A Big Surprise: Troubled Assets Garner Rewards

American taxpayers are already poised to make unexpected billions from rescuing the nation’s banks. Now, they could reap another sizable profit from a government program devised to purge troubled real estate assets from the financial system.

The Obama administration made the so-called Public-Private Investment Program a centerpiece of its plan to help unlock the frozen credit markets in the spring of 2009, when a lack of buyers for complex mortgage securities threatened the health of the nation’s banks and put a drag on lending.

Under the program, the government provided matching funds and ultracheap loans to investment firms like AllianceBernstein and Oaktree Capital that agreed to buy mortgage securities from banks, insurers and other financial institutions.

Taxpayers stood to share in any of the profits, though the prospects of such a windfall were seen as secondary to the goal of unclogging the markets.

Nine months into the program, the eight investment funds chosen by the Treasury Department have generated an estimated return of about 15.5 percent for taxpayers, according to an analysis of their results through the end of June by Linus Wilson, an assistant professor of finance at the University of Louisiana, Lafayette.

Two of the investment funds — one operated by an Angelo Gordon-GE Capital consortium and another by BlackRock — have gotten off to even stronger starts, posting returns of more than 20 percent.

That translates into a paper profit of roughly $657 million for taxpayers. Some Wall Street analysts project that taxpayers could earn as much as $6.2 billion on these investments over the next nine years, from an investment of about $22 billion.

To be sure, the funds’ standout performance can be attributed to a rally in the mortgage bond market that began late last year and may be hard to repeat.

Still, it is a remarkable turnabout. When the administration announced the Public-Private Investment Program, critics lambasted it as yet another giveaway to private equity firms and other Wall Street money managers — a program so ill-conceived that one prominent economist, the Nobel laureate Joseph Stiglitz, characterized it at the time as a “robbery of the American people.”

But the strong start of the funds has pushed aside many of those concerns.

“We feel very good about the performance to date,” said David N. Miller, the Treasury Department’s chief investment officer who oversees its bailout-related holdings.

The administration has not yet provided its own profit projections, and all proceeds will be used to pay down the nation’s ballooning debt. But any windfall, Mr. Miller suggested, would be icing on the cake for taxpayers.

The program’s main benefit, he said, has been to help revive the market for complex mortgage bonds, whose trading ground to a halt a year and a half ago. That helped break the downward spiral of asset prices and paved the way for a wave of new bond deals, which lenders rely on to finance new mortgages.

“We view that as accomplishing the mission,” Mr. Miller said.

The scope of the government’s action was scaled back before it got started. In fact, the original purpose of the $700 billion federal bailout program, authorized by Congress during the tenure of Treasury Secretary Henry M. Paulson Jr., was to buy mortgage assets much more aggressively. Instead, that money was used to make direct investments in troubled banks.

So, to restart the trading of mortgage assets, the incoming Treasury secretary, Timothy F. Geithner, announced the creation of a smaller Public-Private Investment Program. The administration hoped to establish market prices for the assets so that banks would not have to sell them at fire-sale prices, which would have threatened their solvency.

As a side effect, though, the extraordinary government interventions in the banking system made necessary by the financial crisis have turned the United States government into one of the world’s biggest vulture investors.

In addition to the $22 billion the Treasury Department has invested in the public-private program, the Federal Reserve has amassed about $69 billion of distressed loans and bonds from the 11th-hour rescues of Bear Stearns and the American International Group. That program appears poised to turn its own multibillion-dollar profit for taxpayers.

Together the Treasury and Fed have allocated more than twice as much taxpayer money toward distressed real estate assets as the combined total the 10 largest private real estate investment funds have raised for such assets over the last decade, according to Prequin, a financial information provider.

In normal market conditions, these funds are the lifeblood of real estate financing.

All that money invested by the government is still tiny compared with the estimated $1.8 trillion worth of distressed residential and commercial mortgage-related securities that were eligible for sale when the investment funds drafted by the Public-Private Investment Program began their purchases last fall, according to a Barclays Capital research report. Those assets remain on the books of many Wall Street investment houses, insurers and banks.

What the program has provided, though, is a big dose of confidence in the markets, assuring investors that there would be a steady stream of buyers for distressed securities.

More than 100 investment firms applied to participate in the program and raised money from private investors. Even though only eight funds were chosen to receive government money, many of the others have nonetheless been dabbling in the market, helping to bid up prices.

“That literally changed supply and demand,” said Wilbur L. Ross Jr., the veteran vulture investor who helps manage Invesco’s public-private fund.

The Public-Private Investment Program has run into its share of problems. For example, a second component of the program — to be run by the Federal Deposit Insurance Corporation and intended to encourage the purchase of real estate loans rather than bonds — never got off the ground.

Also, some of the early promises that ordinary investors would be able to “profit from the bailout” by owning stakes in public-private investment funds have failed to materialize. BlackRock, for example, failed to win regulatory approval to create a mutual fund for ordinary investors that would have largely invested in the firm’s public-private fund.

Legg Mason and Nuveen Investments have offered consumers the chance to own smaller slivers of the program’s investments through the Mortgage Opportunity mutual funds they sell — although they have only modestly outperformed their peers.

Government watchdogs have also raised concerns about the program. Neil M. Barofsky, the special inspector general assigned to monitor the use of bailout funds, faulted the Treasury Department by saying it had failed to establish “appropriate metrics and internal controls.”

Fund managers brief federal officials at least monthly on their performance, but Mr. Barofsky concluded that expecting private firms to develop detailed policies and procedures “is not appropriate in light of the risk of conflicts of interest inherent” in the public-private investment program. His follow-up audit of the public-private fund managers is expected to be completed in September.

Meanwhile skeptics like Professor Wilson question whether the government’s favorable financing terms were actually encouraging the fund managers in the program to make risky wagers without giving taxpayers a big enough piece of the upside.

“The U.S. Treasury has given the asset managers incentives to swing for the fences,” Professor Wilson said. “The asset managers have hit some early home runs, yet we are still in the first inning of these investments.”

Although the program’s eight investment funds have posted solid results so far, they have invested only about $16.2 billion, or just over 55 percent of the $29.2 billion of the total money they have raised, according to government data through June.

The Treasury Department has put up roughly three-quarters of that total, matching dollar-for-dollar money put up by private investors while also providing an even bigger helping of debt financing at about 1.3 percent, well below normal interest rates.