The Public-Private Investment Program Isn't Dead

Despite what you may have read, the Treasury's Public-Private Investment Program (PPIP) is falling into place, according to Bloomberg. Geithner may be gloating. The ten asset managers have been selected, and we will learn their names later this week. Bloomberg says that Blackrock, Invesco, and Wellington are among the chosen. That's not surprising. What will be surprising is if they actually have much to buy.

Here's some more useful detail from the Bloomberg article:

PPIP will start with about $20 billion, half raised by the money managers and half from the Treasury, people familiar with the plan said last week. The firms will have access to $10 billion in financing backed by the government. That will enable money managers to offer enough to persuade banks to sell their troubled assets, said Wilbur Ross, chairman and chief executive officer of WL Ross & Co., the New York-based Invesco subsidiary that will lead that company's PPIP efforts.

Will it? Because I'm not convinced. Now that many banks are more comfortable with their capital levels, it's a little unclear to me that they'd bother participating. Here's why I could be wrong, also from Ross via Bloomberg:

"Because of the very favorable leverage, we'll be able to pay between 5 and 10 percentage points closer to par than we would have been able to without PPIP," he said yesterday in an interview with the CNBC television network.

The question then becomes: will that 5 to 10 percentage points be enough? I suspect it will be a case-by-case situation. It depends on two factors.

Where Those Assets Are Currently Marked

In the event that bids come in for these assets that actually exceed where they are marked, banks might accept. The fact that I just said "might accept" should be noted. A lot of these assets have already been marked way down, due to fire sale prices in the market. If a bank is well-capitalized and believes these assets are worth a lot more than what their mark indicates, then even the bids from PPIP asset managers might not measure up to the bank's internal valuation for holding the assets to maturity.

A Loss Banks Can Stomach

But not all banks have been marking down these securities as low as they probably should be. As a result, I'd expect that some bids will come in lower than where they're marked. Again, if banks have adequate capital levels, then they probably won't be too eager to sell their assets for much of a loss -- unless their internal valuations predict an even lower ultimate value. I find that generally unlikely, however, as the hold-to-maturity value of these securities almost certainly exceeds the market value, where they should be marked.

But it isn't all bad news. For those banks whose capital is not as solid, getting rid of these bad assets still provides a great opportunity -- assuming they don't have to realize large losses to sell them. As a result, the program could be particularly attractive to smaller banks that might not have scrounged up as much new equity.

Of course, if they're smaller banks, they probably hold less of these securities. The government has also made clear the largest banks that likely hold more of these securities are too big to fail. With their safety ensured by Uncle Sam, I'm not sure why they'd bother settling for market value when they can gain more by holding to maturity.

I predict that the smaller banks will be the most likely to participate for the reasoning explained. Since small bank interest will probably drive the PPIP, unless a huge number participate, I think the size of the program is likely to be much smaller than originally anticipated. Could it reach $50 or even $100 billion? Possibly. Will it come anywhere close to its "potential to expand to $1 trillion over time?" Don't count on it.