Is there a way for American banks to get rid of high risk mortgages? Yes there is. Sell them to private investors, pension funds or insurance companies.

The US government is offering individuals and firms the possibility to invest in the toxic assets that banks want to lose, through the Public-Private Investment Program (PPIP).

The US Secretary of the Treasury, Timothy Geithner, announced this program in March. Since then, nine private fund managers and investors have participated in PPIP; amongst others Invesco and BlackRock.

40 billion dollars
How does PPIP work? The US government together with private fund managers and investors buy 40 billion dollars worth of devaluated mortgages and toxic assets from US based financial institutions. For every dollar invested into these toxic assets by private investors, the US government invests two more dollars. In total, the US government will invest a total of 30 billion dollars, private investors are to invest a minimum of 500 million dollars.

It appears that the PPIP program allows banks to get rid of their toxic assets and thus increase their health, which should in turn lead them to provide more credit. This, of course, is good for the economy in general. Another advantage is that the bidding will help determine the actual value of the toxic assets.

‘Changed rules’
But is the sale of toxic credits really beneficial for banks? Professor Lucian Bebchuk of Harvard thinks not, and in a recent article in the Wall Street Journal he explains why. He states that the accounting rules have changed, so that banks don’t have to sell the assets for the amount that buyers are likely to offer. That might lead to banks selling only the toxic assets that are really beyond hope.

Bebchuk also has some doubts regarding the benefits for fund managers. He fears that the government contribution might cause fund managers to invest more than is good for them. Bebchuk: it is better to wait for the Federal Deposit Insurance Corporation (FDIC) to auction off the assets of financial institutions that went bankrupt, which should happen later this month.

‘Win-win situation’
Bill Gross, manager of the Pacific Investment Management Company (Pimco – one of the first supporters of the PPIP), is more optimistic. He describes PPIP as a win-win situation: fund managers can make a good profit on the bonds when the credit market recovers. Nevertheless, Pimco pulled out of the PPIP program due to uncertainties regarding the structure of the program. Other parties are also expressing their doubts, amongst others about the complexity and the yield of the program.

What is your opinion on the Public-Private Investment Program? Let us know.

A change of plans
The US government originally wanted all parties to make a combined investment in the financial sector of 1000 billion dollars, instead of the current 30 billion dollars. The program was adjusted because of an improvement in the economic climate, which makes it easier for banks to acquire capital themselves.