naked capitalism

As readers may recall, we had been skeptical (and critical) of the Public Private Investment Partnership from the outset. It was the third effort at a program that had failed twice under Hank Paulson, namely, to have banks get dud assets off their balance sheets by selling them to a sucker.

That’s why this program has never gotten airborne. It requires a bagholder.

The problem isn’t, contrary to PR designed to mislead the public, that the assets are hard to value. That holds only for an itty bitty percentage of the total. The real problem is that the banks are carrying them at above market values, and above any reasonable long term value too (their protests to the contrary). The problem is not the saleabilty of said assets, it’s that they don’t like the prices. Selling them at below the marked value leads to losses, which in turn would reduce their equity at a time when they have been told, in no uncertain terms, to get more.

So the only way the plan works is if someone overpays. The only party that might have reason to is Uncle Sam. The whole point of the “public private investment” part of this is to disquise the overpayment. So the plan is an opaque subsidy to the banks.

Why not do so in a more straightforward fashion? Well, if the Treasury did that, and got equity back, it starts to challenge the fiction that the public private partnership called banking in the US ought to be private. Team Obama has been schizophrenic about oversight, reacting to political hot buttons but not reining in bank risk taking, which is what it really should be worried about. Banksters have every incentive to swing for the fences to try to show good earnings and slip the government leash. And the Feds, contrary to expectations, are taking a tougher line on that front. I’m encouraged that the powers that be are not allowing the banks to base extrication from TARP based on 1Q earnings, which Meredith Whitney dismissed as “manufactured.” She was also of the view that core earnings were “negligible” and that banks had broken business models and no clear remedies. Apparently the authorities share at least some of her reservations.

From the Wall Street Journal:

Big banks were hoping billions of dollars in future revenue would help them fill the capital holes found in the government’s stress tests earlier this month. Now the Federal Reserve is limiting how much of that performance can be counted, according to people familiar with the situation.

The Fed’s decision is forcing Bank of America Corp. to come up with billions of dollars in capital from other sources, these people said. Other stress-tested banks also have revamped their capital-raising plans or might need to, including PNC Financial Services Group Inc. and Wells Fargo & Co.

The move by the Fed, which began notifying banks last week, has deepened tensions over the stress tests, which are intended to help steady the banking industry and shore up confidence in the financial system. The results were announced May 7, and banks face a June 8 deadline for government approval of their capital-raising plans.

Some banks had planned for financial performance in 2009 and 2010 to cover 20% or more of their capital shortfalls.

The Fed initially said the 10 banks ordered to raise a combined $74.6 billion would be allowed to essentially count $215.3 billion in revenue toward their estimated losses through the end of next year.

Since announcing the stress-test results, though, Fed officials have grown concerned that some banks are leaning too heavily on future revenue projections, according to people familiar with the matter. Under the new requirement, projected revenue can be used for no more than 5% of the additional equity being demanded from the 10 banks….

Bank of America, for example, said earlier this month that its financial performance would “significantly exceed” the government’s estimate, generating about $7 billion of the $33.9 billion the Charlotte, N.C., bank was told to raise. The bank said the $7 billion figure also would include security gains or other one-time actions.

Fed officials were surprised by the bank’s statements, believing they had been clear that such projections wouldn’t be allowed as part of the bank’s capital-raising plan, according to people with knowledge of the discussions. Since then, Bank of America has been told it won’t be allowed to count the entire projections toward its capital needs, which the bank viewed as a changing of the rules, these people said.

Hhhm. On this one, my instinct is to trust the Fed. I suspect someone at BofA at best interpreted an ambiguous remark in its favor. Not that the “he said, she said” matter, but the banks have been keen to portray the government as inconsistent, when they should be bloody grateful to not be nationalized and have had the temerity to negotiate the stress tests when they shoudl not be negotiable. So when the government accedes it is not being “inconsistent” (taxpayers would sure disagree with that one), only when it imposes requirements that the banks did not anticipate (but not anticipating them is a function of self-serving thinking, not necessarily a sign that the demand is unwarranted).

Back to the PPIP charade. We had heard early on that the bank loan side, aka the Legacy Loan Program, was going nowhere, so the semi-official word is no surprise. The excuse is that buyers fear a rule change (code for executive comp restrictions, amusing how that is the new hobbyhorse), but the bigger issue is that (again) the banks see no reason to participate. Translation: the program appears unlikely to produce bids for more than the carrying value of their assets.

From the Wall Street Journal:

A government program designed to rid banks of bad loans, part of a broader effort once viewed as central to tackling the financial crisis, is stalling and may soon be put on hold…

The Legacy Loans Program, being crafted by the Federal Deposit Insurance Corp., is part of the $1 trillion Public Private Investment Program the Obama administration announced in March as a way to encourage banks to sell securities and loans weighing on their balance sheets to willing investors.

But prospective buyers and sellers have expressed reluctance to the FDIC about participating for fear the program’s rules will change in a political atmosphere hostile to Wall Street. In addition, some banks that might have sold troubled loans into the program earlier in the year have become less eager as they regained a sense of stability.

PPIP was to be split between the FDIC program, which would buy whole loans, and one run by the Treasury Department focusing on securities. Treasury is expected to push ahead with its plan — the larger and more substantial of the two — and could begin purchases sometime this summer. But the size of that program could be smaller than initially envisioned, government officials say.

The scaling back of the FDIC program is potentially good and bad news for investors, indicating that the health of the financial system — while improving — remains fragile….

But, at the same time, administration officials say they believe the program to purchase toxic securities mightn’t be as integral to a recovery as it once seemed. Markets seem to have stabilized and banks appear more able to digest losses associated with the troubled securities.

Yves here. Given the carnage in the mortgage markets today (to be discussed in our next post), that optimism seems a tad premature. Back to the article:

People familiar with the matter say the FDIC is expected to delay a test run of the program that was set to take place next month. The program could be put on hold in the near future, people familiar with the matter said. FDIC officials had initially believed the program could buy as much as $500 billion in loans.

The program has also been controversial. Bank trade groups asked the FDIC to allow banks to use the program to purchase their own assets, which some felt could allow banks to game the process. Ms. Bair on Wednesday said that would never have been allowed to happen….

Another reason is concern about government scrutiny related to potential conflicts of interest. A recent law that allows the special inspector general of TARP to conduct audits of participants in the public/private partnerships spooked some investors, Ms. Bair said.

“Treasury will need to issue regulations, I think, to clarify those issues before we will have comfort by the participants,” she said.