Big Banks ‘Making A Killing’ Thanks To Geithner’s Investment Program

Early last year, I highlighted a couple of reports that banks were aiming to exploit the Public-Private Investment Fund (PPIP), which Treasury Secretary Tim Geithner set up to purge financial institutions of their toxic assets. At the time, the banks which were supposed to be getting rid of their toxic waste — particularly Bank of America and Citigroup — were instead using TARP money to scoop up more financial garbage, in anticipation that once the PPIP was up and running, they could offload it and make a tidy profit.

And indeed, that seems to be exactly what’s happening. Bloomberg reported today that “the banks that received the biggest taxpayer bailouts are seeking to reap trading profits from securities rescued by the government,” as the program “designed to purge debts of no immediate discernable value from the balance sheets of troubled banks has helped transform the frozen debt into a money-maker.” And look which firms have been purchasing bundles of it:

Bank of America Corp. and Citigroup Inc., who received 22 percent of the $418.7 billion American taxpayers loaned to troubled financial institutions, boosted holdings on their trading books of home- loan bonds that lack government guarantees while investors were raising cash for the program, according to Federal Reserve data. Charlotte, North Carolina-based Bank of America along with Citigroup, Morgan Stanley and Goldman Sachs Group Inc., all based in New York, added a combined $2.74 billion of the debt, for which there were few buyers as recently as March, to their short-term trading assets during the third quarter, up 13 percent from the second quarter.

So before the program to offload the securities began, the big banks ran around purchasing lots of them, and if the prices of these securities go up, these few banks stand to reap a large share of the benefits. But due to the program’s design, if the price of the securities go down, taxpayers are left holding the bag. Joshua Rosner, who advises regulators and institutional investors, said that “it’s a trade that will likely work out, but it’s still a speculative trade, which is not what a taxpayer should want from firms that have only recently come out of critical care.”

Michael Schlachter, managing director of the investment consulting firm Wilshire Associates, was even stronger in denouncing the banks, saying it’s “absolutely ridiculous” that they may claim outsized profits from the program. “Some of them created this mess, and they are making a killing undoing it,” he added.

With banks inching their way back to profitability and financial stocks driving the 2009 market rally, PPIP and the weakness of bank portfolios largely faded from view, swallowed by concerns over unemployment, Wall Street bonuses, and housing. But are the banks really healthy? The coming year may be when we find out how much of their return to strength is real and how much is due to government support and accounting gimmickry.