Public-Private Investment Program: The Legacy Loans Program (US)

In early 2009, huge markdowns on mortgage-related assets continued to afflict the banks in possession of them, consuming their capital and inhibiting their ability to make new loans (PPIP White Paper 2009). That March, in recognition of the risks associated with these assets, the Treasury established the Public-Private Investment Program (PPIP) with two primary goals in mind. The obvious aim was to create new demand for troubled mortgage assets, thus enabling financial institutions to sell them. At the same time, the Treasury wanted a considerable portion of the new demand to be from private investors. In order to achieve this, it sought to form investment partnerships with them.

While the government could have purchased these assets on its own, it concluded that incorporating the private sector into its approach had three clear advantages: It would (1) “[leverage] the impact of each taxpayer dollar,” enabling for the purchase of more assets using less TARP funding; (2) reduce government exposure to risk, as the private sector would help to shoulder losses on investments; and (3) “provide a mechanism for valuing the assets,” helping the government to avoid paying the wrong price for them, which would have further distorted the dysfunctional market it sought to fix (PPIP Fact Sheet 2009; Elliott 2009; Polk and Wardwell 2009).

Created by Congress in October 2008 with the enactment of the Emergency Economic Stabilization Act (EESA), the Troubled Asset Relief Program enabled the Treasury “to purchase and insure certain types of troubled assets for the purposes of providing stability to and preventing disruption in the economy and financial system” (Public Law 110—343). The law defined troubled assets as:

(A) residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before March 14, 2008, the purchase of which the Secretary determines promotes financial market stability; and (B) any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, but only upon transmittal of such determination, in writing, to the appropriate committees of Congress.

Legacy loans and securities that were eligible for purchase through PPIP largely conformed to the description in definition (A). However, given the existence of definition (B), the Treasury Secretary also had the authority to decide if other assets needed to be purchased and what characteristics to apply to them.

Meanwhile, the FDIC sought to participate in the program by citing the systemic risk exception created by the Federal Deposit Insurance Corporation Improvement Act of 1991. It is unclear, however, if it ever received the authority to do so (GAO 2011).

The illiquidity of legacy loans in large part was due to the inability of buyers and sellers to settle on the price of them amid the ongoing housing correction and credit crisis (Elliott 2009). By holding auctions for these loans, the FDIC intended to manufacture a market for them, helping to “provide a . . . mechanism for valuing [them]” (PPIP Fact Sheet 2009).

In announcing PPIP, the Treasury stated the goal of committing up to $100 billion for its implementation, with the hope that—once the program incorporated private capital—it would be able to provide for the purchase of up to $500 billion in troubled mortgage assets. Although the FDIC’s commitment fell in line with this expectation, the agency gave no definitive indication of the amount of debt it was willing to guarantee.

The FDIC was responsible for most of the program’s elements. Its primary duties were to (1) “provide oversight for the formation, funding, and operation of [all] PPIFs,” which included vetting and approving private sector investors before they could participate;^FThe FDIC said that it would “pre-screen” private investors but did not say what specifically it would look for. (2) appoint and work with a “third-party valuation firm” to assess the quality of loan portfolios that banks wanted to sell, and to specify a leverage limit for the purchase of them; and (3) hold auctions (presumably with the help of third-party contractors), which not only required it to coordinate bids but also “preparation of required marketing materials” (i.e., making information on auction items—loans—available to PPIFs that were interested in purchasing them). The Treasury’s role was that of a funder; it agreed to provide exactly half of each PPIF’s equity base.^FThe FDIC noted that it would permit PPIFs to accept less equity from the Treasury but did not clarify terms that would apply to such a decision. The Special Inspector General for TARP and Government Accountability Office (GAO) were ready to assist in a supervisory role (Legacy Loans Program Terms).

No guidance was given as to how many auctions the FDIC would hold and over what time frame nor as to how long the PPIFs would have to manage any purchased assets.

Because the private market was hesitant to invest in troubled mortgage loans, the government needed to provide an incentive for it to do so as part of the Legacy Loans Program. As a result, the Treasury agreed to take a 50% stake (or less if investors so desired) in assets they purchased, and the FDIC promised to guarantee the nonrecourse debt they issued to fund these investments. In so doing, the program effectively reduced the risk borne by these investors while amplifying any returns they generated—decreasing the amount of capital they would have to gamble on these assets while assuring they had access to affordable debt to purchase them (Polk and Wardwell 2009).

At the same time, the provision of cheap financing was also supposed to increase investor tolerance for paying higher prices for these assets (Polk and Wardwell 2009). In this way, the program would help to convince holders of these assets to choose to now sell them (Polk and Wardwell 2009).

For the purpose of the program, these institutions were defined as any “bank or savings association organized under the laws of the United States or any State of the United States, the District of Columbia, any territory or possession of the United States, Puerto Rico, Northern Mariana Islands, Guam, American Samoa, or the Virgin Islands” (Legacy Loan Program Terms). 

The FDIC and Treasury anticipated that a wide range of investors would want to invest in PPIFs—including “financial institutions, individuals, insurance companies, mutual funds, publicly managed investment funds and pension funds”—and did not explicitly prohibit participation by anyone except for some foreign firms (Legacy Loans Program Terms; Financial Crisis Manual).

This was the only explicit asset eligibility guideline issued by the FDIC. Aside from this, banks were instructed to “work with their primary bank regulators . . . to identify and sell assets with a view to restoring maximum confidence for depositors, creditors, investors, and other counterparties”—suggesting that eligibility determinations would be made in consideration of the circumstances faced by individual banks (Legacy Loans Program Terms).

In February 2009, the Obama Treasury announced its Financial Stability Plan. Even though a wide array of financial stability efforts were already underway, the Obama Treasury saw the need for a second wave of crisis-fighting programs—ones specifically designed to “attack the credit crisis on all fronts” (Financial Stability Plan). The plan involved the participation of several government agencies and—in addition to PPIP—included proposals that ultimately became the Supervisory Capital Assessment Program (SCAP), Capital Assistance Program (CAP), expansion of the Term Asset-Backed Securities Loan Facility (TALF), Small Business Administration Section 7(a) Securities Purchase Program, and foreclosure prevention programs, including the Home Affordable Modification Program (HAMP) and Home Affordable Refinance Program (HARP).