Under all relevant outcomes, the failed banking assets were always winding up in the US’s possession as creditor of last resort. The only question was on terms.

It could be through bad ideas like nationalization from swelling ranks of zombie banks, or better ideas that include reconstruction of banking, it’s role and governance or as announced today, through a design like the Public Private Investment Program (PPIP) to purchase the failed assets, package them and resell them into the capital markets. This last approach was previously blogged about in October.

PPIP is a necessary part of reconstruction. But its final regulatory codification and execution is where the effort will be won or lost. As outlined by the Treasury Secretary, its aim is true but there is a good amount of trouble in its preliminary structure. The approach strikes me as a mutation of a PIPE. There is public investment financing private fee revenue and capital gains, for the sake of hoping it unlocks the lending markets.

A particularly troubling element is that the principal buyers of PPIP assets will be the unregulated community of private equity (PE) and hedge funds (HF). And…they will be bidding for PPIP assets with future US tax revenues. 93% of their buying power is financed by the Treasury (FDIC also but Treasury funds them too).

The terms of the program require private investors provide only 7.5% of the funding (and bear corresponding limited risk of loss) but they will be determining the bid price, with the leverage of 93.5% US financing. There’s so much not to like about that.

As an industry, along with the banks’ own negligent risk management, these groups were substantially responsible for the reckless investment practices that led to the insolvency of US monetary system and we’re expecting them to change their stripes and get us out of the problem responsibly. They are an industry driven by constructing unrealistic and unsustainable deals that garner them up front fee revenues and offload risk to syndicated borrowers. Pensions, endowments & states are buried under junk rated debt and deeply discounted ownership interests from their deals, while PE holds the cash from fees and possesses little remaining ownership risk.

There is no reason to believe these groups can accomplish anything more than being a 1st stage transfer agent for the government. They can be expected to establish the initial bid price, take momentary possession and then redistribute the assets and risk back into the marketplace, for a fee.

“If this is profitable, and I think it will be very profitable, you’re giving more profit to private investors,” added FDIC Chairman Sheila C. Bair.

For this profit, PE and HF will relocate the nonperforming assets, at a discounted price. The furniture will be re-arranged but nothing will have been done to improve the underlying performance of the assets, so the risk of loss will remain, leaving the US on the hook as guarantor. But PE and HF will have bloated up with some more fees.

Treasury officials made changes to the plan in recent days in a way that makes it more favorable to private investors, according to government and industry sources. The Treasury increased private investors’ share of potential profits from 20 percent to 50 percent.

The unsavory characteristics of this model for reacquiring the failed financial assets are a pill the White House feels it has to swallow. Congress has closed the door to funding a good plan based on reconstruction. They’re afraid for their seat at reelection but not afraid for the nation’s well-being. So what we’re left with is us, the taxpayer, taking the same role and model of the failed banks and providing mammoth leverage to the PE and HF community to purchase deeply discounted assets.

They will again earn fee revenue from reselling US government insured PPIP assets back into capital markets and offload the limited risk they briefly took on. The taxpayer will retain possession of the risk of loss as the redistributed assets will not have gone away. They will only have changed their address.