The press has given mixed signals about the amount of credit support. The early reports made it sound as if The Entity would be guaranteed; later reports backed away from that.

But one would have to think that the whole point of this exercise is to lower the capital required by Citi et al. Otherwise, why bother? But one fallacy seems to be that hiving off the better assets suggests that the rest are hopeless. I’m not certain that is a net gain.

Thank you for the response but context was understood. I was not so clearly relating to Japan’s earlier banking crisis which, as you know, included quite a bit of MOF and BOJ involvement and actual downgrades of govt bonds.

Certainly no perfect analogy w/Treasury and Fed yet the tune is reminiscent.

Agree completely with your implicit referral to weakening, possible endings, of dollar hegemony.

Regards
Juan

In context, I meant their currency in terms of moral authority and clout with the institutions they regulate. The more they respond when the financial services industry has a sniffle, the less power they have. They become less effective in calling for action in a real crisis.

But it is separately fair to observe that the dollar and US Treasuries may not be the rock solid standard that they are now. We noted yesterday that the Treasury is likely to increase its bill, note, and bond auctions by 50% in the upcoming year. In the 1970s, the Treasury bond’s standing was relatively untarnished by sustained inflation because many other industrialized nations were suffering similar pain, and there was no alternative to the dollar as reserve currency. The Euro is becoming an increasingly viable option. As the Eurobond market becomes more and more liquid, the Treasury’s standing as the preferred place to stash excess cash may suffer.

You said: “The Treasury is debasing its and the Fed’s currency by playing such a prominent role.”

While I have no expectation that rating agencies would do this, I do wonder about potential for de facto downgrading of Treasury debt.

The whole situation seems to have a tonality of later 1990s Japan.

http://financialpetition.org/

Send it to ten of your friends.

So are the banks crying wolf, or is Citi in worse shape than the other banks, or would any further contraction be the straw that broke the camel’s back? Hard to tell, but the lack of any visible distress heretofore seems inconsistent with the launch of this program.

If they wait until a liquidation of assets, which will be forced if enough CP runs off or marks on the assets decline further, prices will be low and losses large.

This plan lets them move the good assets into a new structue (which presumably can be funded by investors at reasonable prices) and leaves the bad assets with the junior investors of the original SIVs. The junior investors are happy to do this because if they do nothing, they will be wiped out by the current market prices of the bad assets. This gives them an opportunity to reduce losses. The senior investors are happy to run away without losing anything. And of course by finding new money for the good assets, the banks keep all of this off of their balance sheet.

The hard part will be negotiating the price that the old SIV sells the good assets to the new SIV. It is a game of chicken between junior investors who are scraping for every dollar, senior CP investors who want to run, and banks who want the whole thing to go away. It will get done becuase it is in everyone’s interst for it to happen.

Yves would probably address your question better than me (given my limited knowledge of SIVs).

If I’m not mistaken, the “beauty” of the SIV structure for the banks is that they invest little or no capital into the SIV and reap 100% of the equity (and 100% of the profit on the SIV carry trade). The financing of the SIV is almost pure debt (and no equity)—meaning tremendous leverage and tremendous return on equity invested.

If the SIV assets fall in value, the banks don’t take a hit because they hardly invested anything anyway. The ones left holding the bag are the ABCP debt-holders.

Bernard

However, this still leaves $200 billion in riskier ABS assets with $200 billion in ABCP that will eventually come due. May I ask what do they do later when that ABCP needs to be rolled over?

Beyond this, even with this MLEC program, the banks will still have to set aside $100 billion in funds to buy these assets, which will come right out of the hide of other borrowers (meaning: credit contraction).

Looks like this plan only buys a little time (and not much at that given the short-term maturities on ABCP). And it might lessen the SIV forced liquidations by one-third, since the SIV assets are reduced by that proportion ($100b/$300b) and transferred to the banks who wouldn’t be forced to sell.

I think this is still re-arranging the chairs on the Titanic. What drives everything is the underlying deterioration in MBS values, which will be fundamentally driven by the deflating US real estate market (causing mortgage defaults as homeowner equity evaporates in conjunction with mortgage rate resets). Eventually, the investment banks and hedge funds will be forced to mark-to-market most of their massive MBS/CDO/CDS holdings (no more Level 2/3 accounting BS), and when they do, many of them will be deemed insolvent and the game will be over.

Bernard