Fundamental Problems Remain Unaddressed by the Public-Private Investment Program (PPIP)

Last month the Treasury Department detailed its plan to try to stabilize the housing market, and by extension the financial system, by sponsoring investments and backstopping any potential losses by private investors in mortgage pools and mortgage pool-derived securities. While this theory sounds promising and may encourage some investment – indeed, a few investment banks have already expressed keen interest[1] – this plan suffers from the same serious flaws as other plans that have come before it.

The flaw upon which most people have focused is that there is no reliable means of pricing the assets in question at this time. Many point to Merrill Lynch’s fire sale of similar assets for 22 cents on the dollar last summer[2], and question whether buyers and sellers will be able to agree on a price. Without such agreement, the plan cannot be implemented. However, the more serious flaw is that this plan does nothing to address the underlying toxicity of the assets in question. We cannot simply hope that these assets will somehow miraculously recover their value of their own accord once they are sold. Without a plan to address the underlying problem that has caused the assets to become toxic, the government is simply transferring the risk of these assets from the large financial institutions to the taxpayers. Again.

Unfortunately, the PPIP utterly fails to address the toxic nature of the mortgages upon which so many assets are based. If we do not find a way to address the problems that are causing loans to default, the loans that have already defaulted will remain in default and will not recover, and troubled loans that have not yet defaulted will not be prevented from defaulting in the future. And, make no mistake, many more loans will default if those problems are not addressed. Most of the loans that default are adjustable-rate mortgaged (ARM’s), or loans with a similar structure, such as interest-only loans (I/O’s) or negatively-amortizing loans; most of those loans have 3-year to 5-year introductory periods; and such loans were aggressively made to investors through the end of 2006.[3] This means that those loans will continue to reset, and then default, through the end of 2009, and some perhaps even as late as 2011. That’s several more years of potential mortgage defaults. Of course, as mortgages continue to default, the assets that are based on those mortgages will continue to lose value as well.

However, if the Treasury Department would adopt a bottom-up approach, rather than this top-down approach, it could address the underlying problems that have made the mortgage-backed assets toxic in the first place, and prevent defaults and foreclosures. By preventing further defaults and foreclosures, we could provide a stable foundation in the primary instruments (the mortgages) that would, in turn, provide stability to the secondary instruments (the mortgage-backed securities and other mortgage derivative instruments) that are based upon those mortgages. The plan that I have proposed describes a fair and effective model for preventing such further defaults and foreclosures and could provide the stabilization that the Treasury Department seeks.


[1] See, for example, “Can Geithner’s Toxic Asset Plan Work?,” BusinessWeek, March 26, 2009: http://www.businessweek.com/magazine/content/09_14/b4125024185951.htm?chan=top+news_top+news+index+-+temp_news+%2B+analysis
[2] See, for example, “Merrill Fire Sale Just Another Ponzi Scheme,” MoneyNews, July 30, 2008: http://moneynews.newsmax.com/hans_parisis/merrill_ponzi_scheme/2008/07/30/117582.html
[3] See, for example, “May 2007 Economic Outlook,” Freddie Mac, Office of the Chief Economist: http://www.freddiemac.com/news/finance/pdf/May_2007_FRECOM_Outlook.pdf