When the country's three largest banks reached agreement on Friday on how to structure a US$75 billion fund to prop up distressed securities, an exhausted group of its top planners gathered in a Bank of America conference room to toast their success with 12-packs of Bud Light. But the celebration might have come too soon.
Having settled on the fund's composition, officials from Bank of America, Citigroup and JPMorgan Chase will now have to raise more than US$60 billion of the fund from dozens of financial institutions around the globe in the next few weeks. The goal is to have the fund operating by the end of the year. But the big question is: Will it actually help?
The answer, some analysts and big investors say, is probably not much. The backup fund will not save troubled structured investment vehicles (SIVs) that hold billions of dollars in packaged loans, though it could delay their demise. It may help calm the turbulent credit markets by preventing a sharp sell-off of securities, though analysts say the fund will probably not be able to offset the deteriorating prices of the securities.
Banks, meanwhile, may benefit if the backup fund can reignite trading in the packaged loan market and keep SIV assets from bogging down their own balance sheets.
"It is quickly being realized that it doesn't really solve the problems," said Joshua Rosner, a managing director at the research firm Graham Fisher & Co who had been skeptical of the proposal.
"The path they have taken of skimming off the cream from the top doesn't resolve the fact there is poison at the bottom," he said.
The fund will not help troubled SIVs survive. Nor is it intended to do so. Rather, it is meant to help set a market price for the securities they hold.
SIVs are entities created by banks and hedge funds that own pools of home, auto and credit card loans. They became a booming business, dependent on easy credit from investors as well as confidence in the packaged loans they bought.
Now this business model is ailing, because both are in short supply. And the backup fund may not cushion the blows as much as originally thought.
For one, the credit markets have worsened since the proposal was set in motion with the assistance of the US Department of the Treasury in September. And some of the technical details of the way the backup fund is to be structured could limit its impact.
First, the three banks have committed to put up only around US$5 billion to US$10 billion each, leaving the remaining portion of the US$75 billion to be funded by other financial institutions, according to a person involved with the plan. The 30 or so remaining SIVs have about US$250 billion in assets they need to unload in the coming months. That suggests the backup fund will not be a meaningful purchaser of last resort, even if it wanted to.
Where the fund may have an impact is in stabilizing the financial markets, though only to a point.
The fund will not purchase the most distressed assets in the SIVs. Bank organizers agreed that it would not accept any subprime mortgage-related assets or many types of risky, complex instruments like collateralized debt obligations.
But the criteria mean that SIVs, or the banks that sponsor them, will be left holding their most battered securities or worse -- they may be forced to sell them at fire-sale prices.
Meanwhile, the backup fund is expected to charge SIVs a fee of up to 1 percent for participation, making it prohibitively expensive for them. In fact, most SIVs have already unloaded their securities on their own, working on the assumption that it would not work or is only a last resort.
With capital positions already weak from unsold leveraged loans, mortgage-related securities and other assets they have not been able to sell, they may be forced to tighten up other forms of lending. The backup fund is intended to help them avoid that.
"Will this resolve the basic issue of the assets of the SIV trading below what they were originally?" asked Steven Abrahams, the chief interest-rate strategist at Bear Stearns.
"No, it defers the day of reckoning," he said.
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