PPIP banks may be able to buy rivals' toxic assets

The scheme, which was initially planned to start on May 1, would use $75 billion to $100 billion from the Troubled Assets Relief Program (Tarp) and at least $100 billion in matching private capital, to initially create $500 billion in purchasing power to buy whole loans and securities, with the potential to expand to up to $1.1 trillion over time.

The PPIP is intended to cleanse bank balance sheets of toxic assets to revive lending while also using private sector expertise to ensure the government does not overpay for the assets. Although institutions will not be able to use public funds to bid on toxic assets they already hold, it remains unclear whether banks will be permitted to buy each other's assets.

The PPIP is split into two schemes. The legacy loans programme will allow banks to approach the Federal Deposit Insurance Corporation (FDIC) with portfolios of distressed mortgage loans, which the bank insurer will then auction off to potential buyers after determining the amount of funding it would be willing to guarantee on the assets, up to a 6:1 debt-to-equity maximum.

Successful bidders would form a public-private investment fund (PPIF) with the Treasury, in which both parties would provide 50% equity. Thus, if a mortgage loan portfolio with a par value of $100 is auctioned off for $84, the private investor and the Treasury would split the $12 equity stake (assuming 6:1 debt-to-equity) and the PPIF would then issue FDIC-guaranteed debt for the remaining $72 to finance the deal.

This mechanism is open to collusion among banks to overbid for each other's assets during the FDIC auction, inflating the cost to taxpayers while potentially creating windfalls for institutions gaming the system.

At a press conference on May 27, FDIC chairman Sheila Bair was unable to categorically rule out whether such activity could take place. "Banks will not be able to bid on their own assets. There will be no structure where we would allow banks to bid. I think there have been separate issues about whether banks can be buyers on other bank assets and I think that's an issue that we continue to look at," she said.

The second element of the PPIP, the legacy securities programme, is similarly open to potential abuse as the Treasury partners with private investors to form PPIFs to buy legacy mortgage securities. The Treasury will approve five official fund managers - which must have at least $10 billion in assets under management to qualify - which must raise a minimum of $500 million in private-sector capital to invest in their respective PPIFs to participate.

The Treasury will match the amount of private capital raised under the PPIP and provide loans of up to 100% of the total combined public-private equity capital of the fund. Analysts have noted that, although the Treasury has stipulated fund managers "may not, directly or indirectly, acquire eligible assets from or sell eligible assets to its affiliates, any other fund or any private investor that has committed 10% or more of the aggregate private capital raised by the fund", there is nothing to prevent banks taking a 9% stake in all five PPIFs and influencing purchasing decisions in this manner.

The five successful fund manager applicants were to be informed by May 15, but that deadline came and went without any word from the Treasury and no launch date for the PPIP more precise than "late June or early July" has been provided.

Bair also acknowledged that would-be PPIP investors might be wary of partnering with the government, following the compensation restrictions and injunctions against the hiring of foreign professionals imposed on US banks that accepted money under the Tarp in late 2008.

"I think there are a couple of factors that are still at play here as we look towards the launch of PPIP. One is we're finding on both the buyer and the seller side there continues to be discomfort about Congress's view of this programme, whether the rules could potentially change. The Treasury will need to issue regulations to clarify those issues before we will have comfort by market participants," Bair concluded.

See also: The big clean-up
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PPIP participants possibly exempt from compensation limits
Questions raised over US scheme to buy toxic assets