PPIP & Our Financial Future. The Good, the Bad and the Opportunists.

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This week the Treasury’s “stress tests” came out. There was some good news. After an unprecedented aggregate analysis of the 19 largest banks, we learned that many banks suddenly found themselves in much better shape than we had heretofore been told. Perhaps it was not wanting to be controlled by government, which was about to happen. Bye, bye big bonuses!  Suddenly–surprise–they are not in such bad shape as they thought. Hmmm.

So what is going on with the banks? Perhaps Tim Geithner was not such a patsy after all. Don’t misunderstand. Very smart guys like Dr. Joseph Stiglitz and Dr. Paul Krugman, both Nobel Prize winners, and others were against the toxic asset sale to private interests, the so-call PPIP program ( Public-Private Investment Program) But let’s be clear about what it is.

Under PPIP, the Treasury department is going to make private investors an offer they can’t refuse. Basically, it says that the government will give private investors a guaranteed number for the bad assets of a bank. Then, based on that number…what the Fed says the value of the assets turn out to be…the private financial group makes a bid on the bank, which the Fed will help finance to the tune of about 90%. Then, when the bank makes money, it will continue to pay off the amount it borrowed to buy the bank and it will split the profits 50/ 50 with the government until it owns the bank outright.

If the bank fails, the investors potentially only lost 7.5%. (Half of a 15% down payment. Government put up 7.5% too.) The “stress test” has now let the government know what these banks are really worth. They know how much the taxpayers should pay as their share. And they also know the strength of the bank as a viable operator in the future. It is a very favorable deal for investors. But it was meant to be for one single reason.

Unemployment. We have 13.2 million people drawing unemployment right now. The statistics lag the actual number, so that means that there are probably more like 13.6 million unemployed. We have a stimulus in place. Part of that stimulus, as more and more people begin to work in stimulus-related jobs, is to prepare the banking system. With solid, well-capitalized  banks  in place and with strong balance sheets businesses will be able to borrow more money to expand as the economy improves.

So that’s the good news. Apparently most of the 19 banks to a greater or a lesser degree either passed or are about to be restored to sound financial positions one way or another.

The bad news is that the deep recession continues. In the April survey by the Federal Reserve of senior loan officers at 53 U.S. banks and 23 U.S. branches of foreign banks, the quick and easy result can be expressed as: down 40-50%. In almost every category from consumer loans to prime and sub-prime mortgages to commercial loans, the volume is anticipated to be down by 40-50%. They report that credit standards have tightened and demand has weakened. So that picture is still relatively bleak, if expected.

The PPIP will help this. The critics say that this program has such favorable terms that it is a giveaway to the financial community. But it has already had some effect. The 19 banks that had such difficulties and such toxic assets and would have been required to become a part of PPIP somehow were able to revitalize themselves.  It could be that it was the realization that someone else would come in, purchase the assets at a very favorable price and start to make money.

Perhaps the stockholders who own these banks had second thoughts. TARP funds and Federal Reserve funds pumped into the financial sector stemmed the tide of red ink. They may have decided it was time to raise the funds to pass the stress test. That automatically gives round one to the Treasury, because it means a huge amount of money that will stay in the government coffers while private investment has flowed back into the banks. Assets now are priced more realistically. Details are not out yet, but in several weeks, we will see how much the American taxpayers will be asked to loan. It looks now that it will be much less than anticipated.

So did Geithner and the banks go eyeball-to-eyeball and the banks blinked? Probably not. It is more likely that the banks looked around and saw some pretty well financed suitors standing in the wings, ready to take the stage.

Money flows. Private investment groups have money. As Tim Geithner said on Charlie Rose, there is still a lot of money out there. The fact that the Geithner plan has very favorable terms has not gone unnoticed by private investors. The problem is that many banks which may become very substantial cash generators are heavily regulated. For example, investors cannot be part of a non-financial organization. One interested firm that would like to change that is the Carlyle Group, the large holding company with key interests in the defense industry.

The law is pretty clear. It does not allow ownership of banks by non-financial companies. But that does not stop them from trying. They are pressuring the Fed and Treasury with the fact that they have hundreds of billions of dollars ready to invest at a time when the financial system could use a substantial influx of cash.

So where do we stand? PPIP will work. That’s pretty clear. Because the objective is to make sure that banks are ready to loan when the demand turns up. Private investment is interested, but do we want non-financial interests involved with banking. The last time it was involved, we had huge problems including one very serious recession and the last Depression. Geithner and Bernanke are adamant that the new banking system will be carefully regulated. Let’s hope that they and Congress stick to their guns.

The banking lobby is one of the most powerful in Washington. The opportunists, the non-financial suitors for these banks, like Chis Flowers of New York and the Carlyle Group make no bones about the fact that they are in it for the money. They see undervalued properties that happen to be in the banking business. Flowers who is already buying small banks, says he can make a 35% return…a pure investment play…when the economy turns around. Didn’t we just end up in this mess as a result of these kinds of people?

We will find out soon if the existing bank managements feel as bullish about the future of the financial community. Moreover, we will soon see whether Geithner, Summers and Bernanke stand strong for the people, or merely for the people who own the banks.