Some of Wall Street's biggest banks are still haggling over vital details of a rescue plan which they hope will stave off tens of billions of dollars in losses from secretive off-balance-sheet vehicles.
Citigroup is leading a consortium of financial institutions that will create a new $80bn-$100bn fund to buy up mortgage-backed debts that few other Wall Street investors now want to buy.
But several banks are still to decide whether to join the rescue plan, and participants had yet to hammer out important questions about what sort of assets the fund will buy and how much it will pay for them. Meanwhile, the whole idea faced criticism from outsiders who argued it was delaying an inevitable day of reckoning, when the fin-ance industry will have to crystallise many billions of dollars of losses on the obscure mortgage-backed debt instruments created over the past few years.
The scale of the rescue deal reignited concerns that the global debt markets, far from returning to normal after the convulsions of the summer, could again be thrown into turmoil, as problems at banks' off-balance-sheet vehicles cascade through the financial system.
The aim of the new fund, called the Master Liquidity Enhancement Conduit (M-LEC), is to prop up dozens of off-balance-sheet vehicles – known variously as structured investment vehicles, SIVs, or conduits – which might otherwise have to be taken over by the banks that created them, crimping their ability to do other types of business and hitting their profits.
Citigroup is the biggest manager of SIVs, controlling vehicles with an estimated $80bn in assets, although European banks such as Barclays and HSBC have also created such vehicles in recent years, and there is an estimated $400bn invested in SIVs in total. HSBC sources said it has not decided whether to participate; Barclays declined to comment but is known to not be on board at present. JPMorgan Chase and Bank of America were the only other named investors in M-LEC.
SIVs raise money at low interest rates in the short-term debt markets in order to buy longer-term investments, mainly mortgage-related securities, which pay a higher interest rate. The value of the longer-term assets collapsed when Amer-icans started defaulting on mortgage debts in record numbers, and as the short-term debt comes due over the coming months, SIVs are finding it hard to find outside investors to refinance them. As a result, they may be forced to sell assets. Fire-sales by distressed SIVs could drive prices sharply lower, triggering a new round of huge losses across Wall Street, and SIVs may not find buyers at any price for their riskiest mortgage investments. Sources said M-LEC is likely to buy only the least risky mortgage assets, raising questions of how effective the rescue plan might be, while regulators will be concerned that the fund is not being used to artificially inflate the price of assets that should properly be written down.
John Makin of the hedge fund Caxton Associates, a visiting scholar at the free-market American Enterprise Institute, pointed out that talks to create M-LEC were overseen by the US Treasury, headed by former Goldman Sachs chief executive Hank Paulson, rather than by the Federal Reserve, which is responsible for fin-ancial market stability.
"This is not a systemic issue," Mr Makin said. "This is the banks going to bail out the banks. Everyone is think-ing Citigroup has a lot of risky assets in their SIVs, and are thinking that if Citi-group has problems then they will all have problems. But if Citigroup took the $80bn of assets on to their balance sheet, it won't sink the bank, [it will] just mean they have less ability to grow their portfolio – and isn't that the way it is supposed to work?"