So, like a movie monster that won’t die, PPIP is a go. Here’s The New York Times:
Agency 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.
Residential Credit will put up $64 million of its own money to obtain a 50 percent stake in the venture, which will hold and manage the $1.3 billion pool of mortgages from Franklin Bank.
The F.D.I.C. will own the other 50 percent stake in exchange for providing the loans as well as the bulk of the financing. Instead of taking cash for the loans, the F.D.I.C. will accept a government-guaranteed note for $727.8 million with an interest rate of 4.25 percent.
Agency officials said the deal meant that investors would be paying about 70 cents on the dollar for the loan portfolio…Had the government not provided Residential Credit with the ability to borrow most of the money it needed at low interest rates, agency officials said, the investors would have probably paid about 20 cents on the dollar less than they did.
So private investors have come in with $64m, to get a 50% stake in a company that purchases $1.3bn in mortgages. The Treasury provides the other $64m, while the FDIC provides 6-to-1 leverage to purchase this. The actual bid on the loan is $727m ( which isn’t $64m * 2 * 6, so I need to investigate further).
They don’t have a chart as to what the final payments look like given the distribution of asset worth; I’ll go ahead and draw that now:
They are equal on the right-hand side. Residential Credit puts up $64m, on a $727m bid for $1,300m in assets. If the assets are worth less than $727-$64 = $663m, then every additional dollar comes from me and you, the taxpayer. If the assets are worth more than $727m, then we split the earnings with Residential Credit.
So for small price of $64m, or about 8% of the bid, they get half the upside gains while only absorbing a bit of the downside loses. We are also on the hook for a lot of interest rate risk, which I’m not going to bother to quantify. This is a terrible deal – but there were other issues at stake. I remember the original PPIP debates well, and there were only two valid arguments, neither I found very convincing, to allow this giveaway to happen.
Get credit flowing again
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.
Astute readers may ask “why wouldn’t we just go ahead and pay the extra $64m above to get that other half of the upside? Why don’t we just ride out the loan if we are going to keep all the downside risk?” The reason PPIP was sold was that it would start to create a market price for these assets. Sophisticated hedge fund managers would come in, bid on the price of toxic assets, and then we could use that to start solving whether or not the banks in question were solvent. In addition to getting credit to flow again, getting a decent market price for assets which had frozen would be worth the taxpayer cost.
So, we have a market price for toxic assets. $1.3bn is only worth $727m. Is the Rubin family and the rest of the Obama economics team going to march to Wall Street and use this to mark down the asset values of the largest banks? I’m not holding my breath. Most of the crucial actions taken to replace PPIP – replacing the accountancy rules and enacting the stress test – were used to replace this information problem with methods that produced numbers that were less transparent and more friendly to the big banks.
So we’ve just auctioned out half the upside of this loan while retaining most of the downside for pennies, without accomplishing either of the major goals of why we were interested in PPIP in the first place. I’d like call my elected official but nobody voted for this bill. I seriously worry this is a prep run for bigger bids coming down the line…