Tuesday, October 16, 2007

Shameless M-LEC Hype

I couldn't believe my eyes when I read the top story in this morning's New York Times:

3 Major Banks Offer Plan to Calm Debts in Housing

Wow! Something new must have happened!

But noooooo! Floyd Norris' article was about M-LEC.

Apparently the front page editor at the Times felt that stretching the truth would sell more papers.

M-LEC's effect on the housing market is extremely tangential. The focus, as the article states, is on fixing the commercial paper market.

I have no problem with the text of the article, although I think two of their "experts" were talking outside their competency.

One, an economist said "It seems a little more like a P.R. move, frankly."

Another, an expert in mortgage-backed securities, was quoted as follows: "'If they really believe these are good assets being mispriced in the market,' he said, the banks could just buy them and wait for the asset values to recover. 'This raises the question of whether the banks are doing this just to avoid taking their losses.'"

The "P.R. move" comment is off the mark, as there is a clear risk reduction to SIV ABCP investors in having multiple banks legally obligated to back-stop their investments.

It's not clear that buyers will reemerge based on M-LEC, but it's more than a publicity stunt.

The other comment seems to reflect a complete misunderstanding of the nuts and bolts of SIVs and M-LEC (or, he's right and I am completely misreading this - I have been doing quite a bit of research on the subject, so I'm highly confident in my interpretation).

If the SIVs sell the assets to their sponsors today using market prices, the SIVs would generally suffer steep losses and be unable to pay off their outstanding commercial paper (which, given that much of the commercial paper is held by money market funds, could create a much larger crisis of confidence of ALL Wall Street products). On the other hand, the banks would be able to profit if, as they believe, the assets are priced below value (in other words they would gain).

The alternative would be for the banks to purchase the assets at, or close to par. This would allow the SIVs to liquidate in an orderly fashion, but the banks would have to cut back on loans (due to reserve requirements) and - when they mark to market - absorb losses (which may be temporary).

Another alternative would be for the banks to purchase new commercial paper from the SIVs. This, however, has the same reserve requirement issue as the second alternative.

The objective here is to minimize direct exposure of the banks' balance sheets so that the commercial paper market will continue to provided financing. The new wrinkle is the back-stop by a group of large banks (not just one, reducing fears of individual bank insolvencies).

As I said, the article is pretty good; it just has a ridiculous headline and some, apparently, misinformed expert quotes.

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Anonymous said...

Hello Lawrence,

Your thoughts on the SIV rescue plan are much appreciated.

It is unclear to me though: are there really bank guarantees in this plan?

It is has been implied by many, but I don't see any direct confirmation of this.

And secondarily, is the MLEC really going to buy the SIV assets near par, when they are actually trading far below that?


Lawrence D. Loeb said...

It's my understanding that the banks intend to provide back-stop financing to M-LEC (otherwise I'm not sure what the purpose would be).

As you'll note from Mark's comment below, there is some question as to the bank's obligations at present. I don't believe that there is recourse, but Mark believes that there might be.

As for the price of the assets being transacted, you hit on a very important point.

This article (mentioned in my next post) gives a good idea of how that is being handled, but I don't believe it's resolved yet.