Enter PPIP

Last month the Federal Deposit Insurance Corporation (FDIC) announced a pilot deal to sell $1.3 billion in mortgage securities in exchange for $856.2 million from the debunked Franklin Bank after the lender was taken over by the agency. This was the official kickoff to the much anticipated Public-Private Investment Program (PPIP). In a joint venture with Residential Credit Solutions (RCS), the Fort Worth, Texas mortgage servicing company put up $64.2 million for a 50 percent stake in the venture, which will manage the pool of mortgages. In exchange for the other 50 percent share, the Treasury Department will put up an additional $64.2 million, while the FDIC will provide the loan and financing. However, instead of receiving cash for the loans and the financing, the agency will take government-guaranteed 10-year notes for $727.8 million with a coupon rate of 4.25 percent, in anticipation of selling them to the private sector in the future. Since the number of failed banks this year has already totaled 94 along with 25 from last year, the agency will surely hold billions more in toxic assets before the recession is completed. Thus the success of the PPIP will be crucial to the removal of toxic assets from not only failed banks, but troubled banks.

It Takes Two to Tango
Recent reports show private investors are now more eager to partner with government agencies and two of the nine established funds have raised over $1.13 billion in equity to purchase these toxic assets with government support. Adding to approximately $4.52 billion of purchasing power ($1.13 of government equity contribution and 100 percent financing), the question remains whether banks are willing to sell their nonperforming mortgages at a heavy discount and realize the losses on their books.

The financial motivations for the private investor are plentiful, such as the non-recourse loans to purchase the distressed assets, funding by the Treasury Department, debt guarantees by the FDIC, management fees and potential gains on their equity stake. On the other hand, it's hard to see the motivation for banks to get rid of these illiquid toxic assets on their books at an agreeable price. The issue on hand is not the fact that the assets are illiquid because liquidity is always available - but at a price. Yet, imagine if banks truly needed to remove these assets from their books to begin their lending activities again. If market prices were close to the values on their books, banks would be more than willing to accept these prices and lighten up their balance sheet. Currently, the price discrepancy appears to be too large a hurdle for the PPIP to be effective enough to relieve troubled banks.

Key Developments
The economy shrank at a 0.70 percent annual rate from April to June, the best performance in more than a year. Gross domestic product contracted at a 6.40 percent pace in the first quarter of 2009.

Personal spending climbed in August by the most since 2001. The 1.30 percent increase in purchases followed a 0.30 percent gain in the previous month. Personal income climbed 0.20 percent in the same period.

Core PCE, which excludes food and fuel, climbed 0.10 percent from the previous month and was up 1.30 percent from a year earlier. This is the smallest year-over-year gain since September 2001. Inflation remains tame and in check.