Public–Private Investment Program for Legacy Assets

The Public–Private Investment Program for Legacy Assets was a financial program announced on March 23, 2009 by the United States Federal Deposit Insurance Corporation (FDIC), the Federal Reserve, and the United States Treasury Department, designed to provide liquidity for so-called "toxic assets" on the balance sheets of financial institutions. It was one of the initiatives launched as part of the Troubled Asset Relief Program (TARP), as implemented by the U.S. Treasury under-secretary Timothy Geithner.

The major stock market indexes in the United States rallied on the day of the announcement, rising by over six percent, with shares of bank stocks rising most.^[1] As of early June 2009, the program had not yet been implemented, and was considered delayed.^[2] The Legacy Securities Program implemented by the Federal Reserve had begun by the fall of 2009 and the Legacy Loans Program was being tested by the FDIC. The proposed size of the program was drastically reduced when rolled out, relative to its proposed size.

Operation

Using $75 to $100 billion in TARP capital and capital from private investors, the Public–Private Investment Program (P-PIP) will generate $500 billion in purchasing power to buy legacy assets with the potential to expand to $1 trillion over time.^[3] The Public–Private Investment Program will be designed around three basic principles:

Maximizing the impact of each taxpayer dollar: first, by using government financing in partnership with the FDIC and Federal Reserve and co-investment with private sector investors, substantial purchasing power will be created, making the most of taxpayer resources.
Shared risk and profits with private sector participants: second, the Public–Private Investment Program ensures that private sector participants invest alongside the taxpayer, with the private sector investors standing to lose their entire investment in a downside scenario and the taxpayer sharing in profitable returns.
Private sector price discovery: third, to reduce the likelihood that the government will overpay for these assets, private sector investors competing with one another will establish the price of the loans and securities purchased under the program.^{[citation needed]}

PPIP uses a combination of private equity and Government equity and debt through TARP to facilitate purchases of legacy mortgage-backed securities ("MBS") held by financial institutions. In July 2009, Treasury announced the selection of nine Public–Private Investment Fund ("PPIF") managers. Treasury has obligated $21.9 billion in TARP funds to the program. In January 2010, PPIP manager The TCW Group Inc. ("TCW") withdrew from the program. On April 3, 2012, PPIP manager Invesco announced it had sold all remaining securities in its portfolio and was in the process of winding up the fund. The remaining seven PPIP managers are currently purchasing investments and managing their portfolios.

According to Treasury, the purpose of the Public–Private Investment Program ("PPIP") is to purchase legacy securities from banks, insurance companies, mutual funds, pension funds, and other eligible financial institutions as defined in EESA, through PPIFs. PPIFs are partnerships, formed specifically for this program, that invest in mortgage-backed securities using equity capital from private-sector investors combined with TARP equity and debt. A private-sector fund management firm oversees each PPIF on behalf of these investors. According to Treasury, the aim of PPIP was to "restart the market for legacy securities, allowing banks and other financial institutions to free up capital and stimulate the extension of new credit." PPIP originally included a Legacy Loans subprogram that would have involved purchases of troubled legacy loans with private and Treasury equity capital, as well as an FDIC guarantee for debt financing. TARP funds were never disbursed for this subprogram.

Treasury selected nine fund management firms to establish PPIFs. One PPIP manager, The TCW Group, Inc., ("TCW") subsequently withdrew, and another PPIP manager, Invesco, announced recently that it has sold all remaining securities in its PPIP fund. Private investors and Treasury co-invested in the PPIFs to purchase legacy securities from financial institutions. The fund managers raised private-sector capital. Treasury matched the private-sector equity dollar-for-dollar and provided debt financing in the amount of the total combined equity. Each PPIP manager was also required to invest at least $20 million of its own money in the PPIF. Each PPIF is approximately 75% TARP funded. PPIP was designed as an eight-year program. PPIP managers have until 2017 to sell the assets in their portfolio. Under certain circumstances, Treasury can terminate it early or extend it for up to two additional years.

Treasury, the PPIP managers, and the private investors share PPIF profits and losses on a pro rata basis based on their limited partnership interests. Treasury also received warrants in each PPIF that give Treasury the right to receive a portion of the fund's profits that would otherwise be distributed to the private investors along with its pro rata share of program proceeds.

The PPIP portfolio, consisting of eligible securities, was valued at $21.1 billion (~$27.7 billion in 2023) as of March 31, 2012, according to a process administered by Bank of New York Mellon, acting as valuation agent. That was $600 million higher than the portfolio value at the end of the previous quarter. The portfolio value was also affected by Invesco's sale of its remaining securities in March 2012, discussed in greater detail in this section. In addition to the eligible securities, the PPIP portfolio also consists of cash assets to be used to purchase securities. The securities eligible for purchase by PPIFs ("eligible assets") are non-agency residential mortgage-backed securities ("non-agency RMBS") and commercial mortgage-backed securities ("CMBS") that meet the following criteria:

issued before January 1, 2009 (legacy)
rated when issued AAA or equivalent by two or more credit rating agencies designated as nationally recognized statistical rating organizations ("NRSROs")
secured directly by actual mortgages, leases, or other assets, not other securities (other than certain swap positions, as determined by Treasury)
located primarily in the United States (the loans and other assets that secure the non-agency RMBS and CMBS)
purchased from financial institutions that are eligible for TARP participation^[4]

Criticism

Economist and Nobel Prize winner Paul Krugman has been very critical of this program arguing the non-recourse loans lead to a hidden subsidy that will be split by asset managers, banks' shareholders and creditors. Mr. Krugman argues that this will lead to wild overbidding for assets.^[5] Yet, research into the structure of the program shows that the overbidding incentives in non-recourse loans are subtle. If there are overbidding incentives, they depend on the amount of leverage, the interest rates and guarantee fees charged by the Federal Reserve or the FDIC, respectively, and the volatility of the toxic assets.^[6] Banking analyst Meridith Whitney argues that banks will not sell bad assets at fair market values because they are reluctant to take asset write downs.^[7] Removing toxic assets would also reduce the volatility of banks' stock prices. Because stock is a call option on a firm's assets, this lost volatility will hurt the stock price of distressed banks. Therefore, such banks will only sell toxic assets at above market prices.^[8] The program has been hampered by the announcement by Standard & Poor's that many eligible assets would be downgraded by the rating agency, making them ineligible for the program. Federal Reserve of New York president William Dudley stated on June 4, 2009 that "there's a huge administrative hurdle" to implementing the program.^[2]

References

^ Andrews, Edmund L.; Dash, Eric (24 March 2009). "U.S. Expands Plan to Buy Banks' Troubled Assets". New York Times. Retrieved 12 February 2009.
^ ^a ^b Shenn, Jody (4 June 2009). "Dudley's TALF Comments Add Signs of a PPIP Stall". Bloomberg. Retrieved 9 June 2009.
^ "Fact Sheet: Public–Private Investment Program" (PDF). U.S. Treasury. 23 March 2009. Archived from the original (PDF) on 24 March 2009. Retrieved 26 March 2009.
^ "SIGTARP" (PDF). online.wsj.com. The Wall Street Journal. Retrieved 12 September 2023.
^ Paul Krugman (23 March 2009). "Geithner plan arithmetic". New York Times. Retrieved 27 March 2009.
^ Wilson, Linus (17 July 2009). "A Binomial Model of Geithner's Toxic Asset Plan". SSRN.com. SSRN 1428666. {{cite journal}}: Cite journal requires |journal= (help)
^ "Meredith Whitney: A Bad Bank Won't Save Banks". businessinsider.com. 29 January 2009. Retrieved 27 March 2009.
^ Wilson, Linus (14 February 2009). "The Put Problem with Buying Toxic Assets". SSRN 1343625.