PPIP DOA?

Is the Geithner PPIP already over? Clusterstock reports that Jamie Dimon announced that he does not foresee JP Morgan participating in the PPIP, either as a buyer or a seller. From Clusterstock:

Speaking on the company's just-concluded conference call, JP Morgan (JPM) CEO Jamie Dimon downplayed the PPIP, saying the bank had nothing to sell into it, and that it certainly had no interest in partnering with the government as a buyer.

What's more, he said, he didn't consider the PPIP to be that big of a deal, suggesting that it's just one small piece of what Treasury is doing to prop up the system.

Remember, this is coming from the bank that has 10% of all mortgages. They're saying they have nothing to sell and that toxic asset prices aren't the problem.

I guess 6X leverage isn't enough to bid up the prices of toxic assets high enough for banks to still not take enormous losses. This was fairly predictable. Now what's the plan?

Defending Gaming the Geithner Plan

The inevitable gaming-the-PPIP-backlash backlash is on. After Joseph Stiglitz and Jeffrey Sachs lambasted Geithner's plan as a taxpayer rip-off, Noam Scheiber has taken to TNR with his oh-so-contrarian take that the PPIP being a scam isn't necessarily a bad thing. From TNR:

But is this really such a bad thing [if banks game the PPIP]? It sounds a lot like a good bank/bad bank model, in which we recapitalize Citibank to the tune of $925,000 and take the toxic asset off its books and stick it in another entity--a "bad bank"--created for that purpose. As I've said before, there may be moral objections to such an arrangement. (It is offensive that taxpayers have to bail Citibank out.) And the Geithner plan may not have enough money to recapitalize all the banks this way. But that's different from arguing that it can't work....

The only real difference, so far as I can tell, is who pays. Under Sachs's preferred approach, the bondholders and stockholders take most of the hit, while under his hypothetical gaming approach, the taxpayers do. Again, that's not fair. But being unfair doesn't doom something to fail. And I'd take an unfair success over a fair failure. (Though successful and fair would be ideal, and Sachs's proposal may get us close.)

What's a few trillion dollars between friends? But Scheiber ignores the very real possibility that the PPIP will not be enough - that bank losses will go well beyond the funding Geithner can manufacture with the FDIC and the Fed, and that the administration will have to go back to Congress. In that case, if the entire bailout process is perceived as an indefensible giveaway to Wall Street, then there is little hope of convincing Congress to pony up for more. If that happens we could be back where we were last September - financial panic as too-big-to-fail institutions fail.

Therefore, there is a premium on finding a policy that not only will work, but the public will see as being fair. Geithner seems to understand this, which is likely why he has resurrected the Paulson cash-for-trash plan with a few bells and whistles to distract the public (like any good magician, Geithner knows misdirection is key). But rather than trying to trick the public, wouldn't a much simpler plan that put insolvent banks into some form of receivership-on-steroids and restructured them make more sense? This would not only be good policy, but good politics as well; Axelrod and Emmanuel certainly understand that getting tough on Wall Street would be a popular position.

These are issues that Scheiber completely ignores. He seems to have completely bought the administration/banks' line that we must save the bankers to save the economy. But saving the banks does not mean saving the bankers who got us in this mess. Oops - I guess that makes me a radical populist.

Sachs: PPIP Is A Scam

Columbia professor Jeffrey Sachs has joined the chorus of those proclaiming Geithner's PPIP a swindle. In the wake of the FT reporting that banks are considering bidding on each others assets, Sachs explains that while most commentators have worried about outsiders profiting at taxpayer expense, the potential for insiders gaming the system is even worse. From Sachs:

Consider a toxic asset held by Citibank with a face value of $1 million, but with zero probability of any payout and therefore with a zero market value. An outside bidder would not pay anything for such an asset. All of the previous articles consider the case of true outside bidders.

Suppose, however, that Citibank itself sets up a Citibank Public-Private Investment Fund (CPPIF) under the Geithner-Summers plan. The CPPIF will bid the full face value of $1 million for the worthless asset, because it can borrow $850K from the FDIC, and get $75K from the Treasury, to make the purchase! Citibank will only have to put in $75K of the total.

Citibank thereby receives $1 million for the worthless asset, while the CPPIF ends up with an utterly worthless asset against $850K in debt to the FDIC. The CPPIF therefore quietly declares bankruptcy, while Citibank walks away with a cool $1 million. Citibank's net profit on the transaction is $925K (remember that the bank invested $75K in the CPPIF) and the taxpayers lose $925K. Since the total of toxic assets in the banking system exceeds $1 trillion, and perhaps reaches $2-3 trillion, the amount of potential rip-off in the Geithner-Summers plan is unconscionably large.

The earlier criticisms of the Geithner-Summers plan showed that even outside bidders generally have the incentive to bid far too much for the toxic assets, since they too get a free ride from the government loans. But once we acknowledge the insider-bidding route, the potential to game the plan at the cost of the taxpayers becomes extraordinary. And the gaming of the system doesn't have to be as crude as Citibank setting up its own CPPIF. There are lots of ways that it can do this indirectly, for example, buying assets of other banks which in turn buy Citi's assets. Or other stakeholders in Citi, such as groups of bondholders and shareholders, could do the same.

Are there any assurances that something like this would not happen? And is there anyone outside the administration willing to defend this plan?

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?

Contrary Indicator?

Jim Cramer thinks our mini-depression is over (but not the recession). He sees us in a cyclical rather than secular downturn, due to the supposed positive impact of the Geithner plan.

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Kinsley: Obfuscation is the Point of the Geithner Plan

Finally, someone from the establishment media (aside from Paul Krugman) speaks the obvious truth about the Geithner giveaway-to-banks-and-hedge-funds-and-private-equity-at-taxpayers'-expense-orgy: it is deliberately opaque, so as to mask how large a subsidy it is to the financial sector. Just as our erstwhile wizards on Wall Street seem to create intentionally abstruse financial instruments in order to keep the masses from questioning their financial hanky panky, Kinsely argues that the difficulty in deciphering the exact workings of the Geithner public-private plan seems similary motivated: to keep the public out. Indeed, Geithner has merely recycled Paulson's TARP idea of buying up toxic assets, which was rejected for being too transparent a giveaway to bankers, and added an extra step - launder the money through hedge funds and private equity firms. Perhaps the success of keeping the identity of AIG's counterparties secret for six months inspired this new scheme. Geithner has explained that partnering with these financiers will tap into the "expertise of the market" in pricing these so-called toxic assets, when in fact, this amounts to passing out lottery tickets to hedge funds and private equity firms, as they siphon off a percentage of any potential gains from the bailout. And, of course, public money will continue to flow into the banks, except this time via hedge funds and private equity firms instead of through AIG. This is the coup de grace of our kleptocratic system: everyone on Wall Street wins, and everyone on Main Street loses.

Of course, once it becomes clear that already rich financiers are becoming even richer thanks to the largesse of the Treasury, there will be public outrage that could potentially dwarf the AIG bonus flap. Maybe then our political class will pay more than lip service to the righteous anger spewing over the transfer of wealth from the masses to the politically connected who have brought the system down.