Brave New World

PPIP details and market response 23/03/2009

Ever since the Treasury Secretary’s first announcement about the Obama administration’s use of TARP money, markets have been less than confident about Tim Geithner’s ability to deliver a coherent workable programme. Today’s announcement has filled in the gaps and even gone one stage further by providing specific examples. 

The announcement has been received warmly by the market,  and the improvement in sentiment has been compounded by the surprisingly positive 5.1 percent rise in US existing home sales.  Equity markets are higher by between 3 and 5 per cent and gold prices are lower. The U.S. dollar has risen against the Euro, British pound and Japanese Yen because the plan creates a floor for some of these toxic assets, which helps to reassure foreign investors. 

The effectiveness of the program hinges upon whether private investors will take the carrot that the Treasury is offering them.  In order to buy into the program, not only do they need to be confident that the assets will appreciate in value, but also that the U.S. government will not rescind on their offer or create some surprising rule like the retroactive tax on bonuses. Also, banks have to be willing to part with the assets, which may not make sense if they have already written them off. 

Nonetheless, it is clear that along with the Federal Reserve’s Quantitative Easing program, the U.S. government is throwing everything including the kitchen sink at the U.S. economy and it could finally work.  The only catch is that the program will probably not begin until the end of the third quarter because applications are not due until May. 

The plan involves the collaboration between the Treasury, the FDIC and the Fed to provide cheap capital to encourage private participation.  The risk will be shared between the private and public sector and the private sector will determine what the toxic assets are worth. 

As for the numbers, $75 to $100B in TARP capital and capital from private investors will be allocated to the PPIP which the Treasury estimates will have $500B in purchasing power with the potential of expanding to $1 trillion over time. 

The plan has 3 basic principles:

1. Maximizing the Impact of Each Taxpayer Dollar

By using government financing in partnership with the FDIC and Federal Reserve and co-investment with private sector investors, substantial purchasing power will be created, making the most of taxpayer resources.

2. Shared Risk and Profits With Private Sector Participants

The Public-Private Investment Program ensures that private sector participants invest alongside the taxpayer, with the private sector investors standing to lose their entire investment in a downside scenario and the taxpayer sharing in profitable returns.

3. Private Sector Price Discovery

To reduce the likelihood that the government will overpay for these assets, private sector investors competing with one another will establish the price of the loans and securities purchased under the program.

According to the Treasury, this will be a much better approach than simply waiting for banks to work the toxic debt, or what they call “legacy assets” off their balance sheets, which would prolong the financial crisis and possibly turn the U.S. into Japan who fell into a 10 year phase of zero growth. By bringing in the private sector, taxpayers will not have to bear all of the risks.