In late 2008, Warren Buffett drafted a plan to save the financial system. He sent the proposal to the U.S. Treasury. Within months, the Treasury implemented the plan almost exactly as Buffett proposed. It's failed miserably since then.
I'm talking about the Public-Private Investment Partnership, better known as PPIP.
If you haven't heard of PPIP, don't sweat it. It's one of who-knows-how-many notions cooked up to save the economy. In short, it's a Frankenstein plan to marry private money with government leverage, creating an investment machine that can buy the putrid junk off banks' balance sheets. Like a public bailout with a dash of free-market input -- Keynes and Hayek holding hands.
Here goes nothing
In March 2009, the Treasury created PPIP, pledging up to $100 billion to be matched with private money and leveraged into a $1 trillion toxic-asset-eating monster. Buy all the terrible assets, thought went, and we're all set. Economy saved.
But to say the plan was met with jeers is an understatement. Almost no one liked it. One government watchdog called it "a sham." Whatever you wanted to call it, it was another bailout at a time of utter bailout abomination.
Soon after, rumors began that PPIP was Buffett's brainchild. Few thought much of it. Some didn't think it was true -- only a public dolt like the Secretary of Treasury could conceive such recklessness.
But an October 2008 four-page letter sent from Buffett to then-Treasury Secretary Hank Paulson recently surfaced. New York Times columnist Andrew Ross Sorkin mentions the letter in his book on the financial crisis. Almost word for word, it describes PPIP five months before its birth. (See it here.)
In the letter, Buffett proposes creating a public-private fund to buy mortgage assets "in a way that dramatically reduces the risk -- to almost zero -- that the Treasury will lose money on its purchases."
To do so, private investors would provide $1 of equity for every $4 of government leverage. Investors would be wiped out before the Treasury took losses, and buyers "would have every incentive to make intelligent purchases," lowering the chances of taxpayers getting hosed.
Buffett's proposal notes that he'd already lined up Goldman Sachs (NYSE: GS ) to work pro-bono on raising $10 billion of equity, with Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) willing to contribute another $500 million. Corral a few more investors, leverage that beast up with taxpayer dole, and you've got the mother of all toxic-asset-buying machines.
More specifically, you've got PPIP. This was all Buffett's idea.
There's a reason he isn't bragging
Almost one year after its creation, PPIP is universally known as a dud.
Matt Taibbi, Rolling Stone's honest yet maniacal columnist, describes it as "this bizarre scheme" in which "the government loaned money to … private investors to buy up the absolutely most toxic [expletive] on the market -- the same kind of high-risk, high-yield mortgages that were most responsible for triggering the financial chain reaction in the fall of 2008."
That's true, but there's little reason to worry: As of Dec. 31, PPIP had raised just $6.2 billion of private capital, leveraged on behalf of taxpayers into $24.8 billion. From this $24.8 billion, all of $4.3 billion worth of toxic assets have been purchased, or 0.43% of PPIP's intended $1 trillion goal. Put another way, it's failed. Miserably.
Why? Where did Buffett and the Treasury's idea go so wrong? Let's count the ways.
1. It targeted the wrong problem.
The market for toxic assets froze for one reason: Banks refused to sell at prices investors were willing to pay. Even with PPIP, that's still the case. Banks don't want to sell some of these assets for anything less than full value, largely because tweaks to mark-to-market accounting have allowed them to resume carrying junk assets at fantasy prices. Yet investors want bargains. They want to pay pennies on the dollar. Even with PPIP's leverage, this "bid-ask" chasm wasn't bridged. Happy buyers couldn't be matched with willing sellers.
2. It's easy to abuse.
Within hours of its birth, examples sprouted showing how banks could exploit PPIP, offloading soured assets while giving taxpayers the firm middle finger. One example involved the banks looking to sell assets simultaneously buying their own assets at inflated prices, contorting market bids and luring PPIP investors into certain losses, leaving taxpayers holding the bag. Who knows if that happened, but Taibbi writes, "In the third quarter of last year, Goldman, Morgan Stanley (NYSE: MS ) , Citigroup (NYSE: C ) and Bank of America (NYSE: BAC ) combined to add $3.36 billion of exactly this [expletive] to their balance sheets." Last summer, JPMorgan Chase (NYSE: JPM ) was rumored to be a potential junk-asset buyer as well.
And since the plan is prone to exploitation …
3. Private investors aren't dumb enough to participate.
The main reason PPIP has failed is because the private investors it relies on have been curiously absent. Oddly, being at the mercy of Congress isn't on every investor's list of savvy business moves. The CEO of hedge fund giant Bridgewater Associates succinctly explained why his firm wouldn't participate: "There will be reasons for politicians to complain and to focus on the [private investors] to see how they 'abused' the system." Apparently the risk of Nancy Pelosi's stink eye ain't worth it.
PPIP made sense in theory. Unfortunately, it was thrown into the most screwed up and convoluted market the world has ever seen. That Buffett himself underestimated the mess shows just how big a problem this is.