When the US Treasury Secretary Tim Geithner launched the Public Private Investment Program (PPIP) last July, he likely didn’t expect one of the selected managers to get caught up in a tabloid story of drugs paraphernalia and sexual devices.

And yet just this story transpired after The TCW Group fired its chief investment officer Jeffrey Gundlach, a key man in the PPIP UST/TCW Senior Mortgage Securities Fund, amid allegations he had threatened to leave the company taking key personnel with him. TCW included even tawdrier details in its suit against Gundlach (see “Sex, lies and videotape”, facing page).

The markets are re-equitising. There's a liquidity bubble forming … The credit markets are healing … they are over-heating

Barry Sternlicht

The situation makes for salacious reading and has certainly livened up financial news, but is mostly a sideshow. However, Gundlach’s departure and the government’s freezing of his former fund has brought into sharp focus problems with the actual PPIP programme itself.

Little more than six months after first announcing the plan, the US Treasury department has seen a fund in one of its flagship programmes fold (TCW’s), been forced to extend the deadlines by which managers were supposed to have held first closes and eased the minimum capital-raising requirements for PPIP vehicles.

Oaktree Capital Management was the last manager to hold a first close on its fund on 18 December, raising an estimated $400 million in private capital, according to people familiar with the matter. Managers were initially given 12 weeks to raise a minimum of $500 million, however those thresholds quietly slipped as some investment firms struggled to quickly secure the required capital.

TCW was one of the first managers to raise $500 million as part of the PPIP programme.  By the time of Oaktree’s first close, the Treasury said up to $24 billion of capital would be available to target legacy mortgage-backed securities, including CMBS and RMBS commercial issued before 2009 with an initial rating of AAA or equivalent. (Private managers have raised $6 billion of capital, which will be matched by the government and then doubled with Treasury financing).

The TCW fund liquidation could potentially reduce that figure by almost $2 billion. The government is believed to have given TCW investors up to 45 days to decide whether they want to transfer to another PPIP manager.

One market participant with knowledge of the situation told PERE though investors were being cautious following the TCW/Gundlach saga. “It reads like a supermarket tabloid. Investors are shocked by this, and when investors are shocked they tend to hide under the table to avoid collateral damage.”

A more fundamental reason why the TCW investors may not redeploy their returned capital into other PPIP funds is this: some have recently begun to wonder whether US government programmes, such as PPIP, are, rather than injecting needed liquidity into the market, instead overdoing what the free market has already done.

Starwood Capital chief executive officer Barry Sternlicht raised such concerns at the Knowledge@Wharton Road to Recovery real estate forum in December, warning a “liquidity bubble” was forming as a cadre of “capital tourists” searched for yield. Although he said PPIP, and other programmes such as the government's Term Asset-Backed Loan Facility (TALF), were “valid” strategies, he said the programmes were not needed in today's market. “The markets are re-equitising. There's a liquidity bubble forming … The credit markets are healing … they are over-heating,” he said.

The CMBS markets alone are proof the frost is beginning to thaw. Since the start of 2010, the CMBS market has seen a tremendous rally, with spreads tightening considerably in the first two weeks of the year. According to data firm Trepp, recent-vintage (around 2007) AAA CMBS was trading at roughly 250 basis points to 350 basis points over swaps as PERE went to press. That figure has fallen from more than 1,000bp over swaps (and sometimes between 1,200bp and 1,300bp over swaps) in early 2009.

Such a shift could possibly be attributed to the existence of PPIP and government bailout programmes.  “The programmes were intended to provide some semblance of normalcy to the market,” said Anthony Frammartino, principal at property investment advisor The Townsend Group. “They were intended as a back stop in an effort to provide liquidity. The market has improved significantly since the introduction of these programmes, and they may or may not have influenced that outcome to some extent, but it is very difficult to say for certain.”

But as investors weigh up the possibility of investing in PPIP, changing market conditions could prompt some to question whether the programme’s funds are the most appropriate vehicle for taking advantage of the current cycle of real estate distress. PPIP funds can undoubtedly secure the best debt, and on the best terms, however there are also a plethora of other debt vehicles coming to market, almost all with fewer restrictions on the type of investments that can be made.

Frammartino said he had seen more than 90 real estate debt offerings in the market. “It’s a significant increase over a year ago,” he added. Not all those offerings will succeed, but as real estate fund managers increasingly turn to debt as an investment strategy, institutional investors will have a greater ability to pick and choose. And as TCW PPIP fund investors ponder the future of their investments, that may be just what they’re thinking.

Sex, lies and videotape

A lawsuit against departed TCW CIO Jeffrey Gundlach includes accusations both serious and salacious

It reads like a supermarket tabloid. Investors are shocked by this, and when investors are shocked they tend to hide under the table to avoid collateral damage.”

Unamed market participant

From the start, language in the lawsuit filed by The TCW Group against its former chief investment officer, Jeffrey Gundlach, and three ex-TCW executives, is emotive, the imagery graphic. Filed with the Superior Court of California on 7 January, TCW’s complaint against Gundlach centres on claims he established his new money management firm, DoubleLine Capital, through the “wholesale theft of vast quantities of TCW proprietary information”.

Naming three other former senior executives, including mortgage-backed securities managing director Cris Santa Ana and MBS senior vice presidents Barbara VanEvery and Jeffrey Mayberry, TCW alleged the trio helped Gundlach steal the firm’s property as they secretly plotted to create DoubleLine. The property allegedly taken included information about private trade transactions, “secretly downloading” client and portfolio holding data and confidential client contact information for 24,000 TCW clients and prospects. “The total amount of stolen information, if printed out, would total approximately nine million pages, or 3,700 banker boxes of documents,” TCW said in the court filing.

TCW also contended Gundlach “lied to TCW, to TCW’s clients, to the press and to the public about his misdeeds”. Claiming Gundlach was also unfit to serve as an executive, TCW said in the lawsuit: “His behaviour had become erratic, increasingly and openly confrontational and starkly inconsistent with the conduct of a senior officer responsible for the management of billions of dollars of client funds and the supervision of TCW employees.”

The firm went on to allege it discovered “inappropriate contraband” in Gundlach’s office following his departure, including marijuana, drug paraphernalia, a collection of 12 sexual devices, 34 hardcore pornographic magazines and 36 “hardcore sexually explicit DVDs and videocassettes”.

DoubleLine Capital hit back at the claims in a public statement saying the “allegations in the lawsuit [we]re meritless” and the personal attacks “gutter tactic[s]”. DoubleLine and Gundlach are filing their own lawsuit to address the TCW claims and “seek redress for TCW’s deplorable conduct”.

DoubleLine, in which Oaktree Capital Management has a minority interest, has filed plans with the Securities and Exchange Commission to launch three bond mutual funds – DoubleLine Total Return Bond, Core Fixed Income and Emerging Markets Income – which will invest up to 80 percent of their assets in debt securities.