Private Public Partnership Details Emerging

The New York Times seems to have the inside skinny on the emerging private public partnership abortion program. And it appears to be consistent with (low) expectations: a lot of bells and whistles to finesse the fact that the government will wind up paying well above market for crappy paper.

Key points:

The three-pronged approach is perhaps the most central component of President Obama’s plan to rescue the nation’s banking system from the money-losing assets weighing down bank balance sheets, crippling their ability to make new loans and deepening the recession….

The plan to be announced next week involves three separate approaches. In one, the Federal Deposit Insurance Corporation will set up special-purpose investment partnerships and lend about 85 percent of the money that those partnerships will need to buy up troubled assets that banks want to sell.

Yves here. If the money committed to this program is less than the book value of the assets the banks want to unload (or the banks are worried about that possibility), the banks have an incentive to try to ditch their worst dreck first.

In addition, it has been said in comments more than once that the banks own some paper that is truly worthless. This program won’t solve that problem. Back to the piece:

In the second, the Treasury will hire four or five investment management firms, matching the private money that each of the firms puts up on a dollar-for-dollar basis with government money.

Yves here. Hiring asset managers to do what? Some investors get 85% support (more as is revealed later), others get dollar for dollar? This makes no sense unless very different roles are envisaged (but how will the price for assets given to the asset managers be determined? Or are these for the off balance sheet entities that should be but are still not yet consolidated, like the trillion dollar problem hanging around at Citi?) Back to the article:

In the third piece, the Treasury plans to expand lending through the Term Asset-Backed Secure Lending Facility, a joint venture with the Federal Reserve.

Yves again. While the first TALF deal got off well, Tyler Durden points out its capacity is 2.7 times pre-credit mania annual issuance levels, which means the $1 trillion considerably overstates its near term impact. And credit demand by all accounts is far from robust. Cheap credit is not enticing in an environment of weak to falling asset prices and job uncertainty. To the Times again:

Although the details of the F.D.I.C. part were still being completed on Friday, it is expected that the government will provide the overwhelming bulk of the money — possibly more than 95 percent — through loans or direct investments of taxpayer money.

The hope is that such a generous taxpayer subsidy will attract private investors into the market and accelerate the recovery of the country’s banks.

The key protection for taxpayers, according to people briefed on the plan, is that the private investors will bid in auctions against each other for the assets. As a result, administration officials contend, the government will be buying the troubled loans of the banks at a deep discount to their original face value.

Because the government can hold those mortgages as long as it wants, officials are betting the government will be repaid and that taxpayers may even earn a profit if the market value of the loans climbs in the years to come.

To entice private investors like hedge funds and private equity firms to take part, the F.D.I.C. will provide nonrecourse loans — that is, loans that are secured only by the value of the mortgage assets being bought — worth up to 85 percent of the value of a portfolio of troubled assets.

The remaining 15 percent will come from the government and the private investors. The Treasury would put up as much as 80 percent of that, while private investors would put up as little as 20 percent of the money, according to industry officials. Private investors, then, would be contributing as little as 3 percent of the equity, and the government as much as 97 percent.

Yves here, If this isn’t Newspeak, I don’t know what is. Since when is someone who puts 3% of total funds and gets 20% of the equity a “partner”?

And notice the hint of skepticism from the Times regarding the Administration’s supposition that the bidding will result in fair prices. Huh? First, the banks, as in normal auctions, will presumably set a reserve price equal to the value of the assets on their books. If the price does not meet the reserve (and the level of the reserve is not disclosed to the bidders), there is no sale; in this case, the bank would keep the toxic instruments.

Having the banks realize a price at least equal to the value they hold it at on their books is a boundary condition. If the banks sell the assets as a lower level, it will result in a loss, which is a direct hit to equity. The whole point of this exercise is to get rid of the bad paper without further impairing the banks.

So presumably, the point of a competitive process (assuming enough parties show up to produce that result at any particular auction) is to elicit a high enough price that it might reach the bank’s reserve, which would be the value on the bank’s books now.

And notice the utter dishonesty: a competitive bidding process will protect taxpayers. Huh? A competitive bidding process will elicit a higher price which is BAD for taxpayers!

Dear God, the Administration really thinks the public is full of idiots. But there are so many components to the program, and a lot of moving parts in each, they no doubt expect everyone’s eyes to glaze over.

Later in the article, there is language that intimates that the banks will put up assets and take what they get. However, the failure to mention a reserve (a standard feature in auctions) does not mean one does not exist. Or the alternative may be, since bidding will almost certainly be anonymous, is to let the banks submit a bid, which would serve as a reserve. That is the common procedure. when at foreclosure auctions, the bank puts in a bid equal to the mortgage value (so either a foreclosure buyer takes the bank out or the bank winds up owning the property).

Regardless, the equity comes from TARP, and Elizabeth Warren of the Congressional Oversight Panel is no slouch. What will happen when she asks for reports of how the actions have gone (for instance, how many failed because the reserve was not met?) The mechanics will become more apparent to the public over time and may yet come back to haunt Team Obama.

Originally published at Naked Capitalism and reproduced here with the author’s permission.

2 Responses to "Private Public Partnership Details Emerging"

  1. Anonymous   March 21, 2009 at 7:36 pm

    hyperinflation on Weimar scales is on the way thanks to Helicopter Ben!

  2. drfrank   March 22, 2009 at 2:20 pm

    Legerdemain under the TARPMarch 22, 2009Early reports of Treasury’s toxic asset purchase plan, to be released tomorrow, are lamentably more of the same generosity to the nation’s financial elites. It promises to do nothing to put a floor under housing prices. It promises to do nothing for beleagued homeowners with underwater mortgages or folks who can’t keep making their payments.The same sweetheart deal proposed for hedge funds and the like ought to be offered to everyone. Just about any American would jump at an opportunity to bid for a home mortgage with 3% cash down—which is pretty much what the new program comes down to. Why not give every American an opportunity to buy a house on these terms.It’s an indirect way to shovel more capital into the banks. That’s the rationale: give them cash for assets they are willing to offer at auction; hope that they will return to lending if they are flush with cash and flushed of toxic assets.To bring buyers to the auctions, and get action at price points high enough induce the banks’ participation, the government will offer non-recourse financing up to as much as 97% of the purchase price, at a decent interest rate and a piece of the upside. The beneficiaries of this largess will be the private investment firms, the hedge funds, asset managers, pension plans, insurance companies who can show they have the wherewithal to manage the gifts the government is so generously about to bestow on them.One can only hope that public outrage, recently ignited over the scandalous AIG bonuses, will consume this ill-advised implementation of a program originally proposed by Henry Paulson. It’s time for the Obama Administration to get beyond elegant implementations of initiatives from the last days of the Bush years, spiced up with flavorings from Barak’s Presidential campaign. Geithner, who has been valuable for providing continuity in the difficult transitional period since the election, will fall to public anger over crony capitalism. We thank him unreservedly for his service.More importantly, Geithner, formerly head of the New York Federal Reserve Bank, seems to share with his former jefe, Fed Chairman Bernanke, the idea that large provisions of liquidity will stimulate bank lending. Maybe that’s because all the Fed can do is provide liquidity. Maybe it is because in hindsight the Great Depression’s depth and length is seen to have been abetted by the failure of the Central Bank to deliver massive injections of liquidity.But the simple fact remains that troubled economic times and uncertain prospects will naturally constrain lending, not only cash flow lending but even lending predicated on asset values. What we need is a stimulus to the turnover of money, increasing its velocity, not just the supply. We don’t need transfers of toxic mortgage backed securities sitting on books of banks to seats on the books of special purpose government guaranteed liquidation partnerships. We need to stimulate the refinancing at market prices of the underlying mortgages themselves. We need to unwind the securitizations, and we likely need to be less reliant on them going forward.In the case of toxic mortgages, owning the mortgage is tantamount to owning the house and owning a toxic mortage backed security is tantamount to owning a portfolio of single-family residences. It wouldn’t be a troubled asset if the original homeowner had any meaninful amount of equity left in the asset. In some cases, the mortgages in the mortgage backed securities have already been converted into ownership of the real property collateral by foreclosure, or are about to be.Home ownership subject to mortgage financing is, to speak for a moment in the language of financial options, or rather constitutes, a right but not an obligation to purchase the home outright for a price equal to amount of the mortgage. Extending the logic of this view, a homeowner with a mortgage is really a renter with an option to purchase—in effect, the mortgagor owns the property.So, the public-private partnerships that buy toxic assets will become landlords and the mortage-paying homeowners will be tenants with an option to purchase (i.e., repay the face value of loan, as perhaps adjusted). Of course, they won’t be landlords in the sense that they will have any responsibility for maintenance, upkeep, utilities, property taxes or tenant improvements–what’s known as a triple net lease.The government would do better owning properties that go to foreclosure and paying prices at foreclosure that mitigate losses to the banks. As a matter of public policy, with the objective of protecting and maintaining the stability of neighborhoods, as a nation we would be better off keeping people in their residences, leasing properties acquired by foreclosure back to former owners. The government could just as easily pay local realtors to manage rental properties as it can pay hedge funds and the like to manage toxic assets. It can bundle and securitize pools of rental properties to investors who now invest in Real Estate Investment Trusts, whose investment decisions would involve valuing a stream of rental payments and the potential appreciation in a sale of the rental property when leases turn over.Meanwhile, give anybody who can put 3% down an opportunity to buy a house with a mortgage whose monthly payments are predicated on the property’s triple net rent income stream, non-recourse, with a share of the upside to the lender. Don’t bother with proof of income or credit scores, but shorten and quicken the lender’s path to repossession. Sell it politically as a extension of the mortgage interest deduction to renters and as a route to extended home ownership. Bundle and securitize these loans with a government guaranty. Stop the bailouts. Put some spring back in the home markets and the economy now.