Monday, October 15, 2007

More on M-LEC

There has been a lot of discussion this weekend about the proposed Master-Liquidity Enhanced Conduit.

The latest report from Bloomberg indicates that an $80 million conduit, backed by Citigroup and Bank of America will be announced on October 15. Additional banks may join in the future.

Some have been negative about this, saying that the plan can't succeed. I'm not certain, but I think it is worth a chance.

One negative blog is Mish's Global Economic Trend Analysis, where I have posted the following commentary:

As I understand the plan (from what has been described by the news), M-LEC would only buy loans from the SIVs of participating institutions. Given that the
total amount of SIV assets is estimated at $325 mm to $400 mm (depending on
which version of Moody's you read), a $100 billion fund as a backstop to the
SIVs could work.

If I understand the structure, SIVs (which currently are free-standing, with no guarantor) will have the ability to sell assets to M-LEC (which WILL have several guarantors - the participating banks).

The concept is to free up the asset-backed commercial paper market for both the SIVs and M-LEC.

As I understand it, this will be a "closed system" with no outside participation. The hope is that, by creating this backstop, the banks wouldn't have to make a choice between letting SIVs that they, or their top clients, sponsored go under; or taking the assets onto their balance sheets (which would reduce funds available for new

While the worst part of the crisis may be over in the interbank market, there appears to be some hoarding of reserves by banks to prepare for the potential need to assume the assets. If M-LEC works, some of these reserves could be freed up for new loans to customers or other banks.

The success depends on whether the commercial paper market is willing to rely on the $100 billion backstop, which seems fairly reasonable.

As the SIVs reportedly have limited sub-prime exposure, their funding difficulties are directly related to fear of the unknown (exactly what the underlying assets are). When liquidity returns to the system, the market may return to normal or the positions can be unwound (just not in forced sales).

As for the anti-trust argument, that isn't applicable. The banks are stepping forward (potentially) to avert a system shut-down created by complex structures developed by Wall Street. The alternative would be a government body directly intervening, but that would create more problems than it would solve.

At least that's what I think.

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