21
Oct

The bail-out fund:

Escrito el 21 Octubre 2007 por Juan Toro en Financial Markets

Early this month Citigroup , Bank of America, JPMorgan, Chase and several other financial institutions reached an agreement to create a superfund to sort out the mess that exists in the SIVs (Structured Investment Vehicles) market. This superfund, that should just be temporary, would buy qualifying highly-rated assets from certain existing SIVs that choose, at their own judgement, to take advantage of this new source of
liquidity. This ad hoc liquidity (provided by the fund sponsors) intended to allow sellers to meet pending redemptions and ease asset-backed commercial paper rollovers. The creation of this $100 billion fund has been brokered by the Treasury Department with the idea of avoiding fire sales of assets held by SIVs which would depress even more this market and damage the balance sheet of some banks.


What are SIVs?
I believe that by now we have all become familiar with these funds. They are similar to conduits. Though SIVs differ from conduits in two main aspects: they also issue longer-dated notes and make use of leverage. SIVs issue short term debt (commercial paper) and the proceeds are invested in high yield longer term debt. SIVs assets are dominated by mortgages (23 %) and corporate financials (43 %). These funds are generally kept off the balance sheets of the banks but agreements are in place whereby banks guarantee part of the funds or provide with credit lines for financing. In normal circumstances, these vehicles can pocket the difference between the cost of financing in short term debt and the juicy return of their assets. Things can turn nasty (as it happened in August 2007) in the fund assets suffer losses or the SIV can not refinance the short term commercial paper that finances their assets. Then, banks that sponsored the SIV are called upon to facilitate financing or get the assets of the funds (into their balance sheets).

Why the need of a bail out fund?

The spirit of the fund is to avoid a coordination failure in the market that would induce a fire sale of some assets held by SIVs depressing the value off these assets. There are a few banks that have sponsored several SIVs. These SIVs are seeing problems in their financing side (refinancing their short paper in the ABCP-Asset Backed Commercial Paper- is becoming harder and harder) as well as on their asset value side (the credit squeeze has affected the prices of many of the assets generally held by SIVs). Any of the SIVs has an incentive to liquidate the funds, now that they can, and avoid further losses if things deteriorate further. If all the funds have the same idea, there will be a fire sale that will overflow the market with the assets held by SIVs, pushing their prices lower and lower, up to unprecedented levels. So everyone (all SIVs) is better off if there is a coordinating effort from the side of banks sponsoring SIVs.
This has led Citigroup and other institutions to promote the idea of a super SIV fund that will buy assets from other SIVs in an orderly way to avoid any fire sale liquidation. The fund will be named the Master Liquidity Enhancement Conduit, and will get financing from the ABCP commercial paper. In order to provide further guarantees banks participating in it will provide a cushion of support from junior layers of capital and liquidity backstops. With a liquidity backstop a borrower facing temporary liquidity problems may draw upon the guarantee to prevent a default on creditors.

Critics to the funds. Can it really work?
Criticism has abounded and has come from many different places. Some critics claim the fund a bailout of Citigroup, the largest sponsor of SIVs. The leader of this coordination effort is the bank that is exposed most to SIVs. These critics just see this fund simply as a bail out for Citi itself.
Other such as Greenspan believes that markets should make their work and SIVs

Comentarios

Charles Bayham 29 Septiembre 2008 - 04:33

I am no economist; however, I do have powers of observation. Over 40 years since my graduation from high school, I have been through numerous cycles of this economy. I have observed during those cyclical economic changes of the past 40 years that the first industry to go into the tank is construction (residential) and that same industry is the first industry to emerge from the tank. While construction is not the single most significant element of our complex hybrid form of free enterprise economy there is, however; an almost one to one relationship between the cycles of the residential construction industry and the cycles of the overall economy. I am, therefore; from my vantage point as a member of this industry, convinced that any final version of a bail out of the banking industry will not avoid an economic downward slide of major proportions. It will, however; enable the providers of the economies capital to preserve and relocate there assets to more favorable investments; probably far a field of mortgage banking in the United States of America.

Before residential construction can reemerge, its excess inventory burn off will have to happen. This burn off would have to take place slowly in a tight money, lack of funds for lending environment due to the exodus of investment capital. This personal economic forecast has me considering getting a teaching certificate and making a career change. If I am lucky this change may enable me to remain employed during the coming crunch. If not I will do what ever I can to survive like every other worker.

At this point, I have to ask where the money will come from that the U.S. Government uses to purchase these securities and thereby liquidate the assets of the economies capital investors. Will that capital remain in this country? Will the

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