The Inherent Dishonesty Of PPIP

Institutional Risk Analyst has a very technical post up about PPIP. Unless you have some familiarity with options pricing it might be a little dense but the conclusions the author draws are in plain English.

Why the complicated structure? Innocent answer: Treasury is unwilling/afraid to ask the Congress for the funds or authority to write a covered call or otherwise unwind the mess. A more cynical view is that complexity is designed to disguise the fact the PPIP requires Federal agencies to take steps well beyond their mandates. The FDIC is called upon to provide option protection to a de novo Treasury created quasi public entity – call it a Geithner/Summers SIV – which is a far cry from providing deposit insurance in return for insurance premiums or liquidating failed bank assets. 

The Fed is called upon to provide financing not for a solvent bank and based upon good collateral or for systemically important firm, but for a Treasury created and sponsored entity. The result of these actions is the writing of a covered call option, when none of the above agencies is authorized to write options. The plan clearly tests the rule of law, but Congress will not protest and reserve its option to protest and change the terms ex post. 

Flaws and dishonesty notwithstanding, we expect that the PPIP with only minor changes to become operational – unless the building angst in the Congress boils over sufficient to change the course of the Summers/Geithner large bank giveaway. There is too much political capital invested in it for the proponents to walk away, we are told, but the irony is that the changes to the fair-value-accounting rule last week may now make many banks reluctant to participate. 

The PPIP is potentially a subsidy for a variety of financial institutions, many of whom have been seen in the markets buying toxic waste at 30 cents so that they may sell it to Tim Geithner’s Treasury at 80 cents. Some large bank CEOs will protest being “forced” to sell assets, but they will eventually rollover rather than be “Rick Wagonered” by Geithner et al. But the big payoff could be for the likes of our friends at PIMCO, Blackrock (NYSE:BLK) and the other asset managers who will be called upon to maintain this floating superfund site.

As tough as it might work through the technical stuff. You won’t be surprised to learn that the entire structure will probably collapse.

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