Private Equity’s Missed Mortgage Opportunity

As a general rule, conscientious objection only matters if non-participation proves a point.

Exhibit A is the private equity industry’s refusal to get involved in the government’s attempt last year to clean up mortgage securities floating unwanted in the markets. While the industry now argues its own economic importance, the fact remains that, when called upon to serve its country, the industry took a giant, pointed pass. The worst part is that it wouldn’t have been a sacrifice for PE. They would have made money on it.

From the beginning, top PE pros made known the industry’s loud objections to the Legacy Securities Public-Private Investment Program, widely known as PPIP. The program, a pet of Treasury Secretary Timothy Geithner, faced immediate opposition. Henry Kravis, for example, said his firm would not participate, because he didn’t trust the government not to change the terms of the deal. Those terms, by the way, were absurdly advantageous to PE firms even at the expense of taxpayers, as economist Joseph Stiglitz pointed out.

In retrospect, PE not only looks bratty, but a bit poorer.

Subprime mortgage securities have been increasing steadily in value this year; according to Fitch’s latest update on May 12, “Since Jan. 1, the 2005 and 2006 vintages have increased by 36% and 22%, respectively. The 2004 vintage has also shown strong growth with a 20% increase.”

As a whole, the non-agency MBS market also looked to be in decent shape as of January, with prices bouncing to the high 80 cents on the dollar compared to only 60 cents in early 2009, according to Housing Wire. Securitization even made a tentative comeback in April, when Citigroup and Redwood Trust waded back into creating mortgage bonds without government backing.

Early evidence shows that PPIP appears to be in robust shape, with all 10 participating managers in the $6.3b raised — $25b of purchasing power with Treasury matches — reporting positive returns since inception. The most recent Treasury report is here.

BlackRock’s holdings rose 12% in value and Invesco’s investments are up 11% so far this year. Another is up 20%. Collectively, the funds’ holdings break down into about 88% residential mortgage-backed securities that aren’t connected to Fannie Mae or Freddie Mac. The remaining 12% are commercial mortgage-backed securities, according to Treasury’s latest quarterly report from March 31.

In the end, private equity’s lack of participation only underscored the fact that the industry wasn’t necessary to the mortgage cleanup, which was one of the biggest issues with the institutional side of the American economy. That doesn’t look too good as it tries to argue in Washington that it’s a crucial part of the American economy that shouldn’t be taxed like the rest of us. In politics, the saying goes, “you got to dance with him that brung you.”