naked capitalism

Readers may recall that during the heat of bailout battle, the Federal Reserve got into the fancy finance business, relying on the sort of deal structuring sometimes used to try to turn toxic odd pork scraps into barely-digestible sausage, the procedure used for pigs so dead that merely putting lipstick on them just won’t do.

The items in question are Maiden Lane, the vehicle used to backstop JP Morgan’s purchase Bear Stearns, and two sons of Maiden Lane created for dodgy AIG exposures. The bank was permitted to move some particularly fragrant collateral from Bear over to the Fed for a loan of $30 billion. The arrangement got reworked on the fly, and in the end, the Fed loan was reduced to roughly $29 billion as JP Morgan agreed to assume $1.15 billion of risk. The assets were placed in a holding company to be managed by BlackRock.

Maiden Lane II and III were spawned in the course of the AIG rescue. I’ve seen much less commentary on those deals, perhaps because commentators find the whole AIG mess so complicated and upsetting it’s hard to know where best to direct one’s ire.

This was so unseemly that even Paul Volcker, who has made a point of not commenting on Fed actions, felt compelled to voice disapproval of the Bear-related subsidy to JP Morgan. Willem Buiter, who has repeatedly pointed out that the three card monte operation being run by the Fed and Treasury are anti-democratic and possibly illegal, tells us that even by Fed’s own, no doubt rosy, calculations. all three SPVs are under water.

From Buiter:

A reader of this blog drew my attention to the informative Fed publication, the Federal Reserve System Monthly Report on Credit and Liquidity Programs and the Balance Sheet. … I will focus here on the three Maiden Lane vehicles created by the Fed to park some of the wonky assets it acquired from Bear Stearns (Maiden Lane (which I shall refer to as Maiden Lane I)) and from AIG (Maiden Lane II and III)…..

By any measure, the Fed is in the hole with all three SPVs. Its own estimates are that the amount by which the fair value of the net portfolio assets of each vehicle falls short of the outstanding balance of the loans extended to each of these vehicles (including accrued interest) is US$ 3.77 billion for Maiden Lane I, US$ 1.97 billion for Maiden Lane II and US$ 2.82 billion for Maiden Lane III. This is likely to be an underestimate of the true loss, because the reported fair value of the assets in the Maiden Lane vehicles is likely to overstate the present value of their held-to-maturity net cash flows. Much of the assets is illiquid, especially those in the AIG-related SPVs, Maiden Lane II and III.

In an earlier post on this subject I wrote “The Bear Stearns-related assets are likely to be rubbish. Maiden Lane II and III I know less about.” Thanks to the Monthly Report on Credit and Liquidity Programs and the Balance Sheet I now know that I may have overstated the degree of awfulness of the Bear Stearns legacy assets. I almost surely also overestimated the quality of the AIG legacy assets.

Maiden Lane I:

Maiden Lane II:

Maiden Lane III:

Most of the assets in the Maiden Lane I vehicle are securities issued or guaranteed by the federal government or federal agencies. But AIG stuck the Fed with a portfolio of RMBS 59.5 percent of which was subprime backed, with most of the remainder, 26.9 percent of the total, backed by Alt-A mortgages. I sincerely hope my retirement fund is better invested than that.

As regards Maiden Lane III, 71.7 percent of the portfolio is rated BB+ or lower – junk in normal language. That is not surprising, as 70.8 percent of the portfolio is supposed to be in ‘high grade’ ABS CDO. A high grade ABS CDO is like a nice schoolyard bully. They may exist, but they are few and far between. We can expected further significant write-downs and ultimately write-offs on these portfolios. The US$ 8.56 shortfall reported by the Fed thus far is likely to be only the tip of the iceberg.