The Public Private Investment Fund
Friday, March 20, 2009SUSIE GHARIB: The nation's budget deficit will top $1.8 trillion this year. And if you think that's big, just wait. The Congressional Budget Office says the Obama budget could produce $9.3 trillion worth of red ink over the next decade. That huge number reflects the worsening economy and the government's payout of billions of dollars to fix the financial system. Meanwhile, next week the Obama administration is expected to unveil one of its most important recovery programs yet, offering details on just how it'll clear all those toxic assets off the books of the nation's banks. It's called the public private investment fund. The idea is to bring hedge funds and other big investors in to help the government value and buy up troubled assets. Now while we don't know all the details, Darren Gersh looks at how the program might work.
DARREN GERSH, NIGHTLY BUSINESS REPORT CORRESPONDENT: Let's pretend we have $1 billion to invest. Villanova School of business Professor Mike Pagano says, we're in the cat bird seat.
MICHAEL PAGANO, PROF., VILLANOVA SCHOOL OF BUSINESS: When markets are panicking, people are nervous and everybody wants to sell, it's great to be a buyer.
GERSH: So if Uncle Sam wants to make us a deal, we're going to have some requirements. First, we're looking for favorable financing. Of course, the best borrower around is Uncle Sam. If he can pass along his low borrowing cost to us of around 2 percent, then we're interested.
PAGANO: Then I can make 12 to 18 percent on this investment and that's usually in the ballpark where these kind of distressed investors, some of these hedge funds find it attractive in other words it becomes worthwhile to take the risk.
GERSH: Our second requirement is leverage. In the go-go days, we would have put one dollar down and borrow $30 more to invest. But go-go is now a no-no, so the Fed's likely to offer us a smaller deal.
PAGANO: You would put in a billion and then the government would put in $5 billion.
GERSH: So any investment we make, we can multiply by six. For those of you who really love math, we have more details on our web site -- and keep in mind this is just one possible example. Dtails of the program haven't been released yet. But an educated guess is that if we buy a toxic asset paying 3 percent on our investment, we make six times 3 percent or 18 percent. And if our leverage turns out to be higher, we make even more. So far, so good, but we are talking about toxic assets, after here, which means we may want the financial equivalent of a hazmat suit, some additional financial protection in case things go wrong. How about this deal?
PAGANO: I'm willing to take some of the risk down, I'm willing to lose half of my money, but after that all losses go to the government.
GERSH: Which means we actually don't have $1 billion at risk. We have only $500 million at risk. In effect, we are doubling our return. Now we might make 25 to 30 percent and that's on the interest. If the value of the toxic assets themselves rise because there are more buyers, we can easily make 40 percent or more. Of course, we'll have to split some of this with our partners in the government, but remember, they put in a lot more money. So what is the government's return?
PAGANO: It looks like between 1 1/2, 2 1/2 percent return on their investment.
GERSH: That doesn't sound very good, but consider that if this works, we've helped the government clean up the pool of toxic assets that's poisoning the economy and that's huge. But if it doesn't work, you know who will be left holding the bag. Darren Gersh, NIGHTLY BUSINESS REPORT, Washington.
