Here it is! Details on Public Private Partnership Investment Program There's no real surprises here. It is very similar to the plan that started leaking out at the beginning of the month. The plan deals with problem loans and problem securities. The government combination of the Federal Reserve, FDIC and Treasury will be providing capital and financing to both loans and securities. Both asset types will receive generous financing in the form of low interest rates and amount of leverage that can be utilized by the purchaser. It's all there in the release. The purchase of securities will have a two pronged approach. The Federal Reserve's Term Asset Backed Security Lending Facility(TALF) will be expanded to provide financing for the purchase of securities on a non-recourse basis. Additionally, there will be a public/private partnership wherebye five large money managers (the same guys who are currently running the Fed and Treasury's other $multi-trillion programs....PIMCO, BlackRock, GSAM...etc..) will invest on a leveraged basis (also non-recourse funding) and share dollar for dollar with Treasury regarding capital investment.)
The troubled loans will be handled the following way;
Legacy Loans - 1)banks will decide which assets – usually a pool of loans – they would like to sell. 2)The FDIC will conduct an auction for these pools of loans. The highest bidder will have access to the Public-Private Investment Program to fund 50 percent of the equity requirement of their purchase. 3)If the seller accepts the purchase price, the buyer would receive financing by issuing debt guaranteed by the FDIC. The FDIC-guaranteed debt would be collateralized by the purchased assets 4)Once the assets have been sold, private fund managers will control and manage the assets until final liquidation, subject to strict FDIC oversight.
At the end of the day, it's all about the non-recourse funding. Let's review how that works;
- Hedge Fund buys security at a price of 60-00
- Fed Lends Hedge Fund 50% or 30-00
- Treasury provides back up capital to allow for non-recourse funding
- Hedge Fund as $30 invested. If the security declines to a price lower than 30-00 hedge fund has lost the maximum it can lose. Treasury is now on the hook for the remaining 30 points of potential price decline.
- Does that sound like Treasury wrote a "put option" on the security for the hedge fund? It should.
It all comes back to pricing. It has been about pricing since since this circus started in October.
How do you determine what the "haircut" is on a problem loan or a problem security? If you're the government odds are that you can't. Hedge funds make money by buying options cheap and by selling them expensive. The government, in the interest of not forcing banks to sell these assets at market, is writing options on the securities and we the taxpayer are the weak hand sellers.
Think about it. You take a AAA rated senior subprime security and you show it to the hundreds of investors (the ones that the President and the Treasury Secretary say do not exist) and they bid around 35-00. The bank selling the security has it marked at 70-00. The bank and the government do not want that bank to sell at 35-00 and take a 50% writedown. So they say to the hedge fund;
"How about we offer you 50% financing with a term equal to the maturity of the security with a rate of Libor flat. And the loan is non-recourse. Would you pay 70-00 then?
"No" (meanwhile the hedge fund has come up with the amount of non-recourse financing he needs to make paying a price of 70-00 with the financing package BETTER than if he just bought the security without the financing and put option at 35-00.)
"How about 60% financing?"
"How about you give me that term funding at Libor flat...and you fund 70% of the purchase price? Then I will gladly pay you 70-00 for the security."
"Sold to you! Thank you Mr. Hedge Fund."
The hedge fund just committed 21-00 of capital (30% of 70-00 purchase price). He has all the upside of the security and downside limited to a 21 point loss on the security. He is happy, the bank is happy, the government is happy and we, the taxpayer have even LESS transparency than we had before....which is amazing considering this whole deal has been about as "transparent" as "The Black Lagoon"!