Sense on Cents

In Wall Street parlance, a trade of respectable volume is defined as a “round lot.” A large trade is often designated simply as “size.” A trade of relatively small size bordering on insignificant is defined as an “odd lot.” Obviously all of these definitions are relative measures predicated on the magnitude of the market and the prevailing situation. On that note, the initial launch of the Public-Private Investment Program, PPIP, appears as if it will be an “odd lot.”

As Bloomberg reports, Treasury’s Distressed Debt Plan Said to Begin With $20 Billion,

The U.S. Treasury Department may begin its program to spur purchases of mortgage-backed securities from banks with about $20 billion in public and private money, down from as much as $100 billion when it was announced in March, two people familiar with the matter said.

Recall that the PPIP has two programs. The program targeted at raw whole loans has been postponed indefinitely. This program highlighted above is targeted at asset-backed securities (ABS, collateralized by credit card receivables, student loans, and other receivables).

Why is the PPIP getting off with a whimper? Market pundits and government officials would promote the principal that the PPIP is less necessary for the financial industry currently. Why? The banks were able to raise billions in equity capital after the results of the Bank Stress Tests were released. If those investors were comfortable putting money into the system, then why should banks feel an urgency to raise more capital via asset sales utilizing the PPIP? Bloomberg reports as much,

Treasury Secretary Timothy Geithner said then that interest in such U.S. programs may be waning as market confidence improves.

I beg to differ. In my opinion, the PPIP is getting off to such a slow start for a variety of other reasons, including:

1. price:investors continue to believe the underlying assets will experience a greater level of delinquencies, defaults, and foreclosures and thus they are not willing to pay the price banks desire.

2. FASB’s relaxation of the mark-to-market: allows the banks to value these securities at levels above market and avoid taking the loss if they were to sell through the PPIP.  Banks can not avoid the loss, though, as the underlying loans continue to suffer higher levels of defaults.

The New York Times highlighted this exact point this past Sunday in an article, So Many Foreclosures, So Little Logic,

But the most fascinating, and frightening, figures in the data detail how much money is lost when foreclosed homes are sold. In June, the data show almost 32,000 liquidation sales; the average loss on those was 64.7 percent of the original loan balance.

Here are the numbers: the average loan balance began at almost $223,000. But in the liquidation sale, the property sold for $144,000 less, on average. Perhaps no other single figure shows how wildly the mortgage mania pumped up home prices. It also bodes poorly for the quality of the mortgage-related assets lurking in banks’ books.

Loss severities, like foreclosures, are rising. In November, losses averaged 56.1 percent of the original loan balance; in February, 63.3 percent.

3. Uncle Sam: investors have seen how Uncle Sam has changed the rules of the game as he goes along. Examples of Uncle Sam’s abusive tendencies include Congress’ lambasting AIG employees over contractual bonus obligations and the Obama administration ‘running over’ senior creditors of GM and Chrysler. Investors are shying away from doing business with Uncle Sam regardless of the attractive terms within the PPIP.

The PPIP looked good on paper but putting it into practice is a totally different ballgame. Given the strength of these three counteractive factors, I am not optimistic the PPIP will ever move off the “odd lot” desk.

LD