By Morgan Housel February 25, 2010 | Comments (13)
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David Gardner called it. He's up 1,334%! See what David's recommending that you buy NEXT.
In late 2008, Warren Buffett drafted a plan to save the financial system. He sent the proposal to the U.S. Treasury. Within months, the Treasury implemented the plan almost exactly as Buffett proposed. It's failed miserably since then.
I'm talking about the Public-Private Investment Partnership, better known as PPIP.
If you haven't heard of PPIP, don't sweat it. It's one of who-knows-how-many notions cooked up to save the economy. In short, it's a Frankenstein plan to marry private money with government leverage, creating an investment machine that can buy the putrid junk off banks' balance sheets. Like a public bailout with a dash of free-market input -- Keynes and Hayek holding hands.
Here goes nothing In March 2009, the Treasury created PPIP, pledging up to $100 billion to be matched with private money and leveraged into a $1 trillion toxic-asset-eating monster. Buy all the terrible assets, thought went, and we're all set. Economy saved.
But to say the plan was met with jeers is an understatement. Almost no one liked it. One government watchdog called it "a sham." Whatever you wanted to call it, it was another bailout at a time of utter bailout abomination.
Soon after, rumors began that PPIP was Buffett's brainchild. Few thought much of it. Some didn't think it was true -- only a public dolt like the Secretary of Treasury could conceive such recklessness.
But an October 2008 four-page letter sent from Buffett to then-Treasury Secretary Hank Paulson recently surfaced. New York Times columnist Andrew Ross Sorkin mentions the letter in his book on the financial crisis. Almost word for word, it describes PPIP five months before its birth. (See it here.)
In the letter, Buffett proposes creating a public-private fund to buy mortgage assets "in a way that dramatically reduces the risk -- to almost zero -- that the Treasury will lose money on its purchases."
To do so, private investors would provide $1 of equity for every $4 of government leverage. Investors would be wiped out before the Treasury took losses, and buyers "would have every incentive to make intelligent purchases," lowering the chances of taxpayers getting hosed.
Buffett's proposal notes that he'd already lined up Goldman Sachs (NYSE: GS) to work pro-bono on raising $10 billion of equity, with Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) willing to contribute another $500 million. Corral a few more investors, leverage that beast up with taxpayer dole, and you've got the mother of all toxic-asset-buying machines.
More specifically, you've got PPIP. This was all Buffett's idea.
There's a reason he isn't bragging Almost one year after its creation, PPIP is universally known as a dud.
Matt Taibbi, Rolling Stone's honest yet maniacal columnist, describes it as "this bizarre scheme" in which "the government loaned money to "¦ private investors to buy up the absolutely most toxic [expletive] on the market -- the same kind of high-risk, high-yield mortgages that were most responsible for triggering the financial chain reaction in the fall of 2008."
That's true, but there's little reason to worry: As of Dec. 31, PPIP had raised just $6.2 billion of private capital, leveraged on behalf of taxpayers into $24.8 billion. From this $24.8 billion, all of $4.3 billion worth of toxic assets have been purchased, or 0.43% of PPIP's intended $1 trillion goal. Put another way, it's failed. Miserably.
Why? Where did Buffett and the Treasury's idea go so wrong? Let's count the ways.
1. It targeted the wrong problem. The market for toxic assets froze for one reason: Banks refused to sell at prices investors were willing to pay. Even with PPIP, that's still the case. Banks don't want to sell some of these assets for anything less than full value, largely because tweaks to mark-to-market accounting have allowed them to resume carrying junk assets at fantasy prices. Yet investors want bargains. They want to pay pennies on the dollar. Even with PPIP's leverage, this "bid-ask" chasm wasn't bridged. Happy buyers couldn't be matched with willing sellers.
2. It's easy to abuse. Within hours of its birth, examples sprouted showing how banks could exploit PPIP, offloading soured assets while giving taxpayers the firm middle finger. One example involved the banks looking to sell assets simultaneously buying their own assets at inflated prices, contorting market bids and luring PPIP investors into certain losses, leaving taxpayers holding the bag. Who knows if that happened, but Taibbi writes, "In the third quarter of last year, Goldman, Morgan Stanley (NYSE: MS), Citigroup (NYSE: C) and Bank of America (NYSE: BAC) combined to add $3.36 billion of exactly this [expletive] to their balance sheets." Last summer, JPMorgan Chase (NYSE: JPM) was rumored to be a potential junk-asset buyer as well.
And since the plan is prone to exploitation "¦
3. Private investors aren't dumb enough to participate. The main reason PPIP has failed is because the private investors it relies on have been curiously absent. Oddly, being at the mercy of Congress isn't on every investor's list of savvy business moves. The CEO of hedge fund giant Bridgewater Associates succinctly explained why his firm wouldn't participate: "There will be reasons for politicians to complain and to focus on the [private investors] to see how they 'abused' the system." Apparently the risk of Nancy Pelosi's stink eye ain't worth it.
PPIP made sense in theory. Unfortunately, it was thrown into the most screwed up and convoluted market the world has ever seen. That Buffett himself underestimated the mess shows just how big a problem this is.
Fool contributor Morgan Housel owns shares of Berkshire Hathaway. Berkshire Hathaway is a Motley Fool Inside Value pick. Berkshire Hathaway is a Motley Fool Stock Advisor recommendation. The Fool owns shares of Berkshire Hathaway, and has a disclosure policy.
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buffett needs to be worrying about his own failing empire.he split his b shares to try and fool the general public into bidding it up so he can pay for his badly timed and overpriced purchase of burlington..so far buttett has found his fools to push his $50 stock toward $80...
with the depression in the US now out of control and with no one running the country here are a few of the name bankruptcys for 2010...GM!chrysler,aig,hertz,sirius,riteaid,etrade,aol,moody's,blockbuster,street.com,sears,and palm...just a few!!
Wonderful article, Morgan!
Perhaps the failure of Buffett's convoluted plan contributed to Munger's dire assessment that: "Basically, It's Over"
http://www.fool.com/investing/general/2010/02/23/charlie-mun...
I'm thinking back right now to the impact the announcement of this program had on the markets. Was it not a cornerstone of the "Financial Stability Plan" that so effectively consoled a panicked equity marketplace back in March 2009? Remember Geithner's confident fanfare?
What does it mean for a "recovery" when one of its initial catalysts crumbles beneath its cracked foundation?
What does it mean for the entire reflation strategy when a $600 trillion derivatives market finally proves too enormous a beast to slay?
Some might recall that I raised the latter question the very week the PPIP was announced:
http://www.fool.com/investing/international/2009/03/24/102-t...
Unfortunately, I believe that political expediency will see this broader, failing reflation strategy pursued with every last dollar the printing presses will churn out. At some juncture, perhaps already in the past, its true underlying intent will morph from one of economic recovery to one of debt reduction through currency debasement and/or default.
Sadly, I think PPIP more accurately stands for:
Past the Point of Inflection from Prosperity.
The originators and peddlers of derivatives have lopped an appendage off of the global economy with their ill-conceived casino. The longer the injury remains effectively un-sutured, the deeper the infection spreads. At this point, I honestly don't know what the solution is ... if there is one. I think the derivatives will continue to delever (that's an 'e') once this counter-cyclical condition of risk-acceptance fleas the market and the specter of off-balance-sheet exposures begin to be taken into account. I believe that currency-based inflation (stagflation) will be the end-result, but I can not hazard a guess for how the Dow will price out accordingly.
These are the opinions of just one Fool, and they are (perhaps thankfully?) still a minority view (right?). I continue to hope with every fiber of my being that I am completely wrong. DYODD.
http://www.fool.com/investing/general/2009/09/23/biggest-mar...
"According to Mark Mobius of Templeton Asset Management, the lack of liquidity and massive scale of the still-distressed global market for derivatives mean that systemic risk has not been cured by the enormous U.S. fiscal interventions (which I gave up tallying at $13.55 trillion). Mobius cautions that the response is simply no match for the $600 trillion mountain of deleveraging derivatives. After all, we're talking about a hitherto-unregulated marketplace that still dwarfs global GDP by a multiple of 10!"
Morgan ... thanks again for a great piece! Sorry (here again) for the dour commentary. I certainly look forward to the day when I can write about more positive economic conditions as I see them.
Plange,
I never get tired of your insistence that companies without one penny of debt are going bankrupt.
Thanks for the constant chuckle,
Morgan
"Fail" is not the right term for the plan. The plan simply didn't do anything. That is not a failure. Failure is when the government loses many many billions of dollars on bailout out crap like Freddie, Fannie, AIG, GM, etc. Buffett's plan was simply not a success, it didn't help but it didn't cost any money.
The PPIP may have worked if the banks were forced to sell their assets at fire sale prices (i.e. the bank shareholders and possibly bondholders take a loss). But why would they do that when there are a couple of other programs that would save them for free?
"PPIP" sounds to me like passing a kidney stone. What might have worked would have been to drag all of Wall Street's bankers and brokers into a public venue and hang the lot of them.
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