Is Treasury’s PPIP Plan Enough To Fix Markets?

Last week, we discussed the Treasury’s Public Private Investment Program which is a way for banks to unload illiquid assets. As we said at the time, it’s a smart program. But the Economist this week points out that it’s only a half plan, and unless banks are forced to sell assets, it’s not likely to work:

As it stands, Mr Geithner’s Public-Private Investment Programme looks like an ungainly political and financial fudge and far from the market solution the government claims it is (see article). It aims to buy $500 billion-$1 trillion of the loans and hard-to-value securities that have swamped the banks’ balance-sheets since the collapse of America’s mortgage market in 2007. Ideally, the government would have raised that money from Congress and parked the toxic assets in a discrete “bad bank”, or offered to guarantee them. But Congress has bail-out fatigue. Bonus-bashing scores immeasurably higher with voters than adding to the $700 billion earmarked to buy bank assets last October. Of what is left, Mr Geithner has a relatively thin $100 billion for his Augean clean-up. Beyond that there is less than $100 billion in the kitty.

Hence the need to conjure money out of thin air, or rather the government’s off-balance-sheet equivalents—the Federal Reserve and the Federal Deposit Insurance Corp, which may provide loans and guarantees without a word from Congress. To show that this is not wasted, there is the figleaf of market discipline: a slug of private money is supposed to ensure that hard-nosed capitalists have enough of a stake to stop the government overpaying. But this is capitalism of the “Heads I win, tails you lose” variety. The government bears almost all the risks, while private investors pocket half the rewards. If there are big pay-offs, Congress could decide to claw back the benefits. Forget bail-out fatigue; the risk is class war.

Hold your nose, however. Mr Geithner’s proposal is worth a try, not least because, as any leader at the Group of 20 summit in London next week will tell you, fixing American banks is one of America’s—and hence the world’s—most urgent economic priorities. However unpalatable it is to shower public largesse on big vulture funds, one of the few ways to see if there is any residual value in all the toxic waste left on the banks’ books is to induce someone to buy it. Without a subsidy, there are many reasons for private investors to hold back. Above all, they do not have the same information advantages as the seller, which is only too keen to offload the worst assets on its balance-sheet while hanging on to the good stuff. The trouble is, the proposal barely has a hope unless banks agree to sell assets, and therein lies Mr Geithner’s unfinished task: arm-twisting them to do so. Many banks value their assets well above the prices they would fetch in an open (albeit illiquid) market. They have incentives to keep them there: the lower the price, the more capital they need to raise; in these capital-constrained times, that means the closer banks are to insolvency.

But if America wants to avoid the fate of Japan in the 1990s—a lost decade of zombie banks—it is vital that its banks face reality. Mr Geithner has a ready-made tool for that, about which he has been mysteriously quiet of late: his “stress tests” to determine whether America’s biggest banks have enough capital. Done rigorously, the stress tests could force the banks to come clean about their balance-sheets and lead to the forced sale of assets into the government’s toxic-asset programme. If a bank cannot raise the capital to offset its losses, it should be deemed insolvent and temporarily nationalised. Mr Geithner’s proposal is part of a process that could lead to more certainty—even healing—in America’s banking system. But only if he has the gumption to turn his half-plan into a whole one.