Hedge fund managers eschew participation in the Geithner PPIP

Ray Dalio, founder of Bridgewater Associates, runs one of the largest hedge funds in the world. Yet he is not interested in participating in Treasury Secretary Tim Geitner’s plan – the Public-Private Investment Program (PPIP) – to extract troubled assets from the balance sheets of banks that made bad investments. You can view the full article here.

thumbnail-ray-dalioWhy not? Well it seems there are lots of little devils in the details. First is the fact that the Fed will only be providing non-recourse loans (those are the kind that you don’t have to pay back if you lose it all) to five – tightly regulated – hedge fund managers. Anyone else who wishes to participate in the auction would have to put up 100 percent of the money.

No one in their right mind would dream of doing such a thing, so this auction will be between five fund managers. The five will have strings attached to their deal and will be directed to buy a great deal of these assets sight unseen. From the Business Insider

The way the buying is envisioned, two different types of buyers will be created — one with a very limited number (e.g., five) of managers who have access to leverage/put via PPIP, and the rest who don’t. So, unless you’re one of the five, you won’t get the benefits, and being one of the five has strings attached that make it difficult to act as a fiduciary.

…those who are selected as PPIP Managers (i.e. these five funds) will be in conflicted positions because the Treasury has expectations of how these managers should behave (like they should buy large amounts) because the whole program’s success hinges on how these five behave, yet, at the time of applying to be one of the five, they presumably don’t know the pricing and terms, or even exactly what will be sold. We couldn’t, and we wonder how other managers can, make commitments to be one of the five without knowing these things.

Now ask yourself why they might have structured it like that. Well it is because the treasury can then direct them to overpay for the toxic assets. The banks are made whole, the fund manager collects his fees regardless of what happens, and the American tax payer foots the bill. If the assets perform then the hedge funds make some serious money. If not, the taxpayer and the hedge fund investors are on the hook. Even with those incentives, hedge fund managers including Dalio do not want to participate.

If you are a hedge fund manager, you are in a no win situation. If the assets perform you are vulnerable to the government/press/big ugly crowd that will vilify them for fleecing the banks. If they do not perform customers (hedge fund investors) are going to vilify them for not performing.

Either these investments will make a lot of money for their investors or the government will lose a lot of money — in either case, there will be reasons for politicians to complain and to focus on the five winners to see how they “abused” the system.

My guess is banks will start hedge funds that will be capitalized by the banks themselves, then buy their own troubled assets having only to put up about 3 percent of the money. This gets the toxic assets off the balance sheet and diverts the risk to the taxpayer. It is a small price for them to pay.