"The Greatest Program That Never Occurred"

One of Treasury Secretary Timothy Geithner's chief duties when he took the job was to solve banks' toxic assets problem. His solution: The Public-Private Investment Program ("PPIP"). The program was unveiled on March 23rd. Over three months later, part has been scrapped, and none of it has gotten off the ground. An article from the Wall Street Journal today implies that it might not have needed to.

The PPIP came with a lot of baggage. Banks were worried selling their securities at a discount would further weaken their capital base. Investors were scared to participate and possibly come under government scrutiny ala the TARP banks. The plan itself came under fire because it did not seem to treat small banks and investors the same as large ones.

One half of the program -- the Legacy Loan Program ("LLP") -- was meant to relieve banks of troubled real estate loans. These assets are very hard to value; some are just plots of land in bad real estate markets. Earlier in the month, the FDIC announced that this part of the program is on hold, indefinitely.

Then there's the other part of the PPIP -- the part that is supposed to help banks sell their toxic securities, like ugly mortgage-backed securities. That's also still simmering on low heat. Applications have been submitted, but a security has yet to change hands through the program.

Could this be okay? Maybe the program has done its job -- without even getting started.

The banks bad assets were something of a problem for their own sake, but they were a bigger problem in banks' efforts to raise capital. Investors did not want to touch banks' equity because they were unsure how much all the toxic assets were worth. That was then. Now that banks of been raising capital, is the PPIP even necessary?

The FDIC portion was put on hold for exactly this reason, according to FDIC Chairman Sheila Bair. From the WSJ:

"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.

She's not the only one who feels this way. The WSJ also quotes a Goldman banker:

Scott Romanoff, a Goldman Sachs Group Inc. managing director, has referred to the current effort, PPIP, as "the greatest program that never occurred," because it "created confidence in the markets so banks can raise equity capital."

Here's a graph of that confidence, from the WSJ article:


Could the government merely declaring that it had an idea for a program to relieve banks balance sheets of these problem assets have been enough?

I'm not entirely convinced. First, if the market realizes that the program is entirely abandoned, wouldn't that damage the newfound confidence? Sure, some banks have gotten capital already. But this revelation might drive back down stock prices for these banks, since those stock prices probably reflect some nonzero probability that banks will benefit from the PPIP program.

And what about those banks who haven't raised capital? Without the PPIP program, they will continue to have difficulty doing so. I would imagine that a lot more failures will occur if the program never materializes. Of course, some more resolved banks might not be a bad thing if they are beyond repair anyway.