PPIP: Bad, Maybe, But Not THAT bad

Tom Bozzo

I’ve been hearing about various potential schemes to game the PPIP, and Jeffrey Sachs gets in on the action with a pure self-dealing scenario (via Americablog):

Here’s how. Consider a toxic asset held by Citibank with a face value of $1 million, but with zero probability of any payout and therefore with a zero market value. An outside bidder would not pay anything for such an asset. All of the previous articles consider the case of true outside bidders.

Suppose, however, that Citibank itself sets up a Citibank Public-Private Investment Fund (CPPIF) under the Geithner-Summers plan. The CPPIF will bid the full face value of $1 million for the worthless asset, because it can borrow $850K from the FDIC, and get $75K from the Treasury, to make the purchase! Citibank will only have to put in $75K of the total.

Did Sachs read the PPIP Legacy Securities term sheet [PDF] before writing that? [Though see the addendum below.] That sort of transaction appears to be forbidden under the ‘Governance and Management’ section of the summary terms:

A Fund Manager may not, directly or indirectly, acquire Eligible Assets from or sell Eligible Assets to its affiliates, any other Fund or any private investor that has committed 10% or more of the aggregate private capital raised by the Fund. Private investors may not be informed of potential acquisitions of specific Eligible Assets prior to acquisition.

Geithner and Summers may or not be the poster children for ‘regulatory capture,’ but they’re not stupid. (For that matter, Sachs’s scenario presumes that only Citi can detect the underlying worthlessness of the asset, so FDIC will permit the maximum leverage under the program.)

There are also some more complicated scenarios that use secret deals and kickback schemes to get around the anti-self-dealing provisions of the PPIP. For now, I would judge those to represent descriptions of serious frauds rather characterizations of actual PPIP loopholes. Such time as Treasury (or DOJ) is caught playing see-no-evil with those, then there may be something more than an attempt to pile on.

This is not at all to say that there are not serious and valid concerns regarding PPIP design. Among other things, I’d be much happier if I saw the likes of Larry Ausubel and Peter Cramton hired to ensure that the private managers effectively compete for the public subsidies and do not overpay relative to some reasonable assessment of fundamental (not necessarily ‘market’) asset values.

Added: The anti-self-dealing terms from the Legacy Securities program, quoted above, are from a 4/6 revision of the term sheet (thanks to KHarris for pointing that out) and may have crossed paths with Sachs’s article (also of 4/6); they’re a little different from the Legacy Loans terms sheet where a prohibition on self-dealing has been a feature all the time. Here’s the original (and apparently current) language for the Legacy Loans sheet:

Private Investors may not participate in any PPIF that purchases assets from sellers that are affiliates of such investors or that represent 10% or more of the aggregate private capital in the PPIF.

It would take a lawyer to determine how this compares to the Legacy Securities terms. The ban on communication prior to asset sales looks new and makes it clear that schemes to coordinate Legacy Securities sales with purchasers are improper.

An issue with many of these critiques is that they seem to combine elements of the two programs. Sachs’s example is based on leverage ratios allowed under the Legacy Loans program but not Legacy Securities, in which case other Legacy Loans program terms should apply.