The P.P.I.P. (inside the beltway, they have already started calling it P-pip) is, in fact, two separate programs. One deals with the kind of mortgage-backed securities that we’ve all come to think of as toxic assets. The other deals with loans that have not been securitized — for things like commercial real estate, or residential mortgages or small businesses — that banks hold on their books. The former program will be run by Treasury and the Federal Reserve; the latter will be managed primarily by the F.D.I.C.

...the whole loan program is in some ways more important than the mortgage-backed securities program. The reason is that, unlike securitized loans, these assets do not have to be marked to market; indeed, as long as the borrowers are current on their loan payments, they don’t have to be marked down at all. And yet it is obvious that many such loans are in deep trouble — and the banks haven’t faced up to that yet.

All over the country, businesses like real estate development companies are using loans they took out in good times to finish projects that are going to be problematic, to say the least. Chances are high that those loans are unlikely to ever be paid back in full. I heard one story this week about a borrower who actually approached the bank and laid out his dilemma. The bank’s response? It granted an extension of the loan for months — with no fees. That is akin to what the Japanese banks did during their decade of insolvency: they rolled over loans to borrowers who they knew could never pay the money back, in order to avoid taking losses that would wipe out the banks’ capital.

There are plenty of investors who would be happy to take bundles of, say, commercial real estate loans off the hands of the banks and work them out — but only if they can get them for a price that makes sense. Good money can be made both for the investors and for the government, which, lest we forget, will get 50 percent of the upside. But the banks are going to be extremely reluctant to give up those loans, because by doing so, they would have to acknowledge the losses on their books.

That is why it is so important that the F.D.I.C. is managing this program. However much banks may not want to sell into the program (and for all the government’s insistence that the program is voluntary) it will be nearly impossible for a bank to resist the entreaties of its primary regulator. All indications are that Ms. Bair and her crew are going to use the program as a tool to force the banks to come clean on the health of their loans.

Once this process gets under way, does it mean that banks are likely to need additional capital? You bet it does. There are going to be new holes in balance sheets, and they’ll need to be plugged. But in the best of all possible worlds (a guy can dream, can’t he?), private capital will come in because investors will finally see that those bad assets no longer constitute a bottomless pit. Even if that assumption turns out to be overly optimistic, it will be far more politically palatable for the government to recapitalize the banks — or close them down, or even take them over, if need be — knowing that we finally can value the bad assets. You really can’t nationalize a bank without being able to make an ironclad case, to the public, that it is hopelessly insolvent. The P.P.I.P. will help make such a case.

posted by speakingcorpse : 3/28/2009 02:17:00 PM