On March 23, 2009, the Treasury Department announced the Public-Private Investment Program (PPIP), a collaborative initiative among the Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC), on the one hand, and private investors, on the other hand, to create $500 billion to $1 trillion in buying power for the purchase from financial institutions of “legacy” (formerly known as “toxic”) loans and securities.  Loans eligible for purchase likely will include primarily residential and commercial mortgages and leveraged loans used to fund buyouts, and eligible securities are likely to include securities backed by eligible loans and certain consumer loans.  The goals of the PIPP include (1) creating a market for currently illiquid assets, thus enabling financial institutions to value and sell those assets, which in turn will enable the institutions to make new loans, raise new capital and repay TARP loans; and (2) reopening the securitization markets, which, at least prior to the credit crisis, generally expanded (some would argue over-expanded) the availability of consumer credit and reduced its cost.  Many of the details of the PPIP remain to be provided.  In the meantime, prior to the provision by the Treasury, Federal Reserve Board or FDIC of further guidance and clarification, hedge and other private fund managers are evaluating the advisability of participation based on the announced parameters of the PPIP.  In particular, hedge fund managers are analyzing the following issues, among others:

1. The scope of the FDIC’s oversight of various aspects of the PPIP, and the role of the Treasury as an equity co-investor and, in the case of the Legacy Securities Program, a lender.
2. With respect to the Legacy Loans Program, the design of the auctions in which assets will be sold, and the timing of the FDIC’s leverage determinations (i.e., the extent to which the FDIC can, as a practical matter, provide clarity with respect to the amount of leverage it can offer prior to commencement of an auction).
3. Any limits that may be imposed on hedge fund manager compensation as a result of participation.
4. How participation may be structured, i.e., whether current funds can invest or whether new dedicated funds have to be organized.
5. Tax issues, including the structures that will be permitted or required for PPIFs, the ability of tax-exempt or non-U.S. investors to invest in PPIFs via offshore feeder funds (likely structured as non-U.S. corporations) and the characterization of income from PPIFs as ordinary income or capital gain.
6. Adverse selection issues, i.e., whether banks will only seek to sell their worst assets under the program (and if so whether appropriate pricing can mitigate the gravity of this concern).

Our article addresses each of these issues in detail.