Rescuing SIVs

From the Wall Street Journal

Rescue Readied By Banks Is Bet To Spur Market
By CARRICK MOLLENKAMP, DEBORAH SOLOMON and ROBIN SIDEL
October 15, 2007; Page A1

The high-stakes plan to rescue banks from losses on mortgage securities amounts to a big bet that a consortium of financial giants — at the prodding of the U.S. government — can persuade investors to pour more money into the troubled credit market.

Over the weekend, the Treasury hosted talks to help a group of banks set up a $100 billion fund to buy troubled assets in exchange for new short-term debt. The banks hope to have the fund up and running within 90 days.

According to people familiar with the matter, the Treasury hopes the plan, which could be announced as early as this morning, will jump-start demand for commercial paper, which froze up this summer amid the credit crunch that roiled global financial markets.

Companies depend on commercial paper to finance day-to-day expenses like payroll and rent. Some financial commercial paper — known as asset-backed paper — has been able to find buyers in recent weeks. But investors have remained skeptical of other types, including paper issued by certain bank-affiliated investment funds

The lack of buying signaled that the markets weren’t working properly, despite the efforts of central banks, and that investor confidence was low, since commercial paper typically is considered a safe investment.

Some influential investors think the Treasury-backed strategy might work. Other object to the Treasury’s role in seeking to help banks avoid a big financial hit for making bad bets.

The coordinated effort is a good way to help restart stalled debt markets, said Mohamed El-Erian, who runs Harvard University’s $35 billion endowment and is set to become co-chief executive and co-chief investment officer of money-management firm Pacific Investment Management Co. in January. “No bank would do this on its own.”

“The proposal has the potential to restore liquidity to a market,” he added.

Four weeks ago, in an unusual move, Treasury officials convened a meeting of some 10 banks, including Citigroup Inc., to discuss a private-sector solution to the problems and sounded out other market participants about their views on a rescue package. The problems stem from affiliated funds called structured investment vehicles, or SIVs, which Citigroup and others set up as a way to make money without taking the risk involved onto their balance sheets. Such vehicles are formally independent of the banks that create them. They issue their own short-term debt, usually at relatively low rates that reflects their high credit rating. Then, they use the proceeds to buy higher-yielding assets such as securities tied to mortgages or receivables from midsize businesses seeking to raise cash.

The government isn’t putting money into the plan but its role could be crucial in luring investors to buy debt issued by the rescue fund as part of the plan.
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Behind Treasury’s concern were banks like Citigroup, whose affiliates owned $80 billion in assets backed by mortgages and other securities. The world’s biggest bank, by market value, held the assets off its balance sheet and was facing the prospect of either having to unload them in a disorderly fire-sale fashion or moving them onto its books.

Either scenario would have hurt financial markets and could have damped the economy by curtailing banks’ ability to make new loans to consumers and corporations. Treasury envisioned a potentially “disorderly” unwinding of assets that could worsen the credit crunch, said a person familiar with the matter.
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Under the proposed rescue package Citigroup, J.P. Morgan Chase & Co. and Bank of America Corp. will set up a fund, or “superconduit,” to act as a buyer of last resort. It will pay market prices for SIV assets in an effort to prevent dumping.

J.P. Morgan and Bank of America don’t have SIVs, but they plan to participate because they would earn fees for helping arrange the superconduit, whose lifespan, according to people briefed on the plan, is expected to be about a year. The superconduit can buy assets from any bank or fund around the world.