Lynn Tilton has gotten her hands dirty in toxic assets and bad banks before, and sees "fatal flaw s" with the Obama administration's plan to kick start the credit markets and make the U.S. financial industry healthy again.

Tilton, the CEO of $6 billion private-equity firm Patriarch Partners, was responsible for creating a "bad-bank" structure for FleetBank, used in 2000 to unload $1.35 billion in troubled loans several years before it was absorbed by Bank of America ( BAC). Tilton engineered a similar deal for CIBC the following year.

She holds a patent for a valuation method that she says effectively finds a middle-ground price for troubled assets weighing down banks' balance sheets. Banks have been unwilling to sell at the fire-sale bids they have received since the financial crisis heated up last year, and investors like private-equity funds and hedge funds have not yet raised offers on their own, either because they are unwilling or unable to obtain financing to do so.

Tilton has been involved in the industry for nearly three decades, and cut her teeth making deals at Morgan Stanley ( MS), Goldman Sachs ( GS), Merrill Lynch and Oppenheimer ( OPY), as well as private firms. Patriarch makes direct investments in over 70 middle-market distressed businesses, including manufacturing, technology, health care and staffing and services companies.

Following is an interview, edited for style and length, about Tilton's views on the Public Private Investment Program that promises to spend up to $1 trillion in government funds to finance toxic-debt deals.


TheStreet.com: What do you think of the PPIP as outlined today?

Lynn Tilton: I think this is good socially, and a good step in the right direction, but I don't think you have mutually aligned incentives. I don't think it will work.

The market is certainly applauding it -- up 310 points -- but for me I think there's a fatal flaw in the structure. It's structured so you either overpay for the assets so that the banks are incented to sell, or if the prices are correct, then the banks don't want to sell and allow taxpayers to win.

The hardest aspect of this program is getting everybody to agree on pricing. When I did this, it worked because the banks shared in the upside. But the most important issue to me was that we didn't pay too much. The bank incentives are not aligned with the public and the private. I think it can be a great deal for the private investor if the pricing is correct. But on the other hand, if you pay too much, it doesn't matter how much leverage you have, you lose money.

Isn't competitive bidding supposed to achieve some kind of fair value?

Well, they're only choosing five players; this is not open to everybody. I don't like that you have to be very big to play. The whole idea is to get private money flowing. However, if you don't have $10 billion in assets, then you're not eligible to play. So you're only benefitting the BlackRocks ( BLK), the PIMCOs, the Carlyles and the Apollos of the world.

It has to be open to many more investors -- you're either too big to fail or not big enough to play.

So how would you address those flaws in the plan?

You have to walk the shortest distance between two points -- from where you are to where you need to be. My frustration is that with $3 trillion of spending, I have not yet seen the government take the shortest distance between two points to get credit flowing to starving industry, hemorrhaging jobs each day.

We're losing technology and know-how that we will never get back with each liquidation. These companies need fresh capital to come directly to them, and every time you add a layer, it's a further hindrance to accomplishing the goal of credit to industry.

Do you think this plan will be revised again? Some of the language is a bit squishy, and seems like the administration gave itself some breathing room to adjust if necessary.

If they have to drag investors and banks to the table and it's not working, then they'll have to keep adjusting. It took me the better part of a year to get my structure to work and get one to which all parties would ante up. I don't understand why I haven't gotten a call from Treasury, since I have a patent for the technology to value these assets.

Have you spoken to people in the Treasury Department?

I've reached out and talked to some people at Treasury. I haven't talked to Treasury Secretary Tim Geithner. But I guess they felt they didn't need my guidance and they already had the right structure in place.

What do you see happening with this plan over the next few months?

I don't think this will get done until at best the third quarter of 2009. By the time this cash gets to banks' balance sheets, how many additional jobs will be lost? How many firms will go under? The front line to recovery needs to be direct lending to the industry, fast.

A straw man is a straw man until deals are getting done. And even when deals are getting done, and we don't know whether a structure is valid until all the winners and losers are known.

I could be wrong that the structure is significantly flawed-- the rest of the world seems to embrace it. I don't know what I see that others don't. Maybe I'm drinking different water.

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