PPIP for Community Banks?

The Wall Street Journal had a front page article today on the PPIP, analyzing why it has failed to get off the ground and suggesting that the failure was thwarting efforts to help smaller banks.

As you probably recall the PPIP was originally going to attack two problems. Legacy securities and legacy loans at banks. The idea was that due to the large bid-ask spread for these assets the federal government would provide outside buyers with financing that would allow them to place a higher bid for the assets and with the help of the government’s low cost leverage provide an adequate ROI. The hope was that the spread would narrow enough to induce the banks to sell.

Before the program got into any gear, the big banks’ fortunes turned for the better as first quarter profits were substantial and they were able to tap the equity and debt markets for substantial amounts of funds. This led most of them to lose interest in the program and it’s pretty much foundered ever since.

The legacy loan program seems to be on hold permanently and the legacy securities part of the program is still alive according to the Treasury but no one has yet to see anything concrete. It’s doubtful that the banks are going to play with any program to sell residential mortgage securities to partnerships under the PPIP but they might need to unload some commercial mortgages.

But let’s go back to the legacy loan part of the program. Here is how the Journal describes its status:

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.

Next month, the FDIC intends to use PPIP for a far narrower purpose: to auction loans the agency has seized from failed banks. Eventually, it hopes to resuscitate the loan-buying program so that smaller banks can benefit from it.

But that could be tricky. The U.S. initially justified PPIP by invoking its “systemic risk” powers, which enable regulators to step in when the financial system is at risk. Regulators have debated whether such a justification would remain if the program were geared toward smaller banks. FDIC officials doubt they will muster the necessary consensus among regulators to invoke the special powers and keep the loan program alive, according to a person familiar with the matter.

Many banking experts contend that the financial system won’t fully stabilize until banks get rid of their bad assets.

Mr. Segal, the bank adviser, complains that federal officials have cited recent capital raising by big banks as evidence that “the system is OK.” That may be true “for the top 15 or 20 banks,” he says. “But for everybody else, there really needs to be more attention paid.”

And this is where I start to become somewhat confused. If memory serves me correctly, the PPIP was set up as an emergency measure to be complimentary to other efforts being undertaken to recapitalize a bunch of too big to fail banks. Because of the systemic risk that they presented, a trillion dollars or more was to be put to work through this program to rid them of toxic assets and thus shore up their regulatory ratios. The country was asked and agreed to hold its collective nose and bailout of the shareholders and creditors of a select group of financial institutions.

Now, there appears to be some intent or at least discussion of extending that same bailout to smaller institutions that aren’t too big to fail, that don’t pose a systemic risk in even the broadest use of the term. I take some comfort from the statements in the Journal article that the FDIC feels it might have a problem convincing other regulators that they have the authority to extend the program to smaller banks but the mere fact that the subject is on the table is troubling.

Frankly, I think it’s time to just get on with resolving the smaller banks. The experience of the S&L days was that you could keep them alive with regulatory forbearance forever but they didn’t heal, the wounds just kept festering and sooner or later the infection took over the body and killed it. Once the government accepted this fact, they started closing them down, aggregating the assets and selling them through the RTC. It worked so what’s the mystery.

There isn’t really any cogent argument that can be made in favor of putting additional taxpayer money at risk through the PPIP in the hope that will save a bunch of banks that are of no material importance to the larger economy. If that should occur, it would represent an inexcusable bailout of private investors for no good reason. The PPIP is a program in search of a cause. It’s a regulators toy and ought to be retired forthwith.

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