While it’s risky to opine about a plan described only in sketchy rumors, what we have seen so far about the possible bailout plan for structured investment vehicles, the entities responsible for the unresolved problems in the money markets, doesn’t give us a great deal of confidence that this program will come into being (see yesterday’s post for more details).
The closest analogue (a bunch of firms that in the ordinary course of events are competitors collaborating on a rescue) was the bailout of Long Term Capital Management, which allowed the firm to avert a collapse and be wound down instead. The SIV program suffers from being more complicated and less time pressured (the prospect of being hanged at dawn wonderfully focuses the mind).
To wit: with LTCM, it was clear what was in the deal, namely, the entire firm. All of its positions were hemorrhaging. Similarly, it was reasonably clear who ought to be in the deal. The Fed had rounded up its major creditors (although Bear Stearns infamously took exception). It was also fairly clear who would manage the assets. Everyone agreed that the LTCM management should be kept in place; the open governance issues were on how much they should be paid, what sort of supervision should be put in place, and who should be involved in oversight.
By contrast, with the SIVs, it isn’t clear which banks will provide assets from their affiliated SIVs, aside from Citigroup (note that JP Morgan and Bank of America, the only two other banks mentioned so far, would not be putting assets into the new conduit, since they don’t have SIVs, but merely providing services to the vehicle). Banks with SIVs that are believed to be candidates for this vehicle but haven’t been consulted in its design may take exception to some of its provisions.
It seems that there are a zillion decisions that have to be made for this idea to get off the ground, far more than for LTCM. A New York Times story reports on some of the open issues:
But whether the banks would buy the assets directly or just buy the short-term debt is still unclear, according to people briefed on the situation. So are other aspects, like the amount of capital each bank would need to contribute, how it would be administrated, and the fee structures and cost burdens.
If this list is accurate, it sounds like pretty much everything is up in the air, and it seems inconsistent with the report in the Journal that the plan could be announced as early as Monday (unless that announcement is something like “We’re working on it”). The Times gives the impression that the working group isn’t even at the letter of intent stage (an outline of key terms), much the less a definitive agreement (the development of the governing contracts). Forgive me for using an M&A metaphor, but bear in mind that many letters of intent fail to mature into successful deals.
And no one has fessed up that the nasty bit will be valuing the assets that go into this vehicle. That needs to be done for any legal transfer to take place. But that is also a highly contentious issue, particularly since a tidbit in a Reuters story suggests that the new conduit may be only for the worst assets in the SIVs:
One plan that was discussed at the meeting involved setting up a “super fund” where “each SIV in the market could pledge up to one-third of its assets and get financing,” the source said.
This resembles the “good bank/bad bank” structure used to deal with some of the failures of large savings & loans in the early 1990s. The bad assets were hived off into a separate entity with new management and raised new capital; the old, cleaned up bank was recapitalized in a diminished form. The two banks, one with distressed assets, the other with solid, easy to evaluate ones, appealed to very different type of investors.
The problem the SIVs have is that there isn’t a functioning market for some (many?) of the assets they hold, therefore no reliable price. Using book value would be appealing from one standpoint, since no one would recognize any losses when they move assets from the old SIV into the new entity, but that approach will almost certainly be deemed to be unacceptable by the SIV owners, since some funds no doubt hold similar assets on their books at very different prices, depending on when and how they acquired them.
And we may have a deal body in the room. Let us say that this new conduit comes up with values for some of this non-trading paper (think of colllateralized debt obligations) that are below the old “mark to model” prices from rating agency models that many players are still using in lieu of market prices. Shouldn’t everyone be required to remark similar assets to the prices set in the transfer into the new super SIV? But isn’t forcing the market to recognize new, lower prices precisely the event we have been trying to avoid?