The Wall Street Journal describes it as a “superconduit”,
the New York Times refers to it as a “super-SIV”,
and the Washington Post is calling it a
“Master-Liquidity Enhancement Conduit”. Whatever you call it, does it make any sense?
The Wall Street Journal yesterday reported:
In a far-reaching response to the global credit crisis, Citigroup Inc. and other big banks are discussing a plan to pool together and financially back as much as $100 billion in shaky mortgage securities and other investments.
The banks met three weeks ago in Washington at the Treasury Department, which convened the talks and is playing a central advisory role, people familiar with the situation said. The meeting was hosted by Treasury’s undersecretary for domestic finance, Robert Steel, a former Goldman Sachs Group Inc. official and the top domestic finance adviser to Treasury Secretary Henry Paulson. The Federal Reserve has been kept informed but has left the active role to the Treasury.
Here’s the background as reported by the New York Times:
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.
And here’s the rationale offered by the Wall Street Journal:
The new fund is designed to stave off what Citigroup and others see as a threat to the financial markets world-wide: the danger that dozens of huge bank-affiliated funds will be forced to unload billions of dollars in mortgage-backed securities and other assets, driving down their prices in a fire sale. That could force big write-offs by banks, brokerages and hedge funds that own similar investments and would have to mark them down to the new, lower market prices.
The ultimate fear: If banks need to write down more assets or are forced to take assets onto their books, that could set off a broader credit crunch and hurt the economy. It could make it tough for homeowners and businesses to get loans. Efforts so far by central banks to alleviate the credit crunch that has been roiling markets since the summer haven’t fully calmed investors, leading to the extraordinary move to bring together the banks.
Before we jump into any such plan, I think it’s helpful to reflect on what are the basic principles on which any government intervention should be based. I would urge the Treasury to embrace the position of the Federal Reserve as articulated last month by Fed Chair Ben Bernanke:
It is not the responsibility of the Federal Reserve–nor would it be appropriate–to protect lenders and investors from the consequences of their financial decisions. But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy.
The goal should not be to bail out Citigroup, but rather to protect innocent bystanders from any potential adverse consequences of their decisions.
I definitely acknowledge that a “fire sale” of assets is an example of an event with a clear potential for precisely these sorts of adverse external consequences, and is something that there is a strong policy interest in avoiding. But the alleged “liquidity crisis” has now been with us for two months. Let’s be honest about the situation. The problem is that no one wants to buy many of the assets held by these SIVs at a price that is anything close to what they are carried on the books for. Nobody wanted to buy them two months ago, and nobody is going to want to buy them two months from now. Mish describes the superconduit idea as “don’t ask, don’t sell”: don’t ask what the asset is worth, and don’t sell or you will find out and not like the result.
We therefore need to be asking, Why doesn’t anyone want to buy these assets? Are we to believe that private investors are incapable of correctly valuing their true worth, whereas Treasury Department officials are? To me the puzzling phenomenon is not the current reluctance of people to buy securities backed by U.S. subprime mortgages. The puzzling behavior was the enthusiasm with which the current set of owners lapped them up.
How then would a superconduit, or whatever you want to call this proposed entity, solve the basic problem? Apparently the sheer size and participation of multiple banks along with the Treasury is supposed to give investors confidence. In my opinion, part of what created the current problem was the perception that participants were too big and too many to fail. If the government won’t let Citigroup fail, could it allow a superconduit to go down?
I am skeptical of any claims for a feel-good, this-will-solve-all-the-problems fix. The reality is that someone must absorb a huge capital loss. The question we should be asking from the point of view of public policy is, Who should that someone be?
My answer is: the shareholders of Citigroup.