Now that we’ve got the buy-side managers for the Obama adminstrations Public Private Investment Program lined up, the question is whether there will be anyone on the sell-side. With the buy-side guys saying that the P-PIP will allow them to pay between 5% and 10% more for toxic assets, you might think banks would be all over this thing.
But that’s not how its shaping up. The P-PIP is still stumbling. Many are now wondering whether bankers will sell into the program. Today Lucian Bebchuck has a guest column on the WSJ’s Real Time Economics blog explaining why banks aren’t eager to unload toxic assets. Mostly, its that so much of what the government has done is enabling and encouraing banks to retain the junk on their balance sheets.
- We suspended mark-to-market. “A month after the PPIP program was announced, under pressure from banks and Congress, the U.S. Financial Accounting Standards Board watered down accounting rules and made it easier for banks not to mark down the value of toxic assets. For many toxic assets whose fundamental value fell below face value, banks may avoid recognising the loss as long as they don’t sell the assets.”
- The Stress Test Gave A Free Pass For Losses After 2010. “In another blow to banks’ potential willingness to sell toxic assets, however, bank supervisors conducting stress tests decided to avoid assessing banks’ economic losses on toxic assets that mature after 2010. The stress tests focused on whether, by the end of 2010, the accounting losses that a bank will have to recognise will leave it with sufficient capital on its financial statements. The bank supervisors explicitly didn’t take into account the decline in the economic value of toxic loans and securities that mature after 2010 and that the banks won’t have to recognise in financial statements until then.”
The combined effect is that banks are strongly discouraged from selling any toxic assets that mature after 2010 for any price lower than the current mark on the books.
Bebchuck’s analysis doesn’t go far enough. The worst off banks, especially those with low levels of common equity, won’t sell because they don’t want to give up the potential upside of the assets.
“My paper “The Put Problem with Buying Toxic Assets” shows that that zombie banks will be reluctant to sell their toxic assets, even if they are marked to market, because they don’t want to give up the volatility,” explains economist Linus Wilson. “That volatility makes their shareholders richer and puts their bondholders and the FDIC, which insures deposits, at risk.”
To put it more simply, zombie banks will be reluctant to sell even if the toxic assets are marked down to at or below fair market value. The private investors will rationally throw caution to the wind because they get the majority of the upside and taxpayers bear most of the downside.
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