Thursday, July 2, 2009

An Alternative to PPIP: CLEFs (Closed-End Funds)

Posted on Wall Street Journal MarketBeat by David Weidner:

Enthusiasm for the Public-Private Investment Program ranges somewhere between the thrill someone gets anticipating a trip to the dentist to the anxious waiting for a quarterly report after investing alongside Ron Insana — almost everyone is looking for an alternative.

Today’s Writing on the Wall column tackles the PPIP, and though it doesn’t argue for the program, it does make the case something should be done.

Wall Street and regulators need to create a fair and transparent system for dealing with toxic assets. It may be that the government requires bank participation in PPIP, or that assets not auctioned will be assigned a value by an independent party. Breaking institutions or the industry into a “good bank” and “bad bank” is still the route favored by some.

Without a plan, the banking system may whistle along, posting suspect profits and clinging to worthless assets, but it’s dangerous living. Small banks, which desperately need to value and sell junk, could fail. Their failure could be the new spark that sets an uncontrollable fire through the system.

David Schachter, writing for the Closed-End Fund Association, has an alternative.

You guessed it, closed-end funds.

Closed-end funds, like open-end mutual funds, are investment companies that hold a portfolio of securities, however unlike mutual funds, the shares of a closed-end fund trade on a stock exchange. Closed-end funds trade at a market price determined by supply and demand for the fund’s shares: not at their underlying net asset value. Because of this, closed-end funds have helped provide liquidity for holdings in less liquid or even illiquid investments such as emerging markets, business development corporations, private placements and small-cap stocks.

Switching to a CLEF system would have the added benefit of delaying any sort of price discovery for at least another three to four months as the Treasury Department and banking industry hammer out the program’s details.

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