It looks like the Legacy Loans Program (LLP) is dead on arrival.
According to The New York Times, the Federal Deposit Insurance Corporation (FDIC) has indefinitely postponed the LLP because it "could not persuade enough banks to sell off their bad assets." Readers might recall that the LLP was designed to remove toxic loans from banks' balance sheets by attracting private capital through a generous FDIC debt guarantee and a matching equity co-investment from the Treasury Department.
FDIC Chair Sheila Bair tried to put a positive spin on the decision to postpone the program, stating that "banks have been able to raise capital without having to sell bad assets through the LLP, which reflects renewed investor confidence in our banking system." But we suspect there might be other reasons why banks are turning a cold shoulder to the program.
Yesterday, The Wall Street Journal published an in-depth article on a fateful decision by the Financial Accounting Standards Board (FASB) to weaken a key accounting rule in response to congressional pressure and a fervent lobbying campaign by the banking industry. The change to the rule on fair-value, or "mark-to-market," accounting has given banks significant leeway to
manipulate estimate the value of the assets on their books.
At the time, Bloomberg columnist Jonathan Weil called the FASB's rule change the "dumbest, most bankrupt proposal in its 36-year history." But it was clearly high up on the banking industry's wish list. Drawing on data from the Center for Responsive Politics, the Journal reported that a coalition of financial firms and trade groups spent $27.6 million on lobbying in the first three months of 2009 and made $286,000 in contributions to members of the House Financial Services Committee to push for the change. And it looks like they'll get a nice return on their investment: the Journal cited one industry analyst who estimates that the rule change will increase bank earnings by an average of 7 percent in the second quarter of this year.
We don't mean to suggest that this is the only reason why the LLP is having trouble getting off the ground, but it seems likely that many banks would be inclined to use the lax accounting rules to place a favorable value on their own assets, rather than relying on outside investors to bid on the price. Despite the extremely generous terms of the program, other commentators have speculated that the government subsidy still isn't enough to close the gap between what the banks are estimating their assets are worth and what private investors are willing to pay for them. Of course, some banks are probably frustrated because they weren't allowed to bid on their own assets, as many had proposed to do in public comments to the FDIC.
Earlier this year, POGO raised concerns about the LLP because it appeared that the FDIC was overstepping its authority and placing billions of taxpayer dollars at risk without congressional approval. We were also alarmed by the serious potential for private investors to game the system, a concern that still applies to the other piece of the Public Private Investment Program (PPIP), the Legacy Securities Program.
As noted above, FDIC Chair Sheila Bair claims that the initial failure of the LLP reflects "renewed investor confidence in our banking system." But we maintain that public confidence is eroded by the potential for banks to overvalue their own assets, and also by the news that deeply entangled firms like BlackRock could still play a pivotal role in the PPIP despite their apparent conflict of interest. We urge Congress to address these and other concerns that have been raised on numerous occasions by the Congressional Oversight Panel and the Special Inspector General for the Troubled Asset Relief Program.
-- Michael Smallberg