Fear and Greed Blog

There is an interesting discussion of M-LEC on the nakedcapitalism blog, although I think there are misunderstandings about what it is supposed to accomplish.

Here is the comment that I left on that blog:

The last comment seems to be closest to the mark.

From what has been reported (since that is the extent of our knowledge at this point)
M-LEC has a very limited purpose. It is not intended to fix the MBS, CDO, CLO, etc. markets. The purpose would seem to be two-fold:

1. Improve liquidity in the asset-backed commercial paper market; and

2. Free up bank reserves for new loans.

The SIVs are non-recourse vehicles. The banks have no actual obligation to take the assets onto their books (although they do provide back-up credit lines). There is, however, the risk of damaging relationships with customers and hurting bank reputations if they allow the SIVs to liquidate.

This problem arises because the SIVs relied on short-term paper to fund their investments. Uncertainty related to SIV assets has led to lack of demand in the commercial paper market and the sale of $75 billion in SIV assets.

If the SIVs are unable to fund themselves in the commercial paper market, they will be forced to liquidate - creating fire sale prices on assets.

These low sale prices will not only hit investors in the SIVs, but will cascade through the system as other holders of the same securities are forced to mark their investments to the distressed sale prices (leading to other liquidations, particularly from leveraged funds).

The alternative to liquidation is for the banks to wind up the SIVs and take the assets on their balance sheets, tying up reserves and limiting their ability to lend.

If successful, M-LEC will provide greater credibility to the SIVs (as commercial paper will be backed by SIV assets AND bank guarantees). This will free up reserves and limit the collateral damage.

It is a bit more than optics.

Yes, I also worked on Wall Street.

I have commented further on this on my blog at blog.lawrencedloeb.com.