Schroders’ head of ABS, Chris Ames, thinks the Public-Private Investment Programme (PPIP) set up by US Treasury secretary Tim Geithner is in danger of being another big rip off of tax-payers:
We constantly hear that banks can’t get toxic assets off their books because there are no buyers. This is not true. The US secondary market is open – there is a price at which buyers will buy virtually any bond. So the problem isn’t primarily liquidity, the problem is primarily price. This seems to be the big elephant in the room that policymakers don’t want to talk about, but it’s quite obviously the case.
If banks genuinely need to get these assets off their books in order to begin properly functioning again, then if market prices were close to the banks’ holding values for those assets, they’d happily sell.
Many of the asset-backed bonds that the banks own, which were formerly rated AAA but now rated much lower, are sellable, in Ames’ estimate, at around 30 cents on the dollar.
But if banks valued them at their real price, they would be forced to make such cripplingly big write-downs, they would be declared insolvent. So at the moment, they are sitting on these bonds, too afraid to admit how little they are now worth.
The PPIP envisages banks selling off their toxic assets to authorised money managers, using some equity from the money managers, and a lot of leverage provided by the Federal Reserve and the US Treasury under the TALF scheme. It’s a hybrid, market-friendly scheme.
But Ames says no money-manager will buy the banks’ toxic assets at the valuation banks need to charge to avoid insolvency. They’d pay fair value for the assets – around 30 cents on the dollar. And the banks can’t afford to sell at that price, while staying in existence.
However, Ames has spotted a loophole in the programme – it says that ‘any private investor’ can also bid for assets in the programme. So the banks could buy the assets from themselves, via an off-balance-sheet vehicle or a friendly hedge fund. All they would need is a small amount of equity from themselves, and a lot of cheap leverage from the Federal Reserve and the US Treasury.
They can then write-off those assets at the new price which they sold them at, even though they set the new price fictitiously high. And if the price then plummets, well, that’s the Fed’s problem, they bank-rolled the acquisition.
So there we have it. The program isn’t likely to get many assets sold by banks to the money-manager partners at appropriate prices. And if the loophole allowing private investors direct access to TALF funds isn’t closed, banks will be able to shift large amounts of their risk directly onto the taxpayer. Instead of punishing management and shareholders for poor investment decisions, it has the scope to give them a free pass.