Special Edition Five Things You Need to Know: Competing Wall Street Banks to Launch Incomprehensible Joint Venture to Bail Out Something You've Never Heard of Threatening to Do Something You Don't Understand to Something You Don't Care About
What you need to know (and what it means)!
Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:
CRITICAL NEWS ALERT!!!
Competing Wall Street Banks to Launch Incomprehensible Joint Venture to Bail Out Something You've Never Heard of Threatening to Do Something You Don't Understand to Something You Don't Care About
Citigroup (C), Bank of America (BAC) and JPMorgan Chase (JPM), the three largest U.S. banks, are reportedly working together to create a fund called a "conduit" that will buy around $80 billion in bonds and other debt from what are called structured investment vehicles (SIVs). This sounds important. God help us.
I've spent hours now attempting to slice through the gibberish spewing from these banks and the best I can come up with is this: Just tell me how much I owe, who I need to make the check out to and if it's possible to structure some type of payment plan in case the balance due is beyond my capabilities. I'm serious. The degree of twisted obfuscation here - obfuscation being Wall Street's one true asset class - is stunning.
1. What's the news?
- OK, so the news is that the three banks are working together to create a fund, called a conduit, that will buy around $80 billion in bonds and other debt from what are called structured investment vehicles (SIVs).
- The fund will be known as the Master Liquidity Enhancement
Conduit, or M-LEC, itself a meaningless name that was probably invented by someone with a deep hatred for anyone without a masters degree in business administration.
The articles appearing in papers this morning all state unequivocally that the M-LEC won't buy subprime mortgage assets, which is where the confusion begins, because by using the phrase "subprime securities" the banks (via the media) are essentially tossing a maguffin into the frame.
With respect to the SIVs this is a non-sequitor. It is meaningless. Why? Because this is not about subprime mortgages. This is about the Asset Backed Commercial Paper market (ABCP).
2. What, exactly, are SIVs?
- SIVs are off-balance-sheet vehicles that invest in a range of ABCP securities and some bonds.
- SIVs issue short-term debt and use the money to invest in longer-term securities with higher yields.
- There is about $300 billion in such vehicles, which are often organized by banks but are not actually owned or held by them.
- They make money by playing the spread (arbitrage is the formal, obfuscatory Wall Street word for it) between short-term borrowing rates and long-term returns based on the assets they invest in.
- Historically, SIVs can borrow so cheaply in the asset-backed commercial paper market because they are essentially backed by the full faith and credit of the banks that organize them.
- That's a pretty sweet setup - free money - as long as times are good and demand for asset backed commercial paper is high.
3. So, what's the problem?
- According to Moody’s, assets held by the SIVs has plunged to $320 billion from $395 billion in July.
- In other words, times are no longer good and demand for asset backed commercial paper is no longer high.
- Since SIVs borrow short-term and invest long-term, what has happened is they can't access cheap, short-term credit and are faced with the possibility of selling their assets at depressed prices, which no one wants to see happen because once the first person sells the rest of the un-priced (un-priceable?) securities get a benchmark valuation.
4. What does that mean?
- The M-LEC will only buy securities rated AAA or AA at Standard & Poor's and Aaa or Aa at Moody's Investors Service at market prices.
- Why are they doing that? Because these SIVs have been unable to obtain financing from the Asset Backed Commercial Paper market since August.
- That has left only two options for the SIVs and banks: 1) liquidate assets to pay back the expiring commercial paper, which they really couldn't do because there were only buyers for those assets at deeply distressed prices, or 2) loan more money to the SIVs, which banks have been doing.
5. What's next?
- The M-LEC is expected to start operating in 90 days and will stay in place for a few years until it has disposed of the assets it buys, according to the New York Times.
- Each bank will put up an unspecified amount of its own capital into the fund, and other banks from around the world are expected to join the consortium in the coming weeks, the article said.
- The M-LEC will supposedly pay market prices for the securities it buys.
- But it remains unclear how anyone will determine the price of some bonds that have not been actively traded since August.
- The difference between what buyers are willing to pay and what sellers want has widened significantly since then.
- The Bottom Line: This entire episode nets out as a way to buy time.
- That's it.
- The M-LEC addresses near-term funding problems for the SIV's, but in no way addresses the underlying problems that are driving this symptom, for that is what the SIVs are more than any other thing - a symptom of overriding credit market issues.
- The collateral is declining. Period.
- So the funding charade will alleviate some of the near-term burden of solvency, but the long-term issues of deteriorating demand and pricing for the collateral on their books remains.
- So, just tell me how much I owe, who to make the check out to and if it's possible to structure some type of payment plan if the balance due is beyond my capabilities.
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