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Saturday, October 13, 2007 7:49 PM

Super SIV Bailout Plan Doomed To Fail

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The New York Times is reporting Banks May Pool Billions to Stop Securities Sell-off.

Several of the world’s biggest banks are in talks to put up about $75 billion in a backup fund that could be used to buy risky mortgage securities and other assets, a move designed to ease pressure on a crucial part of the credit markets that threatens the broader economy.

Citigroup (C), Bank of America(BAC) and JPMorgan Chase (JPM), along with several other financial institutions, have been meeting to come up with a plan to create a fund that could prevent a sharp sell-off in securities owned by bank-affiliated investment vehicles. The meetings, which began three weeks ago, have been orchestrated by senior officials at the Treasury Department, and the discussions have intensified in the last few days.

Another round of discussions is taking place this weekend, and it is still possible that the parties will not reach an agreement. The proposal echoes the 1998 bailout of the hedge fund Long Term Capital Management, when a group of big banks came together to prevent the fund from collapsing after it made a series of bad bets. And the current round of crisis-driven collaboration illustrates the heightened level of concern among both government and financial players.

SIVs, which issue short-term notes to invest in longer-term securities with higher yields, are often organized by banks but are not actually owned or held by them. They are supposed to be financed through the issuance of commercial paper backed by pools of home loans and credit card debt, but the loss of confidence in the quality of subprime mortgage bonds has also tainted these securities.

Analysts say that investors have all but stopped buying SIV-affiliated commercial paper, and the worry is that the 30 or so SIVs will unload billions of dollars of mortgage-related assets all at once. That would put intense pressure on prices. As Wall Street firms and hedge funds mark value of similar investments they held to their new lower values, they face potentially huge hits to their profits.

Still, the impact on the biggest banks is even more severe. In times of crisis, they are committed — either legally or to maintain their reputations — to stepping in to buy those securities. Banks have already been buying significant amounts of commercial paper in recent weeks, even though they did not have to. But if they are forced to bring those assets onto their balance sheets, they might be less willing to lend to businesses and consumers. That could set off a credit crunch and thrust the economy into a recession.

The proposal being floated calls for the creation of a “Super-SIV,” or a SIV-like fund fully backed by several of the world’s biggest banks to provide emergency financing. The Super-SIV would issue short-term notes to finance the purchase of assets held by the SIVs affiliated with the banks, with the hope of reassuring investors.

But whether the banks would buy the assets directly or just buy the short-term debt is still unclear, according to people briefed on the situation. So are other aspects, like the amount of capital each bank would need to contribute, how it would be administrated, and the fee structures and cost burdens.
The Washington Post is reporting Treasury officials seek to help battered SIVs.
Treasury officials are looking into ways to help investment vehicles called SIVs that have been battered by this summer's credit crisis, sources familiar with the situation said on Friday.

Big banks, including Citigroup Inc (C), are discussing a plan to pool together and financially back as much as $100 billion in these investments, which include mortgage securities, the Wall Street Journal reported on its Web site.

A government source also confirmed that there is a Treasury initiative to ease funding costs in the SIV market.

The plan could also get backing banks outside the United States. The Financial Services Authority, the United Kingdom's markets regulator, has suggested that UK banks consider participating in the plan, the Wall Street Journal reported.

The fund, which is tentatively called Master-Liquidity Enhancement Conduit, or M-LEC, could be announced as early as Monday, if banks agree, the Journal reported.
Don't Ask - Don't Sell
  • The plan boils down to this: Don't Ask - Don't Sell.
  • Don't Ask what the asset is worth.
  • Don't Sell or you will find out and not like the result.
Super SIV Bailout Plan Doomed To Failure
  • If banks offer to buy that garbage then any hedge fund, foreign investor, or pension plan holding the crap would be silly to not unload it.
  • If instead banks offer financing it would tie up capital that most assuredly has a better use. It also exposes the banks to potential bad loans.
Desperate measures are being taken so that banks do not have to bring this garbage onto their balance sheets.

It's important to understand the problem was caused by loose monetary policy in conjunction with rules that allowed this garbage to be kept off bank balance sheets. The proposed solution is the same as the underlying problem. It's a delay tactic that simply cannot work.

Perhaps it will appear to work in the short run. Bulls certainly have been stomping as if the economic problems we face are temporary. Unfortunately the problems we face are not temporary. Structural economic problems run long and deep. Whatever final shape this bailout plan takes, it is doomed to fail over the long haul. A collapse in consumer spending and commercial real estate will seal the fate. Both are going to happen.


The above was written Saturday, October 13, 2007. The prediction in the final lines above happened as called.

For an update on the revival of the Bad Bank Super-SIV (don't ask, don't sell shell game) please see Fed and BOE Shell Games to Bailout Insolvent Banks written Saturday, January 17, 2009.

Mike Shedlock / Mish

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