Economic Notes: Lightening Black Holes
3/23/2009
The gravity of a celestial black hole is so intense that even light cannot escape it.
Since the credit meltdown began in mid-2007, nonprime mortgages (and related derivatives) have been the financial sector’s equivalent of a black hole: balance sheet entries whose unknown (but declining) values threaten the survival of individual institutions and, potentially, the collapse of the financial system.
Resolution of the balance sheet black holes is the sine qua non of stabilizing the financial sector, which is prerequisite to righting the general economy.
Although some progress has been achieved by the various policy initiatives of the U.S. Treasury (UST), Federal Reserve (Fed), Federal Deposit Insurance Corporation (FDIC), and their international counterparts, the financial sector remains hobbled by its balance sheet black holes. At least until now.
UST has just announced the Public-Private Investment Program (P-PIP), a strategy to address what it characterizes as “legacy assets” (i.e., real estate loans and related securities issued prior to 2009).
Although there are blanks to be filled in, UST has put forward a coherent approach to a seemingly intractable issue. P-PIP will lighten the black holes.
While P-PIP deals separately with bank-held loans and mortgage-backed securities, the approach is generally the same. Both will encourage investors to purchase banks’ legacy assets through public/private joint ventures that will raise risk-constrained equity.
To implement P-PIP, UST will pre-qualify five (or so) fund managers to raise private equity financing for investment funds (P-PIFs) from various sources, including: mutual funds, pension plans, insurance companies, etc.
UST will be a co-investor in each fund, but fund managers will control the assets.
P-PIFs will leverage their private/UST equity, with their loans guaranteed by the FDIC, to purchase pools of mortgages (or other assets) from participating banks.
The initiatives rely on the existing authorities of the UST (drawing on TARP funds), the Fed (expanding its recently launched asset-backed financing facility) and the FDIC (loan guarantees). Therefore, new legislation is not required – which is propitious in today’s AIG-charged political climate.
Although some rulemaking is necessary and the selection of fund managers will take some time, the loan-oriented program (Legacy Loans) should be launched in relatively short order. The launch date of the Legacy Securities initiative is less certain, however, as its administrative details require further refinement.
Additional information is available at http://financialstability.gov/.
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The statements, opinions, and conclusions contained herein are based solely upon the author’s own studies, research, and personal experience. Neither J.H. Cohn LLP nor the author makes any representation or warranty as to the accuracy or completeness of this information. J.H. Cohn LLP and the author expressly disclaim any liability for any loss or damage which may be incurred, of any kind whatsoever, as a result of or arising from the use of any of the information contained herein or reliance on the accuracy or completeness of it.
For more information, contact Patrick O’Keefe, director of economic research at J.H. Cohn, at pokeefe@jhcohn.com or 973-364-7724.