee compensation.
Both banks (sellers) and investors (buyers) have declined to participate. As we predicted, buyers are deterred in large part by political risk: they do not trust the government as a business partner.
Wall Street Journal reporters David Enrich, Liz Rappaport, and Jenny Strasburg write:
Potential buyers balked at the risk of doing business with the government, concerned that politicians might demonize them for making big profits.
...
When PPIP was announced, big-name investors were intent on figuring out how to profit from it. Raymond Dalio of giant hedge-fund firm Bridgewater Associates, which oversees $72 billion in assets, initially expressed interest in participating. But within days, he was blasting it, saying buyers and sellers would have difficulty agreeing on pricing and fund managers that profited would be exposed to criticism from politicians. The way PPIP is set up "makes us not want to participate and it makes us question the breadth of interest that we will see in the program," he wrote to clients.
Where is PPIP going? Apparently its Legacy Loans Program is dead and the Legacy Securities Program is not doing well, either:
Early this month, the Federal Deposit Insurance Corp. essentially shelved one arm of PPIP -- the government-financed buying of bad bank loans. [Treasury Secretary Timothy] Geithner recently said the other part -- to facilitate the buying from banks of troubled securities, many backed by real-estate loans -- could be scaled back because investors are "reluctant to participate." This week, the government is expected to name investment firms to manage this securities-buying portion.
Enrich et al. report that the Administration is trying to redefine PPIP into something other than failure:
U.S. officials and investors are playing down expectations for the plan -- originally billed as a $1 trillion endeavor. Some federal officials say the banking environment has improved since the program was unveiled. They assert that because a dozen or so big banks recently succeeded in raising capital, they are under less pressure to sell bad assets.
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The slimmed-down program will focus not on bad loans, but on toxic securities, which are a problem for a relatively small fraction of the nation's banks.
Bad loans were the centerpiece of the program when it was launched on March 23.
PPIP faces other seemingly insuperable hurdles. In addition to a tepid reception among prospective buyers, sellers too lacked enthusiasm because fire sale prices could undermine their regulatory capital requirements. Executives of community banks are especially unhappy because they believe the revised program will only benefit the twenty or so largest banks.
