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How the Treasury Department Cooks the Books on Toxic Mortgages

Late Friday afternoon, a Bloomberg headline trumpeted the success of The Public-Private Investment Program thusly: "Treasury Gets 36% Return Buying Toxic Mortgages."

Mortgage
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Mortgage

And the warm fuzzy feelings about Treasury's success don't end with the headline.

A quote from paragraph three is characteristic of the overall tone:

"'The first year has been out of the ballpark,' Jeffrey S. Phlegar, who heads the PPIP fund run by New York-based money manager AllianceBernstein LP, said yesterday in a telephone interview."

The Bloomberg article also juxtaposes Treasury's PPIP return against other market indices as a benchmark: "That compares with the 10 percent return for the Standard & Poor's 500 Index and 8.2 percent for the BarCap U.S. Aggregate Total Return Index of bonds."

In paragraph eight, however, the article does eventually turn to the contrarian opinion of University of Louisiana at Lafayette finance professor Dr. Linus Wilson — who cites a far lower return figure: 5.6%.

I spoke to Dr. Wilson earlier today in an attempt to reconcile that discrepancy.

Dr. Wilson began by explaining the derivation of the 36% figure: "If you take a simple average of the eight fund returns, you get a 36% annualized return. That's what Bloomberg did."

But, according to Wilson, there are other factors which must be accounted for in calculating the actual rate of return.

"Two thirds of the taxpayer's investment is in debt: Taxpayers are receiving a meager 1% return on two thirds of their investment — only the one third that is in equity is doing well."

And, it's worth remarking, that even the equity return is based on Treasury's own mark-to-model figures.

Says Wilson: "The problem the taxpayers have with all the assets is that these things are not being audited. We need to have these returns audited by independent bodies."

Also, there's the issue of how Treasury is annualizing their return figures.

Wilson told me, "The way treasury is handling their annualizing is, I believe, boosting their rate of return by a factor of two. There is nothing wrong with annualizing returns — but you can't eat annualized returns — you can only eat the returns you get. If you look at the 36%, you're not going to be able to say you have 36% more equity — because you don't."

"These are eight to ten year investments," Wilson went on to say. "If it turns out that the underlying mortgage bonds are doing really well right now, it doesn't mean that they are necessarily going to do well in 8 to 10 years."

And there are other ways in which the numbers are less than transparent.

According to Dr. Wilson, "It's too bad treasury doesn't quote an overall equity return number, because tax payers are invested in all eight funds — not invested in the individual eight funds."

And of course, everyone is totally reliant on Treasury's numbers — because we don't know exactly what securities Treasury actually owns.

"We have no disclosure with what they've bought. They're just not disclosing their holdings," Wilson says.

Why wouldn't Treasury disclose the actual securities they hold in their portfolio?

According to Wilson, it's likely that, "they're worried that people are going to copy their trades. The fear is that if investors know what particular bonds these funds are targeting, other people would try to get into similar bonds before them."

In short, Wilson sums up his suspicions rather succinctly: "It appears" he says, "They are trying to overstate how much taxpayers are making."

An absence of transparency and the use of proprietary data have traditionally generated skepticism from investors. Should that skepticism be any diminished when the entity reporting isn't a private company — but a federal executive department?

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