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NEW YORK - First it was central banks, pumping in money to avert a credit emergency in their countries.
Now the fear is spreading.
The three biggest banks in the US, including Citigroup and Bank of America Corp, today said they plan to create a fund to prevent
the sell-off of billions of dollars of bonds linked to subprime mortgages and other debt.
The banks' pool, which a source said could be around US$80 billion, is meant to stave off the risk that certain investment funds would have to dump assets at fire sale prices.
Such forced sales could push debt prices lower, magnify bank losses from the credit crunch, and make lenders even more reluctant to extend new loans. Tighter credit could jeopardize economic growth.
Treasury officials helped organise discussions to create the pool beginning last month, as trouble in short-term debt markets that first arose in August persisted. But taxpayer money is not seeding the fund.
Particulars of the pool are still being worked out, and analysts cautioned the deal could be difficult to set up.
Some critics of the fund say banks are bailing out players that made bad business decisions when setting up funds known as structured investment vehicles, or SIVs.
Citi's SIVs held some US$100 billion in assets at the end of August, making the bank the largest sponsor of the vehicles in the world, while JPMorgan Chase and Bank of America have had little involvement with SIVs.
"All banks are doing is rolling over their problems into a new vehicle," said Josh Rosner, a research analyst at Graham Fisher in New York.
JPMorgan Chase and Bank of America will receive fees for participating in the pool.
Other investors said that the pool could help stabilise credit markets, most notably the market for short-term bonds known as commercial paper, where borrowing costs are still relatively high.
"I truly believe that companies should have to suffer from their bad business decisions, but the whole market could suffer if nothing were done," said Michael Holland, principal at Holland & Co, which oversees more than US$3 billion of investments.
Regulators can ensure that players that made bad business decisions are reined in appropriately, Holland added.
US Treasury Secretary Hank Paulson said regulators did not fully understand the funds, known as structured investment vehicles, which is an issue that must be addressed.
HSBC, one of the largest SIV sponsors, is considering joining the pool, a source said. HSBC declined to comment.
GARBAGE?
SIVs controlled some US$370 billion of assets as of September 14, and some have had trouble refinancing their debt recently.
Concerns about fire sales have boosted borrowing costs for secured short-term debt called asset-backed commercial paper, but those costs edged lower on Monday, signaling the banks had successfully soothed investors.
"The investor is saying: 'OK, I'm willing to take some of this garbage now because somebody is actually going to put a price on it,'" said Howard Simons, a bond strategist at Bianco Research.
The banks said they were still working out the precise size of the pool, known as the master liquidity enhancement conduit, or M-LEC, and how it is put together.
The pool will buy qualifying highly rated assets from SIVs and sell short-term debt, such as asset-backed commercial paper, to help finance the purchases.
If the new pool suffers losses from investments, the banks will be the first to take losses.
Analysts noted other potential questions regarding the new conduit. If the new conduit buys higher quality assets from existing SIVs, then the existing SIVs will be weaker than they were before, which in turn could make it more difficult for them to issue commercial paper, Graham Fisher's Rosner said.
It's also not clear what price the new vehicle would pay for assets from SIVs.
CRUNCH
The credit crunch, originally triggered by a collapse in the US subprime mortgage market, has forced central banks to pump money into the financial system after fears of surprise losses caused interbank lending markets to gum up.
Weaker credit markets contributed to Citigroup's 57 per cent decline in third-quarter earnings, the largest US bank said today.
SIVs bought assets like mortgage securities from banks and financed their purchases with medium-term notes and short-term debt known as commercial paper. They make money by earning more from their investments than they have to pay to fund them.
In recent months, investors have been less interested in buying asset-backed commercial paper, and funding in that market has grown more expensive.
Since hitting an all-time peak of US$1.183 trillion in early August, the US asset-backed commercial paper market has shrunk by nearly 25 per cent during an unprecedented nine consecutive weeks of contraction. As of October 10, the Federal Reserve reported US$899.3 billion in asset-backed commercial paper outstanding.
- REUTERS