"Solution" to the Financial Crisis: Game Theory Exposes PPIP As Fraudulent


by James Keller
Global Research, April 10, 2009
realclearmarkets.com


Game theory tells us that a risk neutral gambler would pay $50 dollars for a coin flip that paid $0 for Heads and $100 for Tails. Game theorists would call $50 the value of the bet.

Suppose someone is willing to fund your gambling problem, and lend you $80 at zero interest. Better still, if you lose the bet you don’t have to pay him back. Under that scenario, the same gambler would pay $90 for the bet, giving him an even chance of winning or losing $10.

This is a microcosm of what the Public-Private Investment Program (PPIP) is intended to do: create an incentive for investors to pay $90 for a bet that is only worth $50. It is bad economics and bad public policy and it is probably fraudulent. Congress should act pre-emptively to halt Treasury Secretary Tim Geithner’s latest scheme.

In the gaming example above the lender has a bet where he gets $80 or zero with equal odds. The value of that bet is $40. Since he paid $80 for it, he has an expected loss of $40. The PPIP puts the taxpayer, via the Federal Deposit Insurance Corporation, in a similar position. The details are only slightly more complicated. A full analysis would include the diversity in the pools of loans, the interest rate charged by the lender, and the opportunity cost to the lender for a similarly risky bet.

We don’t have enough information from the FDIC about what it intends to charge for the 84% of the PPIP it is guaranteeing and we don’t know the exact mix of assets. But once these are revealed, the analysis becomes straightforward, and the expected loss to the FDIC can be estimated with a reasonable degree of certainty.

Why is this particularly interesting? Many commentators have pointed out the obvious: that the PPIP is another welfare program for the big banks, funded by the taxpayer.

It is interesting because the legislation governing the FDIC does not allow it to take expected losses above its capital base, and that capital base is now just $30 billion. Against a $500 billion PPIP, it only requires a 6% overpayment to wipe out the FDIC’s capital.

The New York Times’ Andrew Ross Sorkin pressed the FDIC’s Shelia Bair on this point and she apparently claimed that the accountants “signed off on no net losses.â€