Buffett and Geithner

Andrew Ross Sorkin’s Too Big to Fail sure is a page-turner; even for events that I already knew about in general, it’s full of new details and juicy quotations.

For example, on page 508 it lays out the details of Warren Buffett’s October 2008 proposal for a “Public-Private Partnership Fund,” which would eventually become the PPIP announced by Tim Geithner in March 2009.  I knew that Buffett, Bill Gross, and Lloyd Blankfein had supported the idea, but I didn’t know the details. Buffett’s idea was slightly different from the eventual PPIP.

PPIP ended up having two flavors. In the toxic loan version, the equity would be split 50-50 between private investors and Treasury, and then the FDIC would provide leverage via a non-recourse loan (technically, I think it was some kind of loan guarantee); in the examples, it would be six to one. Buffett, by contrast, proposed leverage of four to one. Like PPIP, money would go first to pay off the government loan. However, then private investors would get all the money, until they had gotten their money back plus the same interest rate that the government got. After that point, investors would get 75% of the upside, and the government would get 25%.

I was curious about how the payoffs differed under these two proposals, so I graphed them. Note that this is for the legacy loans version of PPIP; leverage ratios do matter.

Thin lines are the Buffett proposal, thick lines are PPIP; blue is private investors, red is the government. I assume a single period and a 5% interest rate, but the interest rate doesn’t affect the shape of the curves. Private investors get a lot more upside under PPIP, but that’s basically because they have a lot more leverage (and hence get wiped out faster on the downside). In PPIP, they contribute 1/14th of the money and get half of the upside; under Buffett’s proposal, they contribute 1/5th of the money and get 3/4 of the upside. Curiously enough, the government also does better on the upside with PPIP. That doesn’t seem possible, except that the government is putting up a larger proportion of the money in PPIP than in Buffett. So moving from Buffett to PPIP, the returns for private investors and the government both go up, but that’s because the weighting is shifting from private investors (the higher returns in either case) to the government (the lower returns).

In the toxic securities version of PPIP, the leverage ratio was lower, bringing the thick blue line down closer to the thin blue line.

There’s nothing too scandalous here that I can see. But I thought someone else who made it to page 508 of Too Big to Fail might have had the same question, so here’s the answer.

By James Kwak

15 thoughts on “Buffett and Geithner

  1. What I find most interesting is that Buffett provides a little more downside protection for the Government position. Under his plan, the Government takes home its 5% as long as the portfolio losses don’t exceed 15% (or so). It seems like a small sliver on this graph, but mindful of the fact that the graph only represents one deal, and the Government was envisioned as participating in thousands of these deals, it becomes more significant. In exchange, the Buffett plan gives up some participation in portfolio returns greater than 20%.

  2. Terrific post by James Kwak. So it seems they were quite attentive to Buffet’s suggestions, at least one of them. Typical Buffet common sense answer, trying to get both sectors to bear the burden. I’m still not a Sorkin fan. Sorkin’s ability to carry a shit-eating grin while describing a crisis which has led to job losses and home foreclosures really sticks in my craw.

  3. Interestingly, we can look for legacy CMBS spreads to widen and pricing to go down when the TALF expires and the air is let out of the market, so these PPIP investors may see some rough times.

  4. Don’t buy Sorkin’s book. Sorkin is just another obsequious, despicable, Wall Street ass-kisser. How could he write a book with that much detail otherwise? You need access.

    When a Fed oversight bill was being discussed, he just rushed to publish a “piece” (aka agitprop BS) warning of catastrophic consequences if the sacrosanct independence of the Fed was impaired. “Beware the consequences of outrage” is the title of this little gem.

    Yves Smith duly demolished his feeble arguments.


  5. Kind of reminds you of Truman Capote’s access to Perry Smith and Richard Hickock. Only Capote’s prose is like a dreamlike walk through the most beautiful parts of Yunnan China, and Sorkin’s writing is like walking through a dumpy overused cow pasture, replete with deep references to Oprah Winfrey.

  6. I’m surprised that you don’t think this is a scandal. Sure the chart looks innocent, but with the higher leverage, investors will take more risks. As a result, more investments will fail, and the government will eat more of the downside. So the scandal isn’t obvious when you look at a single transaction, but it’s big if you integrate over all the dollars that will be put into the program.

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