Monday, 15 October 2007

Banks attempt to bail themselves out

Citigroup, Bank of America Agree to Set Up $80 Billion CP Fund

Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co. agreed to set up a fund of about $80 billion designed to help revive the asset-backed commercial paper market, according to people familiar with the discussions.

An announcement may come as soon as today, said the people who declined to be named because the decision isn't public. The fund will buy assets from structured investment vehicles, units set up to finance purchases of securities such as corporate bonds and subprime 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 initiated the talks between the banks after a shut down of the commercial paper market left SIVs and other sellers unable to fund themselves, forcing sales of about $75 billion of assets.

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....."

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."

Firstly SIV's are a bad joke of so-called financial innovation to begin with. They are just a convenient way for banks to keep assets off their balance sheets. It enables banks to create more debt and leverage themselves up without having to abide by 'on' balance sheet capital requirements.

It's difficult to see how the banks will actually benefit from this move in the long run. In the short term it may prevent fire-sale prices as the MLEC provides an artificial market where the assets can be offloaded. However that means the banks have to tie up capital that could be better put to use elsewhere. At the end of the day it comes down to a desperate attempt to delay the inevitable.