Monday, March 23, 2009

Some Notes on the Public Private Partnership Investment Program

The U.S. Department of the Treasury Announced their intention to organize the Public Private Partnership Investment Program (PPPIP). News headlines are touting a $1 trillion fix, but that is not really accurate.

The Treasury will allocate $75 billion to $100 billion from the TARP, so this is not new money being added to the fix. This program also has the same problem as the initial TARP: banks will become insolvent as they participate. The losses that will be incurred as a result of the market priced sale will deplete bank capital. Paradoxically, there will be fewer TARP funds available to prop up bank losses because of the funding of the PPPIP.

In addition, there is a non-trivial amount of leverage being employed to arrive at the initial $500 billion infusion of funds:

- Bank offers to sell loans

- The FDIC would evaluate the loans and decide how much of the pool they would guarantee

- Private sector bidders would then bid on the loan package

- The Treasury would finance 50% of the funds due


- Bank seeks to sell loans, $100 face value

- The FDIC determines that they are willing to provide leverage of 6 to 1 (maximum allowable under program)

- Private sector buyer wins the pool with a bid of 84 cents on the dollar

- FDIC provides guarantee of 72 cents on the dollar [(6/7) * 84 cents]

- Private sector buyer provides 6 cents, Treasury provides 6 cents

Buying securities process:

- Private sector buyer provides $100 in capital

- Treasury provides $100 in capital

- Treasury provides $100 - $200 in loans to the new fund

- Fund has access to TALF

It looks to me that the Treasury thinks that the problem is nowhere near being solved. This is attractive to the private sector because they can basically return to their old leverage ratios while DC picks up the tab. Of course, this will not work for the economy. This program tells us how little interest there is in buying debt and all they want to do is issue more debt.

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