Banks Start Fund for Credit Market

Working with the Treasury department, Citigroup, Bank of America, and JPMorgan Chase are creating a fund that will buy between $75 billion and $100 billion in structured investment vehicles (SIVs) - the mortgage-backed securities that have seen such trouble recently. The New York Times has a story that has yet another piece of the puzzle, which can be hard to grasp if you come at this from the outside, like I do:

The effort is intended to help SIVs that need to sell securities do so in an orderly manner. Bank and government officials are concerned that if these vehicles are forced to dump billions of dollars worth of debt in the coming weeks, it could cause a repeat of the crisis that rattled markets in August and sent the cost of mortgages and other loans soaring.

In other words, these SIVs, like many other forms of financing, come with strings. The people running them have to ensure certain conditions or face serious consequences, like being declared in default (or whatever the equivalent for an SIV would be):

[Christian Stracke of the research firm CreditSights]said that by serving as another buyer of the highest-rated securities, the banks are hoping to ease the immediate strain on SIVs, which could be forced to sell billions of dollars worth of assets in a fire sale if they are not able to raise new financing and when their capital falls below certain thresholds. The effort, however, will not resolve the longer-term problem many SIVs face with more risky mortgage bonds, he said.

The SIVs have financial covenants, and they cannot allow their free capital to fall too much. So they need to sell more short-term debt to keep investing in the long-term debt to get the cash flow to pay off the short-term debt and keep afloat. It sounds, to me, like a legalized version of a Ponzi scheme, but then I'm not a high finance person.

Supposedly the fund - called a conduit - will invest only in top rated securities and won't help the sub-prime area that has most of the fundamental trouble. But then, one of the main problems has been that the rating agencies apparently were favorable in their ratings for the sub-prime. Why should anyone believe that a AAA rating actually means anything, either?

“For me, this is more of a P.R. blitz,” he said. The banks are “saying, it’s not just that we are doing this on an ad hoc, individual basis. Rather, we have a plan and consortium in cooperation with Treasury, which gives it a veneer of respectability.”

But the institutions themselves have lost tremendous credibility because of culpability. Maybe people will forget, or maybe the new investments are actually sound. The question is who will bet on that?