The recently announced Geithner-Summers Plan, also known as
Public Private Investment Program or PPIP, is intended to de-clog
the US financial system of the toxic assets of the subprime era. While the
nitty-gritty of the plan is not being dealt with
here, the plan is all about incentivizing private interests to bid for highly sticky
mortgage-backed assets at a price which can be substantially higher than its
expected value. The essential features of the plan are presented in the form of a table
below, in a simplified and easy-to-understand manner. Though some details
may not find a place, the essential spirit of the plan is kept intact.
The table portrays three different scenarios. Scenario one is about
bidding for a given mortgage-backed asset at its normal expected value under PPIP.
Under this scenario, the expected profits to the private investor with
subsidized non-recourse equity and debt participation by the Fed works out to an
astronomical 350%. This additional return is coming at the cost of the taxpayers,
since $900,000 funding ($100,000 equity and $800,000 debt) is assumed to be
made available to PPIP at zero cost. In an open and competitive bidding scenario,
such profits simply cannot exist because competitive bidders will increase their
bid amounts till the returns from such bids converge with their opportunity cost
of capital. Such a bid, in our example, works out to approximately $15.1
mn, which is depicted in scenario two. |
