Ray Dalio, who runs one of the largest hedge funds in the world, wrote a letter to his investors explaining why Bridgewater wants no part of Tim Geithner’s trash-asset-purchase plan. He says that he thinks most big funds will decline to participate, leaving PIMCO, Blackrock, and a few others to run off with the taxpayer loot (and later be bashed for it).
We’ve excerpted the letter below. Much of it is a sophisticated analysis of the plan’s economics, which is hard to follow if you’re not obsessed with the PPIP. But here’s Dalio’s bottom line:
The only way the plan can work is if the investors buy the assets at low prices, the banks sell them at high prices, and the taxpayer covers the difference. Dalio is worried that, eventually, taxpayers will figure that out.
While we were initially considering participating in the Legacy Securities PPIP program, we decided against it based on how it is designed. Some of our investors asked for our reasoning, so we will explain it to you all.
Let’s start with the deal economics. In digging into the specifics, we learned that the program is not as attractive as it initially appeared to us. As you know, unlike many others, we don’t think that most of these assets are all that cheap because we think that the debt problems will be worse than most others expect, we believe that the legal foundations of creditor rights will be in jeopardy and we think that liquidity in this environment is worth a lot. With these considerations, we find some of these assets a bit cheap, but not cheap enough to buy.
When the program was announced we were originally interested because with the non-recourse leverage (i.e. the ability to put the bad loses back to the government) we thought some of these assets could go for cheap enough prices to lead us to buy. However, as things now stand, very little leverage is actually being offered via the “Legacy Securities PPIP.” The non-recourse leverage that Treasury is offering is only 1:1, though the PPIP Fact Sheet does allude to the potential that this may be re-levered in some unspecified way through the TAL F Program (no details on this are currently available). So, unless the leverage ends up being a lot greater than 1:1, the program offers little value to us (as the put has little value). Additionally, it now appears that participants will essentially be short an unspecified call option to the government in the form of warrants that must be issued by all PPIP chosen funds in order to comply with EESA (the legislation that created TARP). Therefore, without knowing the amount of leverage that will ultimately be provided (and for now looks pretty small), or the strike price of the warrants participating funds are short, we don’t have enough information to even assess the value of the program in aggregate.
Incidentally, this contrasts with the clarity being provided on the Legacy Loan PPIP which clearly offers non-recourse leverage of at least 6:1 and potentially as much as 12:1. This gives the put option real value (which we described in last Monday’s wire), though we aren’t interested in illiquid loans.
Additionally, we have concerns about the execution of the Program. As we see it, the government is essentially creating a new asset class (these assets with the leverage/put attached) and severely limited those who can buy it, which will substantially limit demand and increases the perceived risk of collusion. The way the buying is envisioned, two different types of buyers will be created — one with a very limited number (e.g., five) of managers who have access to leverage/put via PPIP, and the rest who don’t. So, unless you’re one of the five, you won’t get the benefits, and being one of the five has strings attached that make it difficult to act as a fiduciary.
Though we don’t understand why that was done, we presume that it was for good, unavoidable reasons, but it makes us not want to participate and it makes us question the breadth of interest that we will see in the program. That is because those who are selected as PPIP Managers (i.e. these five funds) will be in conflicted positions because the Treasury has expectations of how these managers should behave (like they should buy large amounts) because the whole program’s success hinges on how these five behave, yet, at the time of applying to be one of the five, they presumably don’t know the pricing and terms, or even exactly what will be sold. We couldn’t, and we wonder how other managers can, make commitments to be one of the five without knowing these things. We could not make assurances to both the government and our investors. It would require the investors to have a lot of blind faith, especially as the managers are clearly in a conflict of interest position because they have both the government and the investors to please and because they will get their fees regardless of how these investments turn out.
Then there is the issue about the political risk, which we are more concerned about because there will be such a limited number of managers being allowed to participate in this program that it raises possibilities (or at least perceived possibilities) of them colluding because they all know each other. Either these investments will make a lot of money for their investors or the government will lose a lot of money — in either case, there will be reasons for politicians to complain and to focus on the five winners to see how they “abused” the system.
Additionally, quite frankly, the plan isn’t straightforward. Essentially it is to let private investors (especially these “funds”) buy these assets cheaply (which is the only reason they might be interested) and to simultaneously let the banks sell them at high prices (which is the only way they will sell them) at the expense of the taxpayer. So it gets around the transfer pricing problem because the public doesn’t understand the value of the leverage/non-recourse loan.
We don’t like the political/profile risks. If this plan gets scrutinized, which seems likely, there’s a lot about it that could cause controversy. Maybe we are misunderstanding it, but from what we seem to understand, given all of these issues, it looks to us like the sort of thing that the S.E.C. and other regulators wouldn’t allow if those of us in the private sector did it. Anyway, as it now stands, we don’t want to participate for these reasons.
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