Questions of Faith for Legacy Loans Program

The Federal Deposit Insurance Corp. (FDIC), which is designing the Legacy Loans Program, is receiving concerns from both potential buyers and potential sellers of the loans that the rules of the program might change as public and political views of Wall Street deteriorate further.

The Legacy Loans Program, a big part of the Public-Private Investment Program (PPIP) designed to attract private capital to buy up toxic — or so-called “legacy” — loans may even be closed, reports say, as regulators shuffle programs to find the right balance.

Much like the banks that found themselves the targets of public criticism and tight regulatory oversight for taking Treasury Department funds through the Troubled Asset Relief Program, prospective participants in the Legacy Loans Program fear they might be subject to changing regulations and heightened criticism.

In response, the FDIC may scale back on the program or put it on the back burner altogether, unnamed sources told the Wall Street Journal.

The issue of toxic loans is far from averted by the news, however, and some banks are getting creative with alternatives. Bank lobbying groups asked the FDIC to allow banks to bid on the same toxic loans they put up for sale, sources told the WSJ. Such a move, the trade groups argue, would give banks an incentive to sell assets at low prices or even at losses, to keep capital flowing between banks, remove toxic assets off their balance sheets and encourage lending.

But the request raises the question of just how much more taxpayer money banks would receive through the government-subsidized legacy loan purchases under the PPIP. It remains unclear just how much banks would lose by selling loans at or below market prices, although one analysis of SEC filings by Bloomberg today suggests the figure tops $168bn.

Despite the creative solutions, the only plausible cure-all to the toxic asset situation is for a so-called “bad bank” to buy these legacy loans, according to statements published this week by Pricewaterhouse Coopers.

“The crisis is about to enter a new phase where efforts to remove troubled assets from bank balance sheets must be accelerated,” the firm said, according to a Market Watch bulletin. “US government interventions to date have stabilized individual institutions, but have not created a functioning market and pricing mechanism and therefore have had little impact on reviving the broader markets.”

A real pricing mechanism, according to Pricewaterhouse Coopers, would be for the government to set the price for the assets by purchasing them through the bad bank. Real price discovery, however, cannot be achieved through the PPIP, in which banks would be forced to accept losses on the loans and which would create a disincentive situation, the firm said.

“It is likely that this approach will prove inadequate to the task of relieving banks of all of their troubled assets in a timely manner,” the firm added, “making some form of bad bank solution inevitable — meanwhile prolonging the crisis and increasing the cost of its resolution.”

HousingWire takes a critical look into the PPIP, its mechanisms and the way it works — or doesn’t — in the June magazine issue, out today.

Write to Diana Golobay.

Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments.