In Case You Thought The Problems In Credit Markets Was Over

Just in case you thought the problems in the credit markets was over, it looks like some big US banks are putting together a fund to help bail out structured investment vehicles. I found it interesting that this article came out over the weekend. No need to upset the markets on a trading day. By the way, the credit market issues have not been resolved by a long shot. From Bloomberg:

Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co., the three biggest U.S. banks, agreed to set up a fund of about $80 billion to help revive the asset-backed commercial paper market, according to people familiar with the discussions. . . . . The fund will buy assets from structured investment vehicles (SIVs), units set up to finance purchases of securities such as bank bonds and mortgage debt.

Other banks may join the fund, which would help SIVs avoid selling their $320 billion in holdings at fire-sale prices, further roiling the credit markets, the people said. The Treasury Department in Washington initiated the talks between the banks after a shutdown of the commercial paper market left SIVs and other sellers unable to borrow, forcing sales of about $75 billion of assets. .

. . . . The Treasury jump-started talks between banks with a meeting of Wall Street executives in Washington on Sept. 16, said a person with knowledge of the deliberations. Robert Steel, the Treasury's top domestic finance official, brought the lenders together and prodded the competitors to keep working through the following weeks. Treasury Secretary Henry Paulson, a former chief executive officer of Goldman Sachs Group Inc., also made calls. . . . .

. . . . . The sudden increase in borrowing costs for companies and consumers in August threatens to worsen a housing recession that has slowed the pace of economic growth.

The fund will be known as the Master Liquidity Enhancement Conduit, or MLEC, the people said. The fund will buy securities rated AAA or AA at Standard & Poor's and Aaa or Aa at Moody's Investors Service at market prices, the people said. It won't buy subprime mortgage assets, they said.

``This is mostly symbolic,'' said Christian Stracke, a London-based strategist at CreditSights Inc., a New York bond research firm. ``The banks were going to need to inject more liquidity into the SIVs anyway, so the public co-operation just makes the bail-outs of SIVs seem more orderly.'' . . . .

. . . . . Banks worldwide manage a total 36 SIVs, according to a Moody's report in July. Bank of America, based in Charlotte, North Carolina, and New York-based JPMorgan manage conduits that sell asset-backed commercial paper typically to finance deals for clients. JPMorgan sold its SIV business to Standard Chartered Plc in London last year.

Encouraging the talks that led to the creation of the fund is the latest effort by officials to help restore liquidity to credit markets, a campaign started by the Federal Reserve in August, when it cut the interest rate on direct loans from the central bank. Fed officials have said this month that while there are signs of improvement, some markets remain under stress.

``Some markets have been experiencing illiquidity,'' San Francisco Fed President Janet Yellen said in an Oct. 9 speech in Los Angeles, referring to mortgage-backed securities and asset- backed commercial paper. ``This illiquidity has become an enormous problem for companies that specialize in originating mortgages and then bundling them to sell as securities.''

As losses in securities linked to subprime mortgages started to spread in July, investors retreated from high-risk assets. The amount of asset-backed commercial paper outstanding tumbled to $899 billion in the week ended Oct. 10, from a high of $1.14 trillion at the end of June, according to Fed figures.

Mortgage defaults by Americans with poor credit histories prompted the collapse in June of two hedge funds managed by Bear Stearns Cos. and triggered a worldwide rout in the debt markets. The European Central Bank began adding liquidity on Aug. 9 after BNP Paribas SA, France's biggest bank, was forced to halt withdrawals from three of its investment funds. The Fed followed, along with counterparts from Sydney to Oslo.

As yields on asset-backed commercial paper climbed amid the exodus from the market, some companies found their access to borrowing cut off. Countrywide Financial Corp., the biggest U.S. mortgage lender, had to tap an entire $11.5 billion bank line on Aug. 16 after being unable to fund itself with commercial paper.

SIVs run by hedge funds including Cheyne Capital Management Ltd. in London and TPG-Axon Capital Management LP in New York were forced to sell assets at a loss after being shut out of the short-term debt market.

On average, SIVs lost 1.3 percent from the face value of assets sold since August, with shortfalls as high as 13.7 percent on some holdings, Fitch Ratings said in an Oct. 12 report on the funds it grades.

While concern about rising subprime mortgage defaults triggered the losses on SIVs, the funds only have about 2 percent of holdings invested in the debt. SIVs have about 41 percent in financial-sector debt, 22 percent in prime residential mortgage securities and 12 percent in collateralized debt obligations. Commercial mortgage-backed securities and non- mortgage asset-backed bonds each account for a further 8 percent, according to a Sept. 11 report by UBS AG in Zurich.

Alex Roever, a debt strategist at JPMorgan in New York who wasn't involved in the negotiations, estimates that SIVs have at least $320 billion in assets.

``Eighty billion is great, but it's not that big a number,'' said Roever. ``It still leaves you with $240 billion. That's a lot of dough. There may be enough money to pay the senior debt holders, but it's not enough to pay off everyone else.''