Just Baffling

PPIP finally launches, Mike Konczal lays bare the subsidy, everyone just move along … hey, wait a second!

From the Times article: “[FDIC] officials announced that they had reached a deal to sell $1.3 billion in mortgages from Franklin Bank, a Houston-based lender that failed last November and was taken over by the F.D.I.C.”

Konczal, of course, also caught this:

“The first argument is that it would take banks that were otherwise healthy and allow them to start lending again in the middle of a credit crunch. We taxpayers pay to help unload these loans onto other private markets, so that the bank can start lending again.

“But as financeguy points out, the bank in question, Franklin Bank, is dead. FDIC took it over around a year ago, with its balance sheet deep in the red and after losing double digits in loans since 2007. It took a huge gamble in the real estate market, and it got destroyed. This isn’t an otherwise healthy bank with one bad asset on it.”

But I think he is altogether too cool about this. Let me try for a little more indignation. Our government is providing large subsidies to private investors to buy toxic assets. The only possible justification for these subsidies is that they are necessary to restore health to the banking system, by taking toxic assets off the balance sheets of banks. But these toxic assets are already the property of the U.S. government. This means that the government owns 100% of the upside and 100% of the downside on those assets.

Or at least it did until last week. Then it gave half the upside to an investment fund – “Residential Credit Solutions of Fort Worth, a three-year-old company founded by Dennis Stowe, a veteran of the subprime mortgage industry” – and kept all of the downside to itself. What could they possibly have been thinking?

(And wasn’t there supposed to be an auction in there somewhere? The Times story doesn’t mention one (although that doesn’t mean there wasn’t one). Without an auction, how do we know this isn’t more of a giveaway than it already looks like?)

Update: Thanks to commenter On the Mountain, who points out that there was an auction, and provides a link to the FDIC press release. So that part of the deal is in the clear.

By James Kwak

30 responses to “Just Baffling

  1. The FDIC itself is also providing the financing, so it’s not like this is even a FDIC / Treasury / Fed turf war.

    So the FDIC is providing non-recourse loans to purchase toxic assets from… itself.

    I guess this could make sense if the $1.3 billion in “assets” are actually worth less than the $64 million being contributed by the hedge fund…

    But the more likely explanation is what the heck?

  2. This deserves indignation to the max. This is just absurd on so many different levels. It just turns PPIP into a naked giveaway. The tragically funny thing is, it’s almost like the FDIC is trying to paint this as a triumph for PPIP (look, PPIP is being used!) … like we’re all so addled that we forgot what the program’s original purpose was.

  3. Nothing baffling whatsoever. It’s capital crime in plain sight. Just like every other step of this looting since the beginning.

    The only thing baffling to me is the level of cowardice on the part of the people, when it’s just a handful of thieves doing this.

    We could cleanse them in one day, if there were any human spirit left in this dead country.

    I’m really getting sick of how it only gets worse and worse, literally by the day, and how there’s literally never even small pieces of good news, where not even the tiniest things are ever headed in the right direction. This place is just vile, just a rathole of villainy.

  4. On the Mountain

    Press release can be found here. Looks like there were multiple bids.

    “Bidders for the pilot sale were given the chance to bid two different leverage options, 6-to-1 or 4-1, or to submit a cash bid for a 20 percent ownership interest.”

    “FDIC conducted the pilot sale to test this funding mechanism as part of the development of the LLP. The FDIC will analyze the results of this test sale to determine whether the LLP can be used to remove troubled assets from the balance sheets of open banks, and in turn spur lending to further support the credit needs of the economy.”

    http://www.fdic.gov/news/news/press/2009/pr09172.html

  5. James, thanks for laying that out clearly. Looks like the government blew it on that one.

  6. My paper “Slicing the Toxic Pizza: An Analysis of FDIC’s Legacy Loan Program for Receivership Assets” at http://ssrn.com/abstract=1476333 argues that the PPIP financial structure is largely irrelevant in terms of the long term returns to the FDIC when receivership assets are sold. The inflated prices that the FDIC gets in the short run are matched by an offsetting loan guarantee liability that bites the deposit insurance fund in the long run. I analyze the RCS transaction in that paper.

  7. Many many questions in my mind.

    1. Is Sheila Bair the protagonist here??? Or was she bullied by Geithner and/or others?? If she was bullied, wouldn’t she expose this to the media??

    2. Does this mean Sheila Bair relinquishes her role as a heroine in this story?? As at least some of us (myself included) saw her before.

    3. Was there no auction?? If not, why no auction?

    4. Congress killed the “plain vanilla” loans and credit cards legislation today. Why did they kill it?? Which members of Congress killed it??

    5. Why is the New York Times catching all the big stories?? Is the snooze button broke from overuse at the Wall Street Journal???

  8. “FDIC conducted the pilot sale to test this funding mechanism as part of the development of the LLP. The FDIC will analyze the results of this test sale to determine whether the LLP can be used to remove troubled assets from the balance sheets of open banks, and in turn spur lending to further support the credit needs of the economy.”

    Two things: (1) Wasn’t the idea for the LLPs under PPIP to remove troubled assets from the balance sheets of open banks in the first place? Why does the FDIC now treat this as a revelation, like it’s some great idea they just came up with (Wow! Do you think this might work for open banks too?) So if PPIP was originally intended for open banks, why not run the test sale with an open bank? You could get not only a sense of whether the funding mechanism works, but whether the other more important elements (spurring credit lending etc.) work. (2) Possible answer: the FDIC can’t get an open bank to contribute assets. In which case, if the banks don’t like PPIP and the government has no appetite for forcing them into PPIP, what’s the sense of seeing if the funding mechanism works anyway if there will be zero-to-very-few assets available? Or does the FDIC just plan to keep running this program out for dead banks?

  9. Finance guy,

    Removing assets from troubled banks balance sheets is much more expensive for taxpayers and the FDIC than selling receivership assets through the PPIP. My paper “The Put Problem with Buying Toxic Assets” at http://ssrn.com/abstract=1343625. shows that that zombie banks will be reluctant to sell their toxic assets, even if they are marked to market, because they don’t want to give up the volatility. That volatility makes their shareholders richer and puts their bondholders and the FDIC, which insures deposits, at risk. If the bank is bigger than Lehman Brothers, then that volatility puts taxpayers also at risk of bailouts because regulators are almost sure to consider it “to big to fail” (TBTF). This paper shows that banks with too little common equity will be unwilling to sell their toxic assets at a price that any rational investor would accept.

  10. At first glance your language is a little thick for me Professor Wilson. This maybe a stupid question, but what are your 2 cents on this?? Is it as stinky as Mr. Kwak and Mr. Konczal think it is??

  11. The Fed and the Treasury have joined hands to solve the financial crisis by essentially moving ALL of the private sector debt onto the taxpayer’s shoulders. That irresponsible and transient solution (for which the Fed is still congratulating itself) has worked only because 1) the dollar is still the world’s reserve currency, 2) there’s widespread belief that the U.S. government will eventually pay back, on behalf of its degenerate financial institutions, all the money those institutions stole from the world’s capital markets, and 3) there’s very little push back from the American taxpayer because they have come to believe that they can live beyond their means with impunity and so can the U.S. government.

  12. Gotcha. I’m gonna look over your paper; it sounds interesting. But this still leaves the question at hand: What’s the logic behind selling assets of dead banks through PPIP? Here’s my logic for not: (1) You can get a truer sense of market price (one of the PPIP purported goals right?) when the FDIC goes through its normal auction process for the assets, bcz using PPIP instead just muddies everything up with this “subsidy” question — is it 2% or 10% or what? (2) As far as I can see, even if your “toxic pizza” paper is correct (I think I see where you’re going with it, and that does make sense), PPIP just winds up generating a bunch of fees and middlemen and complexity for what? A team of mighty men with oxygenated bellows can’t breathe life into a dead bank and get it to lend again — another PPIP goal.

    Now, if your point is mainly, “the zombies won’t do PPIP,” no dispute here. I couldn’t agree more. So in that case, let’s just let PPIP die and move on.

  13. Maybe it is a Trojan horse in the turf war. If it were only a non-recourse loan, recovery in an event of default would be limited to the collateral pledged, if any. The FDIC’s release says that the note was “guaranteed by the FDIC.” This suggests that the FDIC would need to reimburse itself if the loans did not perform and the debt could not be repaid. Why would the FDIC guarantee the note itself? Two possible reasons.

    First is the reason they gave, which is that the FDIC intends to sell the note in the future once the loans have been modified under the administration’s Home Affordable Modification Program, which would in theory increase the value of the loans underlying the note. If that worked out as planned, then the government would be providing the financing, providing a guarantee on the financing, and subsidizing the underlying loans. Of course, everyone (especially Sheila) knows how well modifications work out.

    The second is that Sheila has just turned these useless assets into a vehicle to raid the Treasury. Why would the FDIC, which is running out of funding, agree to guarantee debt that is ultimately supported by increasingly non-performing assets, which are therefore clearly overpriced?

  14. FDIC said in the press release that they were just doing this to “test this funding mechanism,” which at least suggests that they will not be doing it with the assets of a failed bank again.

    It does not make it any less of a giveaway, however.

  15. financeguy: “It just turns PPIP into a naked giveaway.”

    Err, was it ever anything else?

  16. financeguy: “You can get a truer sense of market price (one of the PPIP purported goals right?) when the FDIC goes through its normal auction process for the assets, bcz using PPIP instead just muddies everything up with this “subsidy” question — is it 2% or 10% or what?”

    Bingo! Who wants a true market price right now?

  17. Financeguy, I agree that the PPIP structure muddles the true market value of the toxic assets. In the pilot case I argue in “Slicing the Toxic Pizza” the price inflation was over 20 percent.

  18. It’s like we’re in a toxic feedback loop. Everyone knows that the socalled TBTF banks, their managements, and their models have in fact FAILED miserably. Everyone knows the TBTF insitutions are mathmetically and legally unsound. Everyone knows their conduct and practices before the crisis and now are criminal, fraudulent, deceptive, predatory, and fundamentally immoral benefitting the predatorclass exclusively and singularly and causing severe injury to their respective societies. Everyone knows that these socalled TBTF banks and perhaps the entire financial system are malignant cancers, providing NO worthy benefit to society, and ruthlessly feeding of the blood of the people. Everyone knows the TBTF insitutions and the underlying systems have NOT changed in any meaningful way. Everyone knows the shaitans and shades in the TBTF institutions operate above and beyond the law, ownd and control the government and the regulatory apparatus, and are totally dependent of the unending protection of, and monsterous taxpayer funded largess from the government teet.

    And sadly everyone knows that sometime in the unknown unknown future (probably soon) another horrible bubble will burst, economies will be brought to the brink of disaster if not total collapse (nexttime), and when that horrorshow happens, these same shaitans, criminals, and PONZI operators will come crying and begging like little school girls for trillions more in taxpayer funded bailouts.

    What we don’t know is – what will happen when the people finally realize these fiends are monsters threatening our lives, our childrens futures, – and that until and unless the TBTF insitutions, their FAILED managements, and their FAILED models are dismantled, and brought to heal, and whatever remains of that nebulous thing called justice. When day comes, (and the sooner the better of the other 99.5% of the earths population), – all bets are off, and predatorclass be the targets of a real horrorshow backlash. I do not condone a revolution, – but I see it as inevitable based on the current baselinescenario.

  19. what was the alternative here? if the fdic had liquidated franklin, how much would they have been on the hook for?

  20. In general when the FDIC takes someone over, they are left with the assets. So there are two alternatives: first a straight-up, unsubsidized auction, which would have fetched a lower price, but would have been free of the loan guarantee. Second, if (as everyone in Washington claims) these assets are bound to increase in price over time, the FDIC could have just held onto them and taken all of the appreciation itself.

  21. Still waiting for 1932…

  22. I’m sure there are some aspects of this I’m not catching. But the immediate question that always enters my mind is: Why would the FDIC sell these assets at a time when economic activity is slow (where it is now) and hence the assets would fetch the lowest price??? Why not sit on the assets and sell them when they can fetch a much higher price??

    I mean these smaller banks are still dropping like flies. Is it a wise decision to sell off assets when you’re still taking in banks for receivership from the same economic downturn???

  23. also, if you are saying that the FDIC could have kept the assets because they might appreciate in the future, i would have a couple follow up questions.

    first, doesn’t the FDIC need cash right now? they are talking about borrowing from the treasury or from other banks, so I believe they do.

    second, if the FDIC were going to get into the business of holding assets, wouldn’t that mean they need a trading operation? (they would need to analyze them, know when they had appreciated sufficiently, etc — holding to maturity is probably not a good idea given their need for cash liquidity.)

    third, can the FDIC realistically manage these assets? that’s not what it generally does. there are probably a lot of really crappy assets on Franklin’s books, and a lot of value in them is probably going to come from active management (ie the assets probably consist of claims on bankrupt business entities and households — you can’t just wait for the dollars to pour in, you have to show up in court and twist arms. the FDIC is going to be pretty bad at that.).

    and fourth, if the FDIC were going to get into the business of holding assets, why these particular assets? just because these were the ones that were dumped on them? seems a bit arbitrary.

    so to sew it up, i don’t think that holding a lot of distressed assets for a long time is a good idea for the FDIC. i’m not 100% sold on the PPIP idea (haven’t read the details) but it does solve FDIC’s problem.

  24. But they’ll need that expertise to operate the PPIP too, presumably. And they’ll need it if they are going to sell the notes they are using to finance these sales.

    And they seem to have the financial strength to guarantee the notes, which I just do not understand at all. The only way an entity purchasing the notes would want the guarantee is if the loans were not performing, so what does the FDIC get out of that?

  25. i looked at what’s on the FDIC site (followed the link above) and it looks to me like:

    — the FDIC took an initial loss (they judged the assets to be worth less than the value at which they were held on Franklin’s book)

    — FDIC is going to try to sell their debt interest as a FDIC insured bond in the deal, probably to raise cash

    so what the FDIC is going to end up with is

    negatives:
    — a loss to the DIF fund due to the bank capsizing
    — a guarantee on the cash flows of the assets. leverage was 6:1.

    positives:
    — $64M equity
    — cash (about $800M, from the equity and bond sale), which they need

    i couldn’t tell from the materials on the site what interest FDIC is receiving on its loan (which it wants to sell with the guarantee) and what the assets pay when performing.

    the quesiton of who is managing the assets is not answered. in the original PPIP the external equity holders managed it.

    if i were going to venture a guess, the way this deal is put together did not change the expected outcome much. the FDIC gets cash now and limits its volatility somewhat going forward.

  26. I’m sure Residential Credit will manage the assets, since it is a “joint venture.” If they sell the note, the proceeds will only take them out of their original position, assuming the note is sold at par+. FDIC is still stuck with the guarantee.

    This is a very bizarre arrangement.

  27. And why would anyone take the FDIC out of its position anyway? Apart from the guarantee, they already know the assets are overvalued. Think about it this way: Residential Capital was willing to take the risk because all it stands to lose is the $64 million. The rest the “venture” is stuck with. It walks away. Whoever takes the FDIC out on the financing would actually be stuck with the loss. Hence the guarantee. If the loans underperform, the FDIC has just sold a Treasury note.

    Or so it seems to me.

  28. Yes, this is truly baffling. It is a financial non-sequitor. But, lacks the same level of absurdity as the B of A fiasco. Why not support the private sector against tax payers. Let’s face it, that’s what Treasury (and Congress) has been doing ever since last September (and, if fact, for our entire history, but that’s another story).

  29. The FDIC needs cash. The proceeds of the sail go to the DIF.

  30. the “sale” proceeds go to the DIF. Sorry it’s Friday. I was day dreaming.