Over a month after formally announcing the plan, Treasury
Secretary Timothy Geithner yesterday released details on his
proposal for removing toxic assets from the balance sheets of banks
and other financial institutions.
The keystone of the program is the "Public-Private Investment
Program" (PPIP), through which these so-called "toxic" or "legacy"
assets would be taken off the books of financial institutions. In
the wake of the announcement, the stock markets soared, grateful
that the Administration was finally clearing up the uncertainty as
to its intentions. Substantively, however, while the plan does have
positive elements, it is significantly flawed. Just as important,
Secretary Geithner has not demonstrated the need for such
From TARP to PPIP
The proposal is but the latest in a series of initiatives dating
back to last fall to address the problem of toxic assets, the
securities and loans held by financial institutions whose value is
uncertain in the wake of the financial crisis. Last fall,
then-Treasury Secretary Hank Paulson proposed that the federal
government purchase such assets directly. This plan was soon
abandoned, however, due largely to the problem of determining how
much the government should pay for those assets.
Earlier this year, the Obama Administration was reportedly
considering a "bad bank" approach, under which toxic assets would
be aggregated in a government-owned and -managed bank created for
that purpose, thus isolating the assets until they could be sold
and leaving banks with clean balance sheets. This plan, however,
still offered no way of valuing assets.
The current approach was publicly announced by Secretary
Geithner last month. Essentially, the idea is to use federal
funds to facilitate the purchase of toxic (or what Treasury now
calls "legacy") assets by public-private investment groups, which
would bid against each other for the assets. Yesterday's
announcement provided details for how this approach would work.
For "legacy" loans, private investors would provide 1/14 (about
7 percent) of the partnership's total assets, matched by another
1/14 provided by the Federal Deposit Insurance Corporation. The
remaining amount (6/7 of the total, or about 85 percent) would be
covered by guaranteed loans provided by FDIC. For "legacy
"securities (as opposed to loans), up to five fund managers
pre-qualified by the Treasury Department would raise private
capital that would be matched dollar-for-dollar by the government.
Treasury would also provide loans to enable the partnership to
purchase even more assets.
In both cases, while the government would share profits equally
with the private-sector partner, taxpayers bear most of the risk of
losses. In other words, the private-sector partner cannot lose more
than its investment. Any further losses after the private capital
is gone would be covered by the taxpayers.
To its credit, this approach involves the private sector in
making the investments necessary to address the toxic asset
problem. And by allowing competitive bidding, some approximation of
a market could be made.
That said, however, the plan still suffers from a number of
- Risk of uncertainty transferred, not eliminated. The
main goal of the program is to discover the market price of these
assets and to restart the market in them. The plan does a better
job at this than prior proposals, using bidding by private
investors to determine sale prices. However, much of the valuation
will be affected by the government participation and guarantees
against losses. In effect, a major portion of the uncertainty as to
value is shifted to the taxpayer rather than eliminated.
- Government entanglement in management. The plan will
almost inevitably lead to even more expanded government
micro-management of financial firms. Recent history with the TARP
program shows that participants in PPIP can expect
controls-sometimes retroactive-over compensation and other
management decisions. It is hard to imagine a hedge fund or other
investment group enjoying profits under this program without some
level of federal restrictions accompanying the deal or following
soon thereafter. It is equally possible that if profits exceed some
unspecified percentage, there will be an effort to "recapture"
- Lack of participation. The prospect of such restrictions
may very well deter many potential private sector investors from
participation in the PPIP program at all in order to avoid federal
interference in their business operations. Already several banks
either have decided to return TARP money or are considering
returning it for these reasons, and initial participation in other
programs has been less than anticipated for the same reason.
- Problems of complexity. The process both for setting up
partnerships and for purchasing assets or loans is extremely
complex, necessitating identification of qualified assets,
selection of approved fund managers for securities, establishment
of bidding rules, conflict of interest rules, and a host of other
actions. Although the government predicts that the first
transactions could begin in about a month or so, recent experience
suggests such a timetable is highly optimistic to say the least.
More worrisome, with so many moving parts, the chances of error or
poor oversight are substantial, and they only grow if the program
is implemented too quickly.
Is It Really Necessary?
The American public has justifiably grown skeptical of
interventions that create more problems than they solve, entangling
the federal government in the management of private-sector
businesses. And they have good reason to be skeptical of this plan
as well. Since this plan was originally announced, Secretary
Geithner has argued that, despite its massive cost and certain
flaws, the plan is necessary to avoid a complete collapse of the
American financial system. Certainly the banking system is still
quite fragile, and for this reason the Administration should be
very alert to conditions and ready to respond as appropriate.
However, there is not an imminent threat of a collapse. On the
whole, financial markets are impaired but functioning. Indeed, many
of these "toxic" assets are still performing despite problems in
housing and other markets. Given the dangers of market intervention
of this kind-not only to taxpayers in the form of massive costs but
potentially to the financial markets themselves-actions such as the
PPIP program should be a last resort, engaged in only when
absolutely necessary. That standard has not been met.
James L. Gattuso is Senior
Research Fellow in Regulatory Policy and David C. John is Senior
Research Fellow in Retirement Security and Financial Institutions
in the Thomas A. Roe Institute for Economic Policy Studies at The