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It's All About The Capital, Baby

PH2009061703905.jpg

Noam Scheiber had a nice chat with some sources over at the Treasury Department about what happened to the loans portion of Timothy Geithner's Public-Private Investment Partnership (PPIP) program. The answer? The program was meant to raise capital. If the banks are raising capital on their own, then there's no need for it. As one insider told Noam, "If you had asked -- I don’t want to speak for the secretary -- what’s problem number one? I think [Geithner would] say capital. Problem two? Capital. Problem three? Capital. Everything was in the service of that view."

How comfortable you are with this explanation rests on how confident you are that the economy will continue to improve. If the green shoots grow into a lush field, then no one will ever miss the PPIP program that never happened. But if the economy reenters a period of distress -- and there's plenty of historical precedent for that to happen, and plenty of possible culprits (rising oil prices, turmoil in Iran, etc) -- and bank capital dries up, we might wish that these loans weren't around to cause chaos on bank balance sheets. It's like having a weak roof: You can delay worrying about it so long as you don't have much rain.

Earlier this month, I spoke with Raghuram Rajan, a banking expert at the Chicago School of Business, who argued, essentially, that the lesson of the last few years is we might want to be a bit more risk averse when it comes to the banking system, and that we're making a mistake by not doing so now:

"In the best of all worlds," Rajan says, "what you would do is take advantage of a period when the market is really calm to do what needs to be done: Get the assets off the nerve center of the economy -- the banks -- and over to the guys who can hold them in the long term." If that's not done now and doesn't need to be done later, that's fine. But if it does need to be done later -- if we reenter the downturn, and the banks begin to look shakier -- we'll wish we had moved the assets when the market was calm and stable, rather than leaving them to create uncertainty and volatility at the center of the banking system.

"At this point," concludes Rajan, "banks don't have any incentive to sell these loans. But the message of this crisis is that when we didn't use periods of calm to make things better, we found they could get worse."


Photo credit: Marvin Joseph -- The Washington Post Photo.

By Ezra Klein  |  June 30, 2009; 10:15 AM ET
Categories:  Financial Crisis , Solutions  
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Comments

Let me suggest an alternative way of looking at this. I agree that if we are eventually to going to end up in a worse than expected economic downturn and that the PPIP plan comes back again (zombie PPIP?), it would be much better (for them and us) if the banks had taken advantage of this program now rather than taking advantage of it during a time of panic.

However, a lot of people think the PPIP plan was misguided from the start and was not good for the public interest and was simply a way of saving bankers from the consequences of their decisions and avoid the political heat that comes with "nationalization" (what the FDIC does as a matter of routine business but doesn't usually have to do with humongous banks and very politically powerful players).

If we face a sharper than expected economic downturn, and the banks are in trouble, undercapitalized again, then it may actually be a good thing that the PPIP never transpired. That is, if we don't make the mistake of going back to the PPIP.

The PPIP was never anything more than a way of preserving broke banks from FDIC seizure by providing government leverage to the private sector in a way that minimized any potential private sector losses so as to artificially inflate the price of these toxic assets far beyond their legitimate market value.

As a matter of fact, this might be a further illustration of what a delusional world some of these folks are living in. The government was willing to deliberately inflate the price of these assets (compared to their market value in early 2009) and now the banks are still saying these assets will be worth much more in 1 year, 5 year etc. We don't want the deal.

These people don't need a PPIP plan. They need a 12 step program to recover from gambling addiction.

Posted by: seldomused | July 1, 2009 1:12 AM | Report abuse

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