Martin Wolf on How the PPIP Might Make Things Worse

The initial wave of reactions to the Treasury/FDIC Public-Private Investment Plan was pretty hostile. This was followed by a more favorable response on Wall Street and a softening of outside analysts’ reactions on the grounds that (a) this seemed likely to make things better even if it’s imperfect, (b) it’s not really clear what viable alternatives exist. Now along comes to Martin Wolf to ruin the party and say this could make things worse after all:

I think of this as the “vulture fund relief scheme”. But will it work? That depends on what one means by “work”. This is not a true market mechanism, because the government is subsidising the risk-bearing. Prices may not prove low enough to entice buyers or high enough to satisfy sellers. Yet the scheme may improve the dire state of banks’ trading books. This cannot be a bad thing, can it? Well, yes, it can, if it gets in the way of more fundamental solutions, because almost nobody — certainly not the Treasury — thinks this scheme will end the chronic under-capitalisation of US finance. Indeed, it might make clearer how much further the assets held on longer-term banking books need to be written down.

Why might this scheme get in the way of the necessary recapitalisation? There are two reasons: first, Congress may decide this scheme makes recapitalisation less important; second and more important, this scheme is likely to make recapitalisation by government even more unpopular.

If this scheme works, a number of the fund managers are going to make vast returns. I fear this is going to convince ordinary Americans that their government is a racket run for the benefit of Wall Street. Now imagine what happens if, after “stress tests” of the country’s biggest banks are completed, the government concludes — surprise, surprise! — that it needs to provide more capital. How will it persuade Congress to pay up?


I . . . just don’t know. I think there’s a lot of genuine uncertainty about this stuff — what exactly will happen and how will the public react. The hopeful alternative is that the administration seems to be moving parallel to this with an effort to put a framework for nationalization in place such further recapitalization be necessary.