Thursday, February 18, 2010

Gaming the PPIP?

Original posted on the Baseline Scenario by James Kwak:

A couple of weeks ago, Yves Smith picked up on the story that the TARP Special Inspector General is investigating suspicious trades in connection with the Public-Private Investment Program. When PPIP was announced almost a year ago, there was widespread speculation about how banks and other private investors could take advantage of the program to unload toxic securities onto taxpayers (technically speaking, onto investment funds containing some private money, some public money, and a lot of non-recourse financing from the government). That story more or less faded away because PPIP never really amounted to much; banks apparently decided they were better off sitting on their toxic assets, counting on favorable accounting rules and regulatory forbearance, instead of selling them.

Here’s the relevant section from the SIG-TARP report (p. 141):

“The PPIF management company in question operates both a PPIF and one or more non-PPIF funds that invest in similar securities (i.e., mortgage-backed securities (‘MBS’)). In the case of this fund management company, the same person is the portfolio manager for both the PPIF and the non-PPIF fund. In late October, the portfolio manager directed that a particular MBS from the non-PPIF fund be sold after the security — in this case a residential MBS — had been downgraded by a rating agency. According to the company, multiple bids were received, and a quantity of the security was sold to a dealer. Within minutes of the sale, however, the same portfolio manager purchased, for the PPIF, the same amount of the same security from the dealer at a slightly higher price. Later in the day, the portfolio manager bought more of the security for the PPIF from the dealer at the original price.

“The management company involved (the identity of which is not being disclosed at this time pending SIGTARP’s investigation) asserts that there was nothing inappropriate about these trades, and Treasury has concluded that the trades did not violate PPIF rules. The facts, however, give rise to difficult questions. Was the initial purchase really arm’s length, or was the dealer aware that the portfolio manager was prepared to repurchase the securities immediately? How can a manager conclude that it is wise to sell a security at one price but then almost simultaneously repurchase the same securities at a higher price? Were these trades designed to push the risk of this downgraded security from the private, non-PPIF fund onto the taxpayer-supported PPIF?”

I wouldn’t necessarily assume wrongdoing. For one thing, the fund manager is just a fund manager, meaning he makes fees (based on assets under management and performance) from both the PPIF and the private fund. So arguably, shifting losses from one fund to another doesn’t help him that much. Of course, there are various scenarios under which it would benefit him: the fees from the private fund could be higher; one fund could have profits from which he gets a cut while the other may not; he could have his money in the private fund but not in the PPIF; he could have a nudge-nudge wink-wink agreement with the private investors; and so on.

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