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Bankster Bluster Leads to Legacy Loan Program Fail

The Wall Street Journal reports that one part of the Public Private Investment Program (PPIP) is failing, and for the right reason: fear of backlash about the enormous profits the program offered to the financial elites.

The Legacy Loan Program proposed to set up highly leveraged funds to buy bad loans from banks, cleaning up their balance sheets and hopefully encouraging lending. The banksters wanted to rip it off by buying their own loans with government assistance. That isn’t the product of the fevered imagination of some obnoxious blogger (we’ll get to that), that’s from a comment letter sent on behalf of a bunch of big banks to the FDIC.

Potential investors were worried that public outrage would force Congressional action if they reaped huge profits while the Treasury took most of the risk. They were also worried about FDIC regulation of conflicts of interest. Banks didn’t like it because of fears that Treasury might impose compensation caps and other controls. That was such a huge problem that Treasury was considering exempting them from those minor limits.

Apparently, national hostility over the great swindle has reached the stage that Treasury no longer can raid taxpayers for unlimited cash. It turns out that bankers only want taxpayer money if it comes with no strings attached. And, it turns out the FDIC’s Sheila Bair has a spine and isn’t going to let that happen. "We’ll show you," say the banks, "we won’t participate."

Bloomberg points out that comment letter (pdf), but you have to read the whole thing to get the flavor of the arrogance of the giant banks. Here’s a quote:

…both investors and banks must be willing to engage in transactions that involve prices for loans that approximate intrinsic values and reasonable profit expectations for the equity investors. We are concerned, however, that investor return requirements may involve pricing at which banks are unwilling, and even unable, to sell loans. If the pricing is significantly below intrinsic value, many banks will not be willing to participate in the program. For those banks that are willing to participate, not only would they be surrendering substantial value to the investors, but the resulting capital hole could prove very difficult to fill. Such a transfer of value would be inconsistent with the government’s objective of stabilizing the banking system and increasing lending.

The FDIC’s willingness to support leverage should enhance potential returns for investors and support prices that represent intrinsic value. It should be recognized, however, that the leverage proposed by the FDIC is well below the leverage at which even the most well capitalized banks maintain the loans. Accordingly, it is essential that the FDIC support as much leverage as it can justify. Likewise, the cost of this leverage should not exceed the banking industry’s cost of funds and, ideally, match the FDIC’s cost of funds.

Intrinsic value? That term appears seven times in the letter. What does it mean? The problem is that banks have a bunch of loans that look risky to regulators and investors, so much so that the regulators are worried about solvency, and investors have driven down financial stock prices. Those loans don’t have any intrinsic value; actually, no loan has an intrinsic value. They are only worth what someone else will pay for them. The idea of the Legacy Loan Program was to get those loans off the banks’ books, by setting up a kind of market, and establish a value the hard way, with someone else’s cash.

It’s a fair reading of this quote that the banks aren’t going to take less than the fake values on their books, unless the government makes up the loss. I’d just as soon not do that.

The FDIC also asked for comment on “potential conflicts which could arise among LLP participants”, which is probably the FDIC response to the rafter of bloggers who pointed out the risk that banksters would cheat, including Yves Smith. Here’s the bank response:

We believe that some media stories about “gaming” the system, such as banks swapping loans at artificially high prices, are more a product of a feverish imagination than of reality.

Sure. Feverish imagination, like banks using government money to buy out their own assets.

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