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Who Cries For Ppip?

Ezra Klein lamented the demise of the Treasury-FDIC legacy loans program yesterday:

[T]hat doesn't just mean the loans weren't purchased. It also means they weren't priced. That, after all, was the primary virtue of the PPIP plan: The government would pay private investors (by offering them the 6:1 financing deal) to uncover the market prices for the "legacy loans." Once the market could agree on a price for these assets, it could also agree on a form of resolution for the banks -- either the assets could be sold or the institutions nationalized.

Observers suggested there were two ways for this to go. Either the assets would be priced and sold, or they wouldn't be priced because the banks wouldn't be able to sell them without blowing a hole in their balance sheets. In that scenario, the market would have proven the banks effectively insolvent, and we could respond accordingly. Hopefully, this would all happen in tandem with the stress tests, and by the end of the process we'd know two things: Whether the banks could sell their toxic loans, and whether the banks could survive the continual worsening of the economy.

In fact, we know neither.

I disagree. I think we basically know the answer to the first question, which is that most banks couldn't sell their toxic loans--at least not at a price they were willing to accept. That's a major reason why the program collapsed. As this Journal story reported back in May: "The banking industry's lobbying is meant to overcome a hurdle facing PPIP: unwillingness by banks to sell assets at steep discounts." The banks wanted to use government financing to buy their own loans as a condition for participating. The government told them no, and so the program fell apart.

As for the second question, I think we came close to answering that with the stress tests. Sure, the tests weren't perfect. You could argue that their revenue projections were too optimistic, for example. But they did provide what looks like a reasonable (actually fairly aggressive) estimate of losses over the next year-and-a-half. So it's unlikely that they're wildly off base.

More to the point, I don't take pricing per se to be as important as Ezra does. I think the question was always capital. (Though they're admittedly related.) We knew the toxic loans and securities were worth substantially less than the banks were admitting, even if we didn't know precisely how much less. The debate was whether the banks had enough additional capital to sit on them for a while and wait for them to recover.

Back in March, it didn't look like they did. The hope was that moving the toxic assets off their books would make investors more comfortable fronting the banks capital themselves. Or that, failing that, Treasury would have an easier time recapitalizing the banks once the toxic assets were off their books. But now that the banks are raising capital relatively easily on their own, neither of these things is so urgent. Which is to say, I see the demise of PPIP as partly a good thing. We're accomplishing what we were hoping it would help us accomplish. (Though there's no need to get cocky--the situation could easily deteriorate further and those legacy loans could still generate more big losses.)

P.S. Tim Fernholz has some smart thoughts here.

--Noam Scheiber