Who Killed the Public-Private Investment Program?

Earlier in the week, I wrote about my skepticism regarding banks no longer needing the Public-Private Investment Program (PPIP). Ezra Klein seems to be skeptical as well. But he also claims that the program failed, not because the Treasury decided it was no longer necessary, but because banks refused to participate. I don't agree with his logic

Just for some context, Klein is writing about a good post by James Kwak over on the Baseline Scenario. In that post Kwak explains how the government has vacillated between the assets and liabilities/equity sides of banks balance sheets in their rescue attempts. The latest attempt, the PPIP, tries to heal the assets side, as it would allow banks to get rid of their toxic securities.

After quoting a portion of Kwak's piece, Klein says:

I'd amend Kwak's final line a bit: The argument is that as long as the economy keeps improving and the banks can continue raising capital, everything is fine, no matter how many toxic assets the banks hold. And that may be true!

And I agree. But then:

But it continues to be the case that the PPIP plan fell apart not because the Treasury Department decided it was unnecessary but because the banks, which were suddenly flush with fresh capital, refused to participate in it.

Let's think about this. First, the Treasury gave the banks stress tests. Some banks passed; some banks needed more capital. Once that capital is raised, the Treasury is essentially saying, "Okay Generic-Bank, you've reached the capital level we require to deem you safe."

You can question whether those capital levels are truly safe or not. I question that too. But this certainly sends a signal to the market that the government is comfortable with capital levels. And that's a strong vote of confidence. If the bank still had problems after raising that capital, it would have a pretty strong case for going back to Uncle Sam, hat-in-hand, saying: "But you said we'd be okay! Since you were wrong, please bail us out again." Having set those capital requirements killed the PPIP.

Moreover, let's go back to that quote I had from Sheila Bair in that post from earlier in the week, from the WSJ article I source:

Earlier this month, the FDIC formally postponed the loan-buying portion of PPIP, called the Legacy Loan Program. "Banks have been able to raise capital without having to sell bad assets through the LLP, which reflects renewed investor confidence in our banking system," Ms. Bair said.

How can you make the claim that the government didn't kill the program, when you have the head of the FDIC saying exactly that? It's true that banks probably were not so interested in participating, but again, that's because the government first deemed them safe, based on obtaining the capital needed according to the stress tests.

Noam Scheiber over at the New Republic quotes an insider who confirms that the Treasury did not much mind killing the program, given enhanced bank capital levels:

If you had asked--I don't want to speak for the secretary--what's problem number one? I think he'd say capital. Problem two? Capital. Problem three? Capital. Everything was in the service of that view. The legacy loans program was meant to help clean balance sheets. It was not an independent good in itself. It was seen as friendly to equity raising. Now people say the legacy loans thing is not gaining as much traction, so is that a failure? But because we had a good outcome in terms of raising equity, they [the banks] were able to raise equity without shedding assets ... you should be okay with that.

In other words, the Treasury had always been most concerned with capital. Now that they're more comfortable, they're not as concerned with the PPIP going ahead. Banks probably don't want to participate as much now either -- that's true for sure. But their reasoning is the same as the Treasury's: they're happier with their balance sheet due to their new capital levels.

If the banks played any parting killing the program, it was in conjunction with the Treasury. It provided the capital requirement framework through the stress tests and adheres to the same capital-driven philosophy.