Hedge Fund Bridgewater Says No to Public Private Partnership Program

The nays on the public private partnership program, the Treasury’s gimmick program to relieve banks of toxic assets, won positive comments from the obvious beneficiaries, namely banks and possible fund managers, and quite a few negative reviews from those worried about the benefits relative to the cost to the taxpayer (such as Nobel prize winners Joseph Stiglitz and Paul Krugman).

Now illustrating our latest concern, that the Treasury may turn out to be the Gang That Can’t Shoot Straight, our ongoing reservation, that there may be no way to make the program work for banks and investors even with hefty government subsidies, may be coming to pass. If investors have to overpay for assets (and unlike other analyses, we assume and have been told these assets aren’t that hard to value, the issue is bank willingness to take losses), leverage is not going to solve that problem. An expected loss is an expected loss. The only way to make it work under those circumstances is if the banks subsidize investor bids (say via non recourse loans, total return swaps). In other words, the program only works if the price setting mechanism is a sham.

The turndown by Bridgewater is particularly significant. The hedge fund one of the few to be eligible for the legacy securities program (inexplicably, the program sets a very high bar for assets under management. among other selection criteria. If the purpose is to elicit higher bids, more bidders would be a good idea). But as important, the fund is particularly well regarded, Bridgewater publishes research to which central banks subscribe.

From the New York Post (hat tip reader Phil):

In an investor note obtained by The Post, Bridgewater founder Ray Dalio gave Geithner’s plan two thumbs-down, arguing that the hopes of would-be buyers probably won’t be met by what the government is offering, especially when it comes to the sale of so-called legacy securities.

In the note, which is entitled, “Why We Decided Against Buying in the PPIP and Why We Doubt That It Will be Broadly Subscribed,” Dalio cited economic and political concerns with Geithner’s Public-Private Investment Program, dubbed PPIP, saying the numbers just don’t add up — at least when it comes to PIPP’s legacy-securities program.

PPIP aims to remove toxic assets from the system by giving private investors, such as hedge funds and mutual funds, leverage to buy assets through two programs. The legacy-securities program enables those investors to buy older residential and commercial mortgage-backed securities that have been at the heart of many banks’ troubles…..

“When the program was first announced, we were originally interested” because the leverage the government was promising made the assets cheaper. “However, as things now stand, very little leverage is actually being offered via the ‘Legacy Securities Program,’ ” Dalio wrote, pointing out that the leverage offered is just 1-to-1.

He also blasted the program for its initial design, saying it is ripe for conflicts, pointing to the plan to hire five asset managers to run everything on behalf of themselves, the government and the other investors.

“The managers are clearly in a conflict-of-interest position because they have both the government and the investors to please and because they will get their fees regardless of how these investments turn out,” Dalio wrote.

Bridgewater’s investors include pension funds, endowments and foreign governments.

He also questioned the political risks that the program’s design could create, saying the limited number of managers “raises possibilities (or at least perceived possibilities) of them colluding because they all know each other.”

And so regardless of whether the investments make or lose money, “there will be reasons for politicians to complain and to focus on the five winners to see how they ‘abused’ the system,” he wrote….

To be sure, Dalio doesn’t slam everything about PIPP. Indeed, he doesn’t slam the legacy-loan program, in which investors buy loans instead of securities and offers leverage of between 6-to-1 and 12-to-1.

But, “we aren’t interested in illiquid loans,” he said in his note.

Note that some analysts have said they expect to see little uptake on the loan program due to its complexity.

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  1. Anonymous

    Brad DeLong and Nouriel Roubini don’t think the plan is so bad.

    Don’t you think it’s possible that the “plan” is merely a step, one that is taken in a series, and one that considers political context?

    I’m baffled by anyone who can’t seem to grasp this, and the constant exasperation of these same folks.

  2. Doc at the Radar Station

    Somehow, all of these attempts at price-discovery are fodder for a bankruptcy judge and/or the prevention of lawsuits and legal challenges. Just a thought…

  3. Yves Smith

    Anon of 8:37 PM,

    DeLong was in Treasury in the Clinton Administration, and is thus a friend of Rubin and Summers. He has pretty consistently been cheerleading for anything Geithner does.

    Roubini does not appear to have looked at or even considered the many ways this program can be gamed. He also says he still expects banks to be nationalized.

    This is a very costly high profile exercise to address a non-issue. The Treasury has cooked up this elaborate scheme out of the false excuse that they don’t know what to pay for these assets. That is utter rubbish. There are prices for these assets, but the banks don’t like them, This is an attempt to disguise a subsidy to banks, and it is made more costly by introducing the private investors (assuming it works). The investor needs to expect to earn a decent return on his money, which is in conflict with the bank’s aim, of unloading the asset for at least the carrying value on their books. The investor therefore must pay well above market, which means well above what a rational expectation of future returns is.

    There are far higher priorities, for instance, either severely limiting credit default swaps (to cases where there is an insured interest) or getting them on exchanges. Forcing a way through to undo securitizations or some other mechanizsm for facilitiating mods and writedowns is also important, but the Administration regards that as a third rail issue. They assume we will have a securitzation market again without Federal guarantees; I don’t see that (the steps needed to improve incentives would also considerably raise costs and reduce attractiveness of that mechanism). So I don’t see the need to be sanctimonious about respecting “the sanctity of contracts” as far as securitizations are concerned. Put some really top notch legal minds on this, they can come up with a justification. Trust me, I have never seen a contact that can’t be contested (whether you’d win in court is another matter, but they would just need something plausible to give air cover). Contracts get busted all the time, as anyone who lives in Corporate America or deal land will tell you.

    And as for “this is the best we can do given political realities” I don’t buy that for a second. Obama has been much less effective than Reagan was in pushing his agenda (Reagan first term got 75-80% of what he wanted, Obama seems to be settling for 50-60%). I think people would be willing to spend more on banks if we weren’t having all these indirect subsidies (AIG, the PP plan) and were tougher with the banks (of course, The anger and backlash is in large measure due to the capriciousness and cronyism. if we didn’t have these indirect subsidies, there would be more money left for more direct measures). Why aren’t we being as tough on the banks as we are on GM?

    The whole premise of the Geithner bank plans is that the public is too stupid to see it is being had. The numbers are so large that, contrary to their hopes, this is not going unnoticed.

  4. Anonymous

    Bridgewater’s statement only confirms the worst: A private investor won’t overpay for an asset, even with the cheap leverage. The PIPP scheme only works (and makes sense) if the banks sell the toxic waste under the PIPP to an entity that they control or are working in concert with to overpay for the asset. A selling bank comes out ahead to the extent that it receives more for the toxic asset than the actual FMV for the toxic waste for the equity, plus the amount of equity they invest in the PIPP. The maddening thing about all this is that it underscores the utter contempt that the administration has for the American people. It is profoundly insulting.

  5. cap vandal

    “Dalio wrote, pointing out that the leverage offered is just 1-to-1.”


    It looked to me like you could use leverage on the legacy securities. Without 4×1 leverage, there is no way to make it work. It looks like the Treasury will do a 1×1 match and then the securities can then use TALF financing. That would make it 3×1 max.

    I think it needs 4×1 to work, with leverage supplied at about 2%. I suppose if Bridgewater can’t figure it out, then there is no way I can.

  6. Namazu

    I thought (not an original thought, sorry the source escapes me at the moment) the idea was to narrow the field of bidders to a select handful who will pay prices even higher than would be justified by the leverage and embedded put, since at worst they could afford to lose money on the PPIP as a loss leader against the value of the unsecured bank debt they hold (ex: rhymes with “flimco”).

  7. Anonymous

    “I’m baffled by anyone who can’t seem to grasp this, and the constant exasperation of these same folks.”

    What baffles me is if the move to nationalization represents an inevitable final step, why would anyone want to waste time with making incremental moves in the meantime, thereby prolonging the pain. If there is, in fact, something purposeful here, the good sense of it escapes me. Assuming you are right about the intentionality, what becomes obvious is a certain distinguishing mark of Obama’s style – evident elsewhere – his being always the president of the Harvard Law Review, never anything more substantial than that. Somewhere in the man’s psychological make up is an instinctual preference for splitting the difference, with all the damage that that can be trusted to inflict on the truth. Should what you presuppose be true, what we are witnessing is Obama in the process of misidentifying incrementalism with leadership and simply because he lacks an intellectual grounding in anything more profound than the law. And, long term, you and I will suffer for that, count on it.

  8. cap vandal

    By the way, the explicit interest rate subsidy — cheap financing — was the entire juice of this program.

    I could have sworn that it was 4×1. With 3×1 — which would require some sort of TALF guarantee sans haircut, it becomes a lot tougher.

    Everyone was focusing on the legacy loans @ 6×1.

    Anyway, if the objective is to get securitization to work again, the original TALF needs to be put into high gear.

    Buying NEW loans seems way more beneficial then cleaning out the old ones.

    If people don’t think this is killing some companies unnecessarily, check out Harley Davidson. They did a decent job on credit, but can’t unload any of their paper in this environment.

    If the new stuff can be sold via TALF, then let the old stuff amortize on the balance sheets of our legacy banks.

  9. cap vandal

    Part of this is to just get a bid on some of these assets at a subsidized interest rates.
    A lot of the Japan analogies misses the differences that have developed with financial innovation. Bank lending is about as before, but the securitization market is gone. The entire shadow banking system — depending on how you want to define it.

    I think we need to get rational securitization for assets other then conforming mortgages going again.
    Since the securitization model was designed to disintermediate banks, we don’t need em. Just an originator and a buyer.

    Since the government is the only buyer, they can disintermediate the current investment banks and just buy the stuff directly from originators — or — as needed, just get new aggregators. Also, they can spec out the requirements in a similar way to the GSE’s. Vanilla stuff.

    The nationalization argument is getting old and is a distraction to the facts.

  10. Anonymous

    Who are the five “families ” , so to speak ? And they have to be American , right ?And must have experience with handling toxic waste also – 10 billion threshold , right ? Pimco , Black Rock probably . Perhaps Citadel ? With Bridewater out , who else do we have ? Maybe Goldman ? Who else would playwiththe toxic security side ? I’m drawing blanks — any thoughts ? Just want to see if they can even get five managers….

  11. Anonymous

    Hell, the theft has been in broad daylight so far, what have they got to hide? I am sure that the select parties will have the proper leverage, just like cost plus military contracts. This is their government after all.

    It does my soul good to know that I will be protesting on April 11th with others who find our situation revolting…ANewWayForward.org.


  12. Anonymous

    They don’t need no stinken hedge funds they have legalized fraud to get them threw this.

    At first FASB resisted making changes, but that changed within a few days of a Congressional hearing at which legislators from both parties demanded the board act.

    “There is a perception that we are yielding to political pressure,” one board member, Lawrence W. Smith, said as he voted for the changes.

    “We are an independent standard setter, and it is important that we maintain our independence,” Mr. Smith added. “At the same time, how can we ignore what is going on around us?”

    A group headed by two former chairmen of the Securities and Exchange Commission, one who served under President Bill Clinton and one who was appointed by President George W. Bush, said that it feared that politicization of accounting standards would destroy the credibility of the board.
    The Enron Empire: In fraud we trust
    Banana Republic

  13. Edwardo

    Someone wrote about President Obama:

    “Somewhere in the man’s psychological make up is an instinctual preference for splitting the difference, with all the damage that that can be trusted to inflict on the truth.”

    I’ll be more blunt and offer that Obama may be our first President who would could more accurately
    be described as the nation’s Greeter in Chief or Spokesman in Chief. Not for nothing did one journalist routinely refer to President Obama (before he was President) as Senator Slither. I prefer what is no doubt a politically incorrect epithet, the hollow chocolate.

  14. Anonymous

    Its another shell on the table,
    But the marks are now more able …

    They view the cheap leverage
    Like a watered down beverage …

    And the taste is stinking,
    So few are drinking …

    Now its almost instantaneous,
    We’re suddenly all extraneous …

    What is so unconventional,
    Is its all so intentional …

    Bad ‘rule of law’! Sit! Sit!

    Deception is the strongest political force on the planet.

    i on the ball patriot

  15. Anonymous

    I am going a bit off topic also having just read the annex to the G20 communique or whatever they called it. The following is in the PDF annex:

    “we will promote the standardisation and resilience of credit derivatives markets, in
    particular through the establishment of central clearing counterparties subject to
    effective regulation and supervision. We call on the industry to develop an action
    plan on standardisation by autumn 2009;”

    So I read this as the derivative scam with taxpayers dollars as the backdrop will go forward by all these folks at least until the fall. That makes me feel all warm and fuzzy/NOT!


  16. Bonesetter Brown

    I think Namazu has it exactly right.

    The purpose is to limit the bidders to those who have a motivated self-interest to overpay. The equity into the PPIP is indeed a small price to pay (even if completely written off) compared to the current gap in bid/ask on the assets in question.

    Prior to this post I didn’t comprehend that leverage would be so limited for Legacy Assets (and per the comments here there seems some difference of opinion), but even Bridgewater believes the leverage is available for Legacy Loans. It would seem the program would work great as a backdoor bail-out that allows a club of insiders to take CRE or similar loans off their collective books at something close to par (which is where I understand a lot of CRE loans are currently marked).

  17. Bonesetter Brown

    Sorry, above I should have said “Legacy Securities” instead of “Legacy Assets”

  18. Anonymous

    So… this is good news, right? If nobody wants to participate in Geithner’s stupid plan, then it doesn’t go forward and they have to try something else, right?

  19. Anonymous

    Yves said,

    “The only way to make it work under those circumstances is if the banks subsidize investor bids (say via non recourse loans”

    Sorry if this has been covered, but isn’t the Treasury providing non-recourse loans out of remaining TARP funds for the PPIP program? Wouldn’t this give private investors more incentive?

  20. cap vandal

    “My question: why would the plan offer so much more leverage to clear legacy LOANS of the books as opposed to legacy CMBS/RMBS?”

    Good question. Somehow I misread the original document and thought leverage for securities was 4×1. I swear that I didn’t make it up. Sounds like the max is 3×1, but only if they can take the assets and re TALF them with the Fed somehow.

    But … as far as the loans go …. the FDIC is already on the hook for loans. They are using the FDIC to guarantee bonds to buy the assets, since, what’s the diff. You can guarantee the same asset on A’s books or B’s books and it is the same thing, no?

    Not quite because deposits – the insured part – tend to be 1/2 of bank liabilities and the Treasury plan has more like 18% subordination. So, its a bit more risk, but the same basic bet with a little less cushion.

    Meanwhile, the banks selling will likely be busted FDIC insured banks, so, once again. A distinction without a difference.

  21. cap vandal

    If no one participates, then it is ok.

    One of the biggest problems is that they said they had a plan to have a plan.

    Now they have a plan.

    Per T Boone Pickins:

    An idiot with a plan is a better bet then a genius without a plan.

  22. Anonymous

    This baby is getting really over cooked, by the time its all said and done with, it be old shoe leather.

    No truth, no law, just point-counter point BS, everyone is being screw in broad daylight and every one is just passing by (please don’t complicate my life).

    Its all just to big and hard for the masses to digest and with fear of loss (My house, cars, lifestyle, seed) “Cowards” the lot.

    Those with some clue to the crime are left expressing their findings on the web lol, what have we become. The powers that be have accomplished their goals and now we are just cattle with bank accounts and SSN numbers for identification.

    America: the exporter of the lifestyle of lies, we have become domesticated to the point of no return and share our pretty picture with the world in high resolution eye candy media, for the imprinted from birth offspring to devour.

    Beware the noise of chains swinging in the butchers house for their rattle is your impending demise, and by the time you come around the corner to see its activity’s, your path is resolute.

    skippy…Yves, I under stand your distaste for media, lies for consumption.

  23. Darcy

    Anonymous said…10:44 PM
    A bit off-topic but here’s a must read on AIG from Chris Whalen today:

    I concur a must read, definitely gives you an idea of how they got their apprenticeship in pyramid building.

    The more you dig in the sand the clearer the outline becomes, the solid pillars of wall street seems to be sat upon a much larger 4 sided polygon. You keep digging but there doesnt seem to be a bottom. Who could have created such a thing and why? Seems to be such a waste of capital.

  24. Anonymous

    “(inexplicably, the program sets a very high bar for assets under management. among other selection criteria. If the purpose is to elicit higher bids, more bidders would be a good idea).”

    Yves, you’re so good at this usually, better than me by far. As with all this stuff, a good first pass at parsing is to assume the worst, most criminal motives and work backwards from there.

    As someone suggested above, surely this is designed to limit participation to favored parties who will then offload fraud-flavored assets at or above par. Like the favored TARP recipients, it’s all cronyism.

    Just a guess. You’re plenty cynical, so don’t take this as serious complaint.

  25. Darcy

    Is this our financial “Skynet” moment.

    Is it not coincidental that ubiquitous interconnected computing power arrived as the first bloom of the shadow financials opened in the early 1980s.

    The sheer interconnectedness of our world, with hot money flowing through complicated multi layered systems invisibly seeping through loopholes trying to find the best ‘returns’. So many conflicts of interest, bankers accountants, lawyers, politicians, pension fund managers all linked, all wanting to keep the wheels turning. All 1 and Os not real just 1 and 0s . Cant hurt to add a few 0’s can it? Assets sliced into less and less transparent more complicated fractions, more and more leverage, its all insured no worries, the computer geeks say the model works and the lawyers say its legal. Too much information to digest too many side bets, too many layers, its ok we will all get rich just by sitting still thats the power of Pyramid 2.0 software. No more booms or busts its a new paradigm, and anyway my quant has a new product that you might be interested in.

    Can one man build a $70 billion dollar pyramid, the answer is with Pyramid 2.0 he can. “I couldn’t have done it without Pyramid 2.0” Bernie Madoff. Not surprising that a man who built his reputation using new computing tools was an early adopter.

    Other early adopters were Artificial Intelligence of Giza (AIG). Pyramid 2.0s largest and most committed client, trillions of sliced and diced digital virtual assets, shaved and recapitalised, sold on, bought, sold on again, insured round and round, layer after layer until only the software knew how it worked and who owed what to who, the largest biggest blackest pyramid ever built. . A feat of digital engineering, ever rising gargantuan profits spewing forth from its entranceway into the hands of waiting bankers accountants lawyers and politicians. AIG started a craze and soon everyone was building pyramids, they even built one in Antigua and had to import all the digital black stone. Pyramid talked to pyramid and pretty soon every digital asset that could be sold, insured or leveraged had been twice thrice over. Sadly this peak marked the day of the great crash, the day no money poured forth, the day the pyramids fell silent. A panic followed as nobody could figure out who owed what to who and how much anything was worth anymore it was all inside the black pyramids. People stopped working and scratched their heads, wondering how they had got to rely on the pyramids for everything.

    The size of the bubble blown is i hypothesise correlated with Moores law.

  26. Anonymous

    Every buyer has his price. But then that would defeat the purpose of the ‘partnership’, right?

  27. Anonymous

    I Don’t think it is really designed for private investors, but as a way of re-capitalising banks with taxpayers money without nationalising.You might just as well empty your pockets on to the floor next time you are in the bank, they are going to get the money from you one way or the other.

    Step 1: the bank would approach the FDIC to sell assets
    Step 2: The FDIC would determine the leverage of the pool at a 6-to-1 debt-to-equity ratio.
    Step 3: The pool would then be auctioned by the FDIC, with several banks submitting bids.
    Step 4: The FDIC would provide guarantees for 90% of financing.
    Step 5: The Treasury would then provide 50% of the equity funding
    Step 6: The bank would then sell the asset at a loss to another bank subject to asset managers approval and subject to oversight by the FDIC.
    Step 7: Back to step 1

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