Tuesday, 24 March 2009 00:00

Reggie Middleton's Overview of the Public-Private Investment Program

I have reviewed analyses of the PPIP in blogs and news outlets across the web and have perused the comments section in as well. I am impressed by the bright, cogent analysis but need to warn my blog readers that those early analyses may not be based upon the facts as described in the actual plan but upon speculation as to what the plan may contain. I have had my team review the plan and we will reveal what it means to the analysis that we have released as well as what I foresee for the future. the historically ridiculous (as in one of the greatest rallies ever, based upon a plan that practically no one who participated in the rally has actually read cover to cover) is evidence of technical and momentum orientated traders and not a change in the fundamentals. I'm not saying that the fundamentals have not changed, but we need a chance to find out. I can say that price discovery needs to occur on a natural level for a sustainable bull market. To my knowledge, that has not happened and it is not a feature of the PPIP. I will explore the plan and its parameters in detail and report back ASAP! Obviously, this will be a topic for discussion at the BoomBustBlog event tonight (BoomBustBlog Networking - Trading Reggie's Research).

About the Program

The US sponsored Public-Private Investment Program intends to target legacy assets - legacy loans (real estate loans held "directly" on the books of banks) and legacy securities ("securities backed by loan portfolios").

The Aim of Program: A huge decline in prices of legacy assets have strained the capital of financial institutions limiting their ability to lend and have increased cost of credit. The stated goal of the Public-Private Investment Program is to strengthen capital base of financial institutions and enhance their ability to lend, ensure efficient price discovery of legacy assets by involving private players and minimizing the risk to taxpayers while providing opportunity to private players to earn sufficient returns.

Legacy Loan Program

The program intends to attract private capital to purchase eligible legacy loans from participating banks through the provision of FDIC debt guarantees and Treasury equity co-investment.

Financing: The private participants (individual investors, pension plans, insurance companies and other long-term investors) alongside Treasury will provide equity financing. The Treasury intends to provide 50% of the equity capital for each fund, but private managers will retain control of asset management subject to FDIC oversight (this is an interesting point). FDIC will provide a guarantee for debt financing issued by the Public-Private Investment Funds to fund asset purchases.


  • Banks would decide which assets (ex. a pool of loans) - they would like to sell.
  • The FDIC will then conduct an analysis to determine the amount of funding it is willing to guarantee, limiting the leverage to 6:1 (much of the analysis that I have read assumed a foregone conclusion of 6:1 leverage).
  • The FDIC will conduct an auction for these pools of loans. The highest bidder will have access to the Public-Private Investment Program to fund 50% of the equity requirement of their purchase.
  • If the seller accepts the purchase price, the buyer would receive financing by issuing debt guaranteed by the FDIC. The FDIC-guaranteed debt would be collateralized by the purchased assets and the FDIC would receive a fee in return for its guarantee.
  • The Treasury would then provide 50% of the equity funding
  • The private investor would then manage the servicing of the asset pool and the timing of its disposition on an ongoing basis - using asset managers approved and subject to oversight by the FDIC.
  • Private sector investors would stand to lose their entire equity investment in a downside scenario.

Legacy Securities Program (securities tied to residential & commercial real estate and consumer credit).

The goal of this program is to restart the market for legacy securities, allowing banks and other financial institutions to free up capital and stimulate credit flow. Price discovery will also reduce the uncertainty surrounding pricing of these legacy securities held by other financial institutions. My opinion is that this is not true price discovery, primarily due to the non-recourse nature of leverage implemented, which will engender considerably more reckless risk taking due to the warping of the naturally occurring risk/reward curve!


The Legacy Securities Program consists of two related parts to draw private capital.

o Providing debt financing from the Federal Reserve under the Term Asset-Backed Securities Loan Facility (TALF). Non-recourse loans will be made available to investors to fund purchases of legacy securitization assets. Eligible assets are expected to include certain non-agency RMBS that were "originally" rated AAA (read as distressed and most likely sloppily underwritten) and outstanding CMBS and ABS that "are" rated AAA. Duration of loans, lending rates and minimum loan size are yet to be determined.

o Match private capital being raised for dedicated funds targeting legacy securities. Treasury will approve up to five asset managers with a demonstrated track record of purchasing legacy assets who would be provided a time frame to raise capital and matching capital would be contributed by the Treasury. Asset managers could also subscribe for senior debt for the Public-Private Investment Fund from the Treasury Department in the amount of 50% (100% in certain cases) of total equity capital of the fund. Thus Manager could manage as far as $4 of assets for every dollar raised (max out at 4:1 leverage).

Our take on the plan

Private investors under Legacy Loan Program have huge downside risk: The position of private investors is similar to an equity tranche in a CDO. These private investors could enjoy huge upside returns on back of massive leverage as high as 13:1, (6:1 is the leverage for fund of which Treasury would contribute 50% of capital) but however they would be the 1st to bear the loss in the event of further losses. These further losses are imminent, in my (and our) view (see the real estate review in the following post).

The very fact that a bank is willing to sell its legacy assets at a discount underscores the potential risk inherent in those securities. We believe prudent institutional investors would be reluctant to be in an equity tranche position in such high risk securities.Then again, I have overestimated the prowess and prudence of institutional investors in the past.

Potential demand for distressed assets in a zero sum game: The success of the plan to a great extent depends upon risk appetite of plan participants towards distressed securities. Despite the fact that there are huge upside potential for these legacy assets, private investors' would have no methodology to determine what prices to bid for these securities since aggressive pricing to buy assets could significantly reduce returns and even result in losses since the underlying assets of these are plunging rapidly. On the contrary conservative price bidding could force massive wave of write-downs for other banks and financial institutions. This seems like zero-sum game where gains of financial institutions at private investors expense and vice-versa.

Willingness of banks to participate in the program and undertake mark-to-mark write downs

There is no incentive for banks to participate in the program unless and until they require immediate capital. Banks which have already taken huge write-downs (ex. the ex-investment banks) would be better off holding these assets until maturity. On other hand banks which have been conservative on their asset write-downs (ex., the Doo Doo 32) would be reluctant to sell their legacy assets under the plan because that would significantly increase the mark-downs.

Risk of overpayment for legacy assets

Guidelines: An independent valuation firm will provide valuation advice to inform the Legacy Loans Program in its bidder selection. Also as mentioned earlier PPIF leverage would be limited to 6:1 based upon analyses performed by the FDIC with input from a Third Party Valuation Firm

We believe that since the first loss is being borne by private investors there would be no incentive to overbid. The price determination is by auction process so market forces could enforce a better price stability than determined by Treasury alone.

Huge downside loss do not justify the potential risk: If one were to simply run the numbers in a simple spreadsheet, you will see that although there is the potential for significant upside, the risk is not trivial.

Sample Investment under the Legacy Loans Program

value of pool of mortgages
Price determined by auction 84.0 <--Be aware that the lower this number, the greater the
capital hit to the selling bank!
Debt-Equity ratio 6.0
Debt FDIC Guaranty 72.0
Equity by private investor 6.0
Equity by treasury 6.0
Interest on FDIC Debt 4.0%
Discount Face Value by X% 2.2%
$ Gian
Interest on FDIC debt Gain to equity investor Gain / loss to Private investor* % return
Actual Value
Face value $100.00 $16.00 $2.88 $13.12 $6.56 109.3 %
97.8% discount on FV $97.80 $13.80 $2.88 $10.92 $5.46 91.0 %
95.6% discount on FV $95.65 $11.65 $2.88 $8.77 $4.38 73.1 %
93.5% discount on FV $93.54 $9.54 $2.88 $6.66 $3.33 55.5 %
91.5% discount on FV $91.49 $7.49 $2.88 $4.61 $2.30 38.4 %
89.5% discount on FV $89.47 $5.47 $2.88 $2.59 $1.30 21.6 %
87.5% discount on FV $87.51 $3.51 $2.88 $0.63 $0.31 5.2 %
85.6% discount on FV $85.58 $1.58 $2.88 ($1.30) ($1.30) (21.7)%
83.7% discount on FV $83.70 ($0.30) $2.88 ($3.18) ($3.18) (53.0)%
81.9% discount on FV $81.86 ($2.14) $2.88 ($5.02) ($5.02) (83.7)%
80.1% discount on FV $80.06 ($3.94) $2.88 ($6.82) ($6.00) (100.0)%

*Assuming gains are shared on proportionate basis to investment

As seen in the table above the downside risk does not justify the risk undertaken by the prudent investor.The risk/reward profile here happens to be very similar to the equity tranches of the CDO's that blew up last year. We have seen many of those equity tranche investors take 100% losses. After taking an empirical look at the program, I now see why the non-recourse sweetener and excessive leverage had to be added, but the fact still remains that the existence of this highly favorable financing distorts price discovery. If it is an unfavorable risk/reward ratio with near free money that you don't have to pay back, just imagine what the natural pricing would look like without these extra-market incentives!!! For those who want to play with their own assumptions, simply register for a free membership at BoomBustBlog and download the model that created the table above -
pdf Quick and Clean Public Private Partnership Risk/Return Model 2009-03-24 09:57:27 57.50 Kb .

Potential Impact on Banks and Insurers

  • Plan could lead to considerable write-downs of assets particularly for those banks and financial institutions who have been conservative in their write-downs in case the securities price determined is considerably less than current valuations. This is most likely where Geithner is planing to plug in the stress testing and the forced capital injection program from the TARP. I believe that many of the insurers, asset managers and regional banks covered in BoomBustBlog have a ways to go in writing down their assets (see topics: Insurers and Insurance, Commercial Banks, and Financial Services).
  • According to estimates, banks are currently holding at least $2 trillion in troubled assets, mostly residential and commercial mortgages. If successful the plan could considerably help banks to transfer their toxic assets and free up their capital. The plan currently plans to buy $500 billion of assets with potential to increase to $1 trillion.

I will follow up on this tomorrow, with further analysis and opinion, and will continue with an update on real estate value trends (undoubtedly extremely negative). For all who do not realize, downward real estate price trends will considerably distress, further, the most of the assets at the base of the PPIP program.

For those who are not members of the BoomBustBlog, I have detailed this crisis from the beginning in what is now a 36 part series:

Recommended Global Macro Reading:

  1. China Macro Update
  2. Debt - Thoughts On A Global Problem (Part 1),

  3. Banking out of Control (Part 2)
  4. Global Debt Stats (Part 3)

Recommended Reading - The Asset Securitization Crisis:

  1. Intro:
    The great housing bull run - creation of asset bubble, Declining
    lending standards, lax underwriting activities increased the bubble - A
    comparison with the same during the S&L crisis
  2. Securitization - dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble - declining home prices and rising foreclosure
  3. Counterparty risk analyses - counter-party failure will open up another Pandora's box (must read for anyone who is not a CDS specialist)
  4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
  5. Municipal bond market and the securitization crisis - part I
  6. Municipal bond market and the securitization crisis - part 2 (should be read by whoever is not a muni expert - this newsbyte may be worth reading as well)
  7. An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital, PNC addendum Posts One and Two
  8. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux
  9. More on the banking backdrop, we've never had so many loans!
  10. As I see it, these 32 banks and thrifts are in deep doo-doo!
  11. A little more on HELOCs, 2nd lien loans and rose colored glasses
  12. Will Countywide cause the next shoe to drop?
  13. Capital, Leverage and Loss in the Banking System
  14. Doo-Doo bank drill down, part 1 - Wells Fargo
  15. Doo-Doo Bank 32 drill down: Part 2 - Popular
  16. Doo-Doo Bank 32 drill down: Part 3 - SunTrust Bank
  17. The Anatomy of a Sick Bank!
  18. Doo Doo Bank 32 Drill Down 1.5: Wells Fargo Bank
  19. GE: The Uber Bank???
  20. Sun Trust Forensic Analysis
  21. Goldman Sachs Snapshot: Risk vs. Reward vs. Reputations on the Street
  22. Goldman Sachs Forensic Analysis
  23. American Express: When the best of the best start with the shenanigans, what does that mean for the rest..
  24. Part one of three of my opinion of HSBC and the macro factors affecting it
  25. The Big Bank Bust
  26. Continued Deterioration in Global Lending, Government Intervention in Free Markets
  27. The Butterfly is released!
  28. Global Recession - an economic reality
  29. The Banking Backdrop for 2009
  30. Reggie Middleton on the Irish Macro Outlook
Last modified on Tuesday, 24 March 2009 00:00


  • Comment Link jpmeia Thursday, 26 March 2009 11:14 posted by jpmeia


    Have also been eying PRU, short-term plays since it seems to have 9+ lives

  • Comment Link NDbadger Thursday, 26 March 2009 08:08 posted by NDbadger

    The TARP is almost completely dry now.

  • Comment Link phirang Thursday, 26 March 2009 07:38 posted by phirang

    I've gone short PRU since it ripped recently, and I've to tell you, of any insurer out there, PRU is most exposed to this: they own a TON of RE. I think they're the 3rd largest owner of RE in the US, actually!

  • Comment Link EGRP Thursday, 26 March 2009 00:13 posted by EGRP

    The TARP at $800 billion basically covers three months of decline in exposed mortgages. See the math below. As long as real estate continues its free fall, the Keystone's cops rescue plans du jour will never catch up with it.

    100,000,000 Homes
    75&#xPo;rtion with mortgages
    75,000,000 Homes with mortgages
    30,000,000 40% of homes bought since 2000 exposed to walk aways

    $275,000 Average value

    3&#xMo;nthly decline in value (Case Schiller)

    $8,250 Per home

    $247,500,000,000 Monthly decline in exposed homes

    $800 billion TARP last Sept covers three months of equity declines

  • Comment Link greenja1 Wednesday, 25 March 2009 22:56 posted by greenja1

    Um, There is a SERIOUS Bond market dislocation upon us. This doesn't feel very good. Any ideas of the ramifications of this? Rally killer?

    Bond Market To Bernanke and Obama: F&$k You

    Good luck Ben:

    NEW YORK (AP) -- Stocks lost ground after a weak auction of U.S. government debt stirred worries about how easily Washington will be able to raise money to fund its economic rescue program.

    Investors gave an unexpectedly cool response to a $24 billion auction of 5-year Treasury notes Wednesday, which also sent prices for Treasurys lower.

    You wouldn't think that would happen on the day that Ben came into the market to buy Treasuries, but it did. Ben had roughly three times the amount he took submitted to him: SOLD TO YOU BEN, and oh by the way, we're not interested in buying any more of this trash either!

    Worse, indirect bidding (foreign interest) essentially collapsed, down by some 50% from last month.

    As if that's not bad enough the BOE (England) actually had a failed Gilt auction, with insufficient bids for the amount pushed out.

    That's coming to America and soon Ben.

    I and a few other astute people who actually believe the market is bigger than any loudmouth with a title (like Bernanke) tried to warn both him and our President that neither of them are capable of forcing people to buy that which they do not wish to buy or fund.

    Well Ben?

    When I wrote my Ticker from this morning, which I actually penned last night, I had no clue that the first piece of this dislocation was going to happen today.

    It did.

    Ben came into the market and bought Treasuries today, and in response yields moved.... up?

    Oh, and the stock market sold off hard too, down some three hundred DOW points from where it was before these bond "operations."

    A blunt, clear warning was issued by the market today Mr. President and Mr. Fed:

    Cut that crap about "borrow and spend", along with playing "circle jerk" and "I'm gonna threaten to print money!" out right here and now, or run the risk of the Treasury market imploding in your face, taking what is left of the American economy and our capital markets with it.

    Are you listening to investors both here and abroad Mr. Obama and Mr. Bernanke?

    You can't force China, Japan and Saudi Arabia to buy our debt. You can only ask, and the results of the bond auction today makes clear that their answer so far can best be described as "Bite Me!"

  • Comment Link NDbadger Wednesday, 25 March 2009 21:56 posted by NDbadger

    payday may come soon:


  • Comment Link NDbadger Wednesday, 25 March 2009 21:25 posted by NDbadger

    does anyone know: did the fundamentals change on MKL or are we just getting another great opportunity?

  • Comment Link NDbadger Wednesday, 25 March 2009 21:16 posted by NDbadger

    The FT doesn't even think the toxic asset plan will happen:


  • Comment Link NDbadger Wednesday, 25 March 2009 15:51 posted by NDbadger

    it's just a shell game. they also say FDIC is going to fund the loan. this implies that the healthy banks (read small community) are going to pay the tab for the big banks, but don't you think the small banks have their lobbyists in there that will push the bill on to the taxpayer.

  • Comment Link Jeff S Wednesday, 25 March 2009 15:25 posted by Jeff S

    Am I mistaken in that the "Treasury Equity" is being funded by the remaining TARP balance? If so, is this not a deceptive title in that this "Equity" is really no different than the additional PPIP funds, and therefore, should be classified as "Debt?" And if so, does this not make the leverage ratio 14:1 (84/6) and not the stated 6:1?

    Me thinks we are being lied to again. But I could be wrong.

    Please advise...

  • Comment Link squashnut Wednesday, 25 March 2009 14:55 posted by squashnut

    OT sorry:
    GS is saying they're selling some of their stake in ICBC to raise cash to pay back TARP.
    Does anyone believe them or is it "stress"?

  • Comment Link NDbadger Wednesday, 25 March 2009 14:05 posted by NDbadger

    you know, this could turn out to be very bad for the banks. If the banks are unable to game it, the auctions could reveal prices well below banks' marks, despite the incentives to come up with a price higher than a competitive market would dictate. If so, banks might be forced to take the marks and would instantly become insolvent.

  • Comment Link phronesis Wednesday, 25 March 2009 12:47 posted by phronesis

    Interesting chart posted on Market Ticker this morning


    Claimed loan portfolio values by bank.

  • Comment Link jpmeia Wednesday, 25 March 2009 11:57 posted by jpmeia

    @Jim Schoenbeck, March 24, 2009,

    AND you get all the cash flow as well...

  • Comment Link reachsb Wednesday, 25 March 2009 11:41 posted by reachsb

    Another ponzi scheme. Exposure to US Taxpayers - 94%. Cost to Common Stock holders/Bond Holders - 0%. Too much ink has been spent analyzing the finer details of the PPIP. But IMHO, the folks are looking at the wrong picture. What if the private money is completely okay with over-bidding on these useless toxic assets and make money by cashing out of the bank stocks/options (that they have been hoarding till now). The maximum loss to these folks for purchasing these worthless assets is only 6% (with unlimited profits from the bank stock sales). My suspicion was confirmed by these 2 articles:



    The end-game will be that the tax-payers will be saddled with a bunch of these worthless assets and the notion of the FDIC's relative stability will be permanently impaired. Down that road lies a massive run on all the US based banks. Time to petition Congress folks.

    Show me a plan that entails losses for stock-holders and bond-holders before deploying taxpayers' money and I will seriously consider it.

  • Comment Link greenja1 Wednesday, 25 March 2009 10:01 posted by greenja1


  • Comment Link tradingbr Wednesday, 25 March 2009 07:33 posted by tradingbr

    This program will decrease long-term US banks capital
    this rally is absurd, people really know what the banks are getting here

  • Comment Link fedwatcher Wednesday, 25 March 2009 05:49 posted by fedwatcher

    There are few qualified people available to analyze these assets. But they do exist for rates of $5,000 per day. They will benefit greatly by this program. The lack of qualified people will slow the process, but their is value in many of these assets.

    The process is made more difficult in that the mortgages in the pools are widely distributed geographicly. This was to give them greater value under the assumption that real estate does not decline everywhere at the same time. That assumption has been proven to be false. But it also makes the analysis of these packages much more difficult in that many real estate markets need to be analyzed.

    The PPIP will test the availability of real bankers to analyze the potential recovery in an uncertain markets. Many of those people left banking in the 1990's and will not be available for the task ahead.

  • Comment Link Maximus Wednesday, 25 March 2009 03:14 posted by Maximus

    Please review this piece from ZERO HEDGE and share your thoughts

    go to


    and click on the link for the TALF BAIT AND SWITCH from ZERO HEDGE under the BEST for March 23....

    --if you have already seen it I apologize, but with your analysis showing many good reasons why the plan will not be effective, it seems like there might be another route that will ensure profitability while getting these off the banks books....

    Looking forward to your reply....


  • Comment Link NDbadger Wednesday, 25 March 2009 00:46 posted by NDbadger

    I was surprised to read Roubini is favorable on the Geithner plan. I think Stiglitz has it right. I don't think you get true price discovery, and it is far too easy to game. And the plan puts the taxpayer at far too much risk with little upside for the taxpayer. But Roubini thinks the plan is to just use it for the solvent institutions with problem assets on their books, as revealed by the stress tests. I think Geithner is going to call everything a solvent institution. Like when Bernanke said AIG & C weren't Zombies.

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