'Vultures' Give U.S. Good Mark

'Vultures' Give U.S. Good Mark

By MATT WIRZ

The credit crisis made Uncle Sam the largest distressed-debt investor in financial history, as the government piled into a $388 billion patchwork portfolio of U.S. banks, insurers, car companies, and even a fast-food franchise.

Granted, the Bush and Obama administrations were more focused on stabilizing the financial system when they began their purchases in Sept. 2008. But based on the unvarnished principles of "vulture" investing—buying into broken companies that other investors avoid—how has the government fared as it begins unwinding its big positions?

Thirteen distressed specialists polled by The Wall Street Journal give the U.S. a begrudging "B" in Vulture Investing 101, with room to earn a "B+" depending on results of upcoming stock sales in General Motors Co. and American International Group Inc.

.Most of those interviewed praise the government for getting so much of its money back in less than two years.

"It's remarkable that they've made any kind of a decent return given that they didn't have any time to do real due diligence," said Wilbur Ross, founder of WL Ross & Co. and a distressed investor in global, steel, textile and automotive manufacturers. WL Ross participated in the recapitalization of the banking system through co-investments with the FDIC and through the $40 billion Public-Private Investment Plan, and its automotive portfolio company supplies GM.

But others pointed out that the government could have extracted greater profits and restructured bailed-out companies more aggressively.

The Congressional Budget Office estimated in November that the U.S. will lose $25 billion on the $388 billion disbursed through the Troubled Asset Relief Program, or TARP. That's down from the $50 billion hit Treasury projected in October and the $105 billion it forecast earlier in the year.

Like all investors, distressed-fund managers evaluate themselves first and foremost on the returns they make relative to the risks they take. They also pride themselves on how well they restructure operations, how quickly they can exit their positions and how effectively they bargain—or bully—at the negotiating table, all of which contribute to profits.

Treasury reported one of its strongest investment performances yet in early December with a total profit of $12 billion, or 27%, on the $45 billion it sank into Citigroup beginning in October 2008. That stacks up quite well against the 28% that the Hedge Fund Research Distressed/Restructuring index returned over the same period.

On the other side of the ledger are Freddie Mac and Fannie Mae, which have yet to return principal on government loans and remain mired beneath underwater residential mortgages. The bailout of the two mortgage lenders has already cost taxpayers $134 billion on top of TARP.

Meanwhile, 123 banks missed November dividend payments on their TARP loans, according to SNL Financial. Those banks collectively have received $3.3 billion in TARP aid, SNL said.

That leaves the remaining asset and stock sales by AIG and GM as the main outstanding measures of profitability. Treasury has said it expects to generate positive returns on both, but it currently faces a paper loss of $9 billion, or 18%, on its $50 billion investment in GM. After committing $120 billion in aid to AIG, the government hopes to eventually turn a profit by selling off the insurer in parts.

Treasury Secretary Timothy Geithner and his advisers earned high marks for the pace they set in restructurings. "If you ask the question, 'did they get in there and establish order quickly?' I think the answer is yes," said one fund manager who invested in the debt of some of the bailed-out companies.

The speed of the workouts—GM exited bankruptcy in 40 days, a record for a company that size—owes a lot to the unparalleled political clout the government brought to bear in the restructurings it initiated. Many restructuring experts argue that Treasury trampled on creditor rights in the bankruptcies of Chrysler and GM just as it swept aside preconceptions about limits to its authority in aiding AIG, Freddie Mac and Fannie Mae.

Some investors still resent the Obama administration's write-off of loans and bonds in the auto restructurings, while at the same time protecting union benefits and bank creditors. But they grudgingly respect the way the government played its cards and forced opponents to fold, something veteran vultures spend years building reputations for.

"I think the government played it very well," said New York University business professor Edward Altman. In the case of GM, creditor treatment may have been unfair, but that gave the company the best shot to survive, and that gave confidence to the market, he said.

The game theory from Treasury's perspective was simple. It could afford to impose haircuts on lenders to the auto manufacturers because GM and Chrysler didn't depend on the owners of its debt for day-to-day funding, as did many banks.

In the case of financial institutions, the government focused on co-opting creditors rather than strong-arming them. "Banks depend on the confidence of their creditors for their day-to-day operations," said Jim Millstein, Treasury's chief restructuring officer. "You can't seek to impair creditors of a financial institution unless you're prepared to liquidate."

By holding back from a wholesale nationalization of the banking system and introducing a credible stress test, the U.S. triggered the virtuous cycle that buoyed capital markets for the past 18 months. It also avoided significant restructuring of the core cause of the crisis, the overleveraged real-estate market.

That bears directly on the one category where distressed-investing pros graded the government most harshly: companies' operational improvements. Many toxic mortgages remain on banks' balance sheets, and the bulk of those now on Uncle Sam's books remain unaddressed given the foreclosure and refinancing morass.

The government has taken much of the prospective mortgage losses from the private banks onto its own balance sheet by funding the lion's share of refinancings since 2008 through Fannie Mae, Freddie Mac and the Federal Housing Authority.

"If you take a bad mortgage and have the FHA refinance it so it comes off one of these bank's books, and then the government takes a loss there, it's really hard to see how that's a success," said Greenlight Capital President David Einhorn.