Saturday, April 4, 2009

PPIP Gaming

It's official: banks will use the non-recourse loans from the PPIP to bid up each others toxic assets. From the FT:
US banks that have received government aid, including Citigroup, Goldman Sachs, Morgan Stanley and JPMorgan Chase, are considering buying toxic assets to be sold by rivals under the Treasury’s $1,000bn (£680bn) plan to revive the financial system.

The plans proved controversial, with critics charging that the government’s public-private partnership - which provide generous loans to investors - are intended to help banks sell, rather than acquire, troubled securities and loans....

But public opinion may not tolerate the idea of banks selling each other their bad assets. Critics say that would leave the same amount of toxic assets in the system as before, but with the government now liable for most of the losses through its provision of non-recourse loans.
This is even worse than the abortive Paulson cash-for-trash scheme. At least under the original version of the TARP, some toxic assets would actually be removed from banks' balance sheets. In trying to resurrect this rejected idea by dressing it up with a bit of financial prestidigitation, Geithner has created a perverse situation where banks have incentives to acquire more toxic assets, gambling that some of this trash will be worth something. Of course, taxpayers are on the hook if the assets are indeed worth as little as current prices imply. Somehow providing huge subsidies to banks for them to buy up worthless pieces of paper from each other does not seem like a fix to the problems plaguing the financial sector. The amount of bad debts the banks hold on their balance sheets is simply too large for the government to buy or subsidize. Debts need to be restructured; insolvent banks need to be put through orderly bankruptcies. Subsidizing failure will only guarantee the existence of zombie banks. Failed banks will eventually be put into receivership anyway - why not do it now when it will cost less?

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