More Leverage Won't Solve Bank Mess

Overleveraging is at the root of the economic crisis, but its perpetrators propose more of the same to get us out of this mess -- and this time, on the public dime.

This summer the Public Private Investment Program, or PPIP, devised by Treasury Secretary Timothy Geithner is scheduled for implementation. This program has the objective of removing toxic assets from bank balance sheets to investor hands. The goal of the plan is to move up to $1 trillion questionable assets from the bank balance sheets and transfer them to the PPIP investors.

PPIP investors can expect reward to risk ratios of 2/1, 3/1 and 4/1 (or even higher). Because 85% of the purchase price for toxic assets purchased under the plan will come from FDIC non-recourse loans, the purchase of assets under this plan actually is more related to investor purchase of an option to buy, rather than an outright purchase.

The PPIP has had notable critics, including Paul Krugman, Joseph Stieglitz and James K. Galbraith. But these earlier criticisms, did not include the manipulation now contemplated. The analysis referenced above also did not consider this.

A Wall Street Journal article on Wednesday reports that "Banking trade groups are lobbying the Federal Deposit Insurance Corp. for permission to bid on the same assets that the banks would put up for sale as part of the government's Public Private Investment Program."

The article goes on to note that "critics see the proposal as an example of banks trying to profit through financial engineering at taxpayer expense, because the government would subsidize the asset purchases. 'The notion of banks doing this is incongruent with the original purpose of the PPIP and wrought with major conflicts,' said Thomas Priore, president of ICP Capital, a New York fixed-income investment firm overseeing about $16 billion in assets."