Thursday, July 2, 2009

PPIP May Have Succeeded Before It Was Ever Launched

Although the Public-Private Investment Program may never launch with its promised luster, it may have already achieved its goal. An interesting article by Noam Scheiber suggests that the idea of PPIP may have improved Wall Street's spirits enough to allow banks to raise private capital on their own. Mark Thoma from Economist's View discusses this in the following post.

The Treasury view, Free Exchange: ...Noam Scheiber has a nice post up examining the view of PPIP—the plan to sell subsidised toxic assets at auction—from inside the Treasury. Here's a quote from a Treasury official:

...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, [the banks] were able to raise equity without shedding assets ... you should be okay with that.

Mr Scheiber also reprints a quote from a Goldman Sachs employee, originally in the Wall Street Journal, noting that PPIP is "the greatest program that never occurred... [because it] created confidence in the markets so banks can raise equity capital".

I don't know that I buy the Treasury spin—that they saw that banks needed more capital than the government could provide, and so they crafted an incredibly generous asset purchase plan understanding that it would boost Wall Street spirits, allowing banks to raise private capital and thereby making actual deployment of the plan unnecessary. Remember just how dire things appeared at the time of the plan's construction, and recall how many defenders of the plan—myself included—argued that there were no other options with tolerable risk levels available. Meanwhile, it's not clear that PPIP (as opposed to other interventions or the natural resolution of the crisis) had anything to do with the market's rebound, which began well after the initial description of the administration's proposal and well before the release of key programme details.

Which isn't to say that no one in the administration foresaw this possibility or planned for it. I would argue, however, that the current state of affairs was not really the expected outcome, and that the banking plan benefitted enormously from events outside of Treasury's control.

I don't disagree with that. But if it's true that the plan inspired confidence, intended or not, and that caused private investors to put capital into these institutions based upon the assumption that the banks would be made healthier by ridding themselves of toxicity through the PPIP, and now the government says "just kidding," isn't that a double-cross? Would the private investors have still put capital into the banks had they known the double-cross was coming? And if they wouldn't have, doesn't the continued presence of these assets on the books mean there's more risk present than we ought to be comfortable with?

This article was republished from Mark Thoma's blog, Economist's View.

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