TradecoHoldco

Killing it like a hooker in Hong Kong

How would I play the Treasury’s Public Private Partnership to buy assets?

Let me count the ways…

To recap, Geither proposes that the Treasury will contribute, say 70%-90%  of the funding required such toxic bank assets as long as unnamed hedge funds and private equity funds put in the remainder. Any loss that occurs would come out of the fund’s equity portion, before affecting the Treasury contribution.

Face value

This structure is essentially equivalent to having private investors contribute equity capital in a bank and having the government provide the deposits and unsecured debt. This would form the liability side of the balance sheet, and then the new shareholders would be incentivized to go out and buy bank assets. The key problem that this structure is supposed to resolve is that of price discovery: the private investors would have the incentive to price assets correctly in order not to lose their shirts.

As Mr. Geithner already knows from the AIG bailout, the devil is in the details, so here is an early preview of what could go wrong. Private investors will make a simple evaluation: Can I buy this toxic asset from a distressed bank, such that after whatever defaults may occur in the future, I will make a profit?

Cherry-Picking

The first thing I would do it cherry pick. I would go over a bank’s book, and wherever they have undervalued assets i.e. assets they have marked down already, but I think has a greater chance of recovery than they do, I would buy. This would load up the PPP bank with the higher quality assets, and leave the banks with lower quality assets. In return, the distressed banks will realize a profit because they sold the asset for a higher price than the mark.

Ring Fencing

The next thing I would do is ring fence, or play the odds. This is actually a typical private equity trick. Let’s say I have a 100 million dollars. I split that into ten vehicles, and have the Treasure give me 10:1 leverage on each vehicle. I have a billion dollars of firepower in 10 vehicles. I then make absolute punts with each vehicle, going for broke, buying stuff that no one else will buy. If each vehicle buys an asset at 30 cents on the dollar,  and just one of the vehicles manages full recovery and all the others go bust,  then for that one vehicle:

10mm equity+90mm debt = 100mm assets

after recovery

333mm assets = 90mm debt + 10mm interest + 233mm equity

My return on 10mm would be 2330% and on 100mm would 233%.

Most real banks are prevented from doing this because the Fed and FDIC has restrictions about how much risk they can take on the book, but the PPP vehicles will not.

My ring fence strategy would probably lose the Treasury a butt load of money, because they will lose money on all the other nine vehicles and won’t have recourse to my profitable tenth.

More coming soon…

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March 20, 2009 - Posted by | Credit Crisis | , , ,

1 Comment »

  1. […] goes back to my earlier ringfencing post. Someone is going to figure out a structure so that assets can be segregated. Investors are […]

    Pingback by PPFI: Going to be a disaster « TradecoHoldco | March 21, 2009


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