Bailed-Out Banks Profit on Rescued Assets

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71 billion, and Morgan Stanley's jumped $785 million to $4.25 billion, the Fed data show. Goldman Sachs's other holdings climbed $76 million to $449 million. Morgan Stanley, now overseen by CEO James Gorman, classified all its holdings as trading assets, according to the Fed data. Both companies are based in New York.

'Free Money'

Of the seven biggest owners of residential mortgage-backed securities, only San Francisco-based Wells Fargo & Co. reduced holdings of the debt on its trading book, by $130 million to $44 million. JPMorgan added $49 million to the trading book, while cutting its other holdings of the securities by $1.47 billion to $12.7 billion, according to the Fed data.

Eric Petroff, director of research at Wurts & Associates, a Seattle-based firm that advises institutions on $30 billion in investments, said it's no surprise that banks added to their holdings following the unveiling of PPIP.

"Any time the government says, 'We're going to buy something in the securities market,' they're putting out a sign that says, 'Free money, come and get it'," he said.

The renewed interest by banks in holding the bonds has helped restore liquidity, said Scott Buchta, head of investment strategy at Guggenheim Securities LLC in Chicago. Higher prices have also eroded potential profits of PPIP funds and increased the risk of losses, making it harder for asset managers participating in the program to attract investors, he said.

Returns Shrink

Four of the nine PPIP managers missed the original Sept. 30 deadline for raising the minimum $500 million by more than a month. One manager, Marathon Asset Management, was allowed to make its initial closing after raising $400 million.

"If you were looking at returns in the high teens to low twenties in PPIP, now you're looking at the low-to-mid teens," said Joel Paula, senior analyst at Cambridge, Massachusetts- based NEPC LLC, which advised Connecticut's state pension board on its decision to invest $200 million with three PPIP managers.

Higher prices are also slowing the pace at which PPIP managers can and want to buy, because they must be more careful when examining securities and their underlying collateral, NEPC's Paula said.

"If you do your homework, you can still find value, but you're not getting 20 percent for doing nothing anymore," Paula said in an interview.

Locked In

While fundraising and investing is moving slowly, time could ultimately play to the PPIP investor's advantage, said Alan Papier, of consulting firm Mercer, a unit of New York-based Marsh & McLennan Cos. Under PPIP's terms, investors are locked in for eight years and managers have up to two years from their initial closings to invest the money, giving them time to wait for prices to drop.

"Managers are trying to figure out whether the rally in residential mortgage-backed securities is sustainable, or if there will be some sort of pullback," Papier said.

Bill Eigen, manager of the $5.4 billion JPMorgan Strategic Income Opportunities Fund, said he bought residential mortgage- backed securities in the spring. Since then, he has sold and begun shorting both residential and commercial mortgage-backed securities, anticipating that their price would fall.

"This stuff was supposed to trade on fundamentals and will again trade on fundamentals," he said in an interview. "PPIP is not going to fill up buildings."

To contact the reporter on this story: Christopher Condon in Boston at ccondon4@bloomberg.net. Jody Shenn in New York at jshenn@bloomberg.net