Fear and Greed Blog

This multimedia feature, from the web site of Condé Nast Portfolio, gives a good explanation of how Structured Investment Vehicles (SIVs) work(ed).

A number of SIVs did make sense. Commercial banks offered their corporate customers the chance to finance their receivables through SIVs. In those cases, the bank was able to earn a fee for managing the SIV, the companies were able to retain more of the value of the receivable, and the bank didn't need to include the funding provided to their clients on their balance sheet (they were able to effectively work with no capital requirement).

The companies would sell their receivables to the vehicle. The funds would be provided by the jointly owned SIV (which would have little, if any equity). The SIV would be funded by issuing asset backed commercial paper (ABCP). The receivables, however, would generally have similar maturities to the paper backing it; so if the ABCP market dried up, the assets could be quickly run off to liquidate the SIV.

The first SIV was structured by Citi in 1988. Since then the structure became more popular and morphed into the structure shown by Portfolio.

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There has been a tremendous amount written about the credit crisis; its origins; who's to blame; potential solutions, etc. Some of this has been excellent; some, not so much.

I am still trying to catch up and provide, perhaps, my own observations.

In the mean time, Gillian Tett and Paul J. Davies of the FT wrote a particularly good article in December that's worth a look. That paper continues to provide insightful information and analyses.

Bill Gross and Paul McCulley, of PIMCO, are also providing good insights that are available here and here.

One thing that I continue to find troubling is that so many of the holders of effected securities (ABCP, CDOs, etc.) seem surprised that it was possible for them to incur losses on their investments. The perception of increased risk for increased return seems to have eluded them.

Perhaps their surprising losses were due to fraud on the part of those who sold the securities to them. I'm sure we'll learn more about this in time.

The entire structured world and the banking system will likely be examined, to various degrees, as the situation in the markets becomes clearer.

It was well known in the financial world that risk was being priced at unusually low cost. Spreads on lower grade securities were squeezed as demand for higher returns apparently outweighed the fear of associated risk.

Given that the positions of many SIVs and conduits have been taken onto the balance sheets of the financial institutions associated with them (CitiGroup being the largest example), there will (appropriately, in my opinion) be a reexamination of what types of entities should be subject to regulation and how their assets and liabilities should be presented on financial statements.

On the other side, however, is the question of what constitutes an "accredited investor" and/or who should be allowed to make the decisions to purchase specific investments.

Personally, except for cases of fraud, I am offended by investors that claim to be sophisticated (the definition of "accredited investor" is an attempt to clearly state who is sophisticated), until they incur a loss.

It's understandable that people/institutions don't want to lose money, but I think it's childish to claim ignorance when investments generate losses.

These parties want to have access to all of the wizardry the financial houses can devise, but not the ones that lose money (I'd like that too, if only the world worked that way).

Perhaps the SEC and other regulators should consider a licensing exam to purchase unregulated investment products instead of assuming that having assets/income makes investors qualified to understand what they are buying.

Agents have to be licensed, why not their customers? It should generate a more sophisticated group of investors, whether or not they pass the test.

I, at least, think it's an intriguing idea.

People and institutions that were defrauded should be protected, but I have a problem with rewarding laziness and/or stupidity. Sophisticated Investors are supposed to be able to understand the risks involved in what they purchase and to be able to bear the burden of any related losses (which is why the Securities Act has an asset/income definition).

The ratings agencies, who are being picked on as the implied regulators, made their own mistakes. They always stated that investors should not rely on their ratings; and almost everyone knows that they are compensated by the issuers.

More later.

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As everyone knows now, M-LEC is dead.

There was never a solid explanation of how M-LEC (the Master Liquidity Enhancement Conduit) would have been structured (without guarantees from the supporting banks it would have had a hard time funding the purchase of SIV assets, even the "best" of those assets).

In the end, I believe, the idea of M-LEC helped to stabilize the markets (in that, without the expectation of some plan, the markets would have been less stable).

Apparently there was no way to make the economics of the structure attractive to both the participants in the Super-SIV and the SIVs that were supposed to be saved.

Actions by the banks themselves (taking the SIV assets onto their balance sheets) seem to have dealt with the problem.

The banks have been able to attract capital from other sources to keep their balance sheets in order.

More later.

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I think everyone reading this has heard about the turmoil in the credit markets that became incredibly obvious this summer.

Now we're seeing a domino effect as fears run rampant.

While I was well aware of Special Purpose Entities (SPEs) and other off-balance sheet structures generally, it wasn't until this summer that I heard of Structured Investment Vehicles (SIVs). A SIV is a special type of SPE (aren't acronyms great?).

Recently we heard that some banks, with the support of the Treasury Department, were creating MLEC (a sort of "Super-SIV"), however no specifics were ever announced (and may not have been agreed). Of course this didn't stop bloggers and columnists from coming out with their opinions on it (mostly negative). I merely voiced the opinion that I didn't see how it would work unless there were specific guaranties made by the institutions creating the entity. I am in favor of giving market players an opportunity to figure out what they own so they can clean up the mess.

I have some specific comments to make about one recent column, but more on that later.

Merrill Lynch shocked the market with $8.4 billion in write-downs last week, $4.9 million more than they had estimated on October 5th. Why did this happen?

Rachel Beck of AP wrote an article today that may answer that question.

On October 3rd, the Center for Audit Quality, an organization founded early this year by the American Institute of Certified Public Accountants (I earned my CPA, but am not presently a member) and eight audit firms, issued three white papers. These were Measurements of Fair Value in Illiquid (or Less Liquid) Markets, Consolidation of Commercial Paper Conduits, and Accounting for Underwriting and Loan Commitments.

These white papers, which I am in the process of reading (but which are described by Fitch Ratings in a very timely report), provide guidance to auditors on how to interpret recent, and not so recent, statements and interpretations by the Financial Standards Accounting Board and the AICPA, principally FASB-157, FIN 46(R), and CON 7 . Fitch also notes that IAS-39, issued by the International Accounting Standards Board, is being employed by some financial institutions.

If you have trouble sleeping, I highly recommend that you read the FASB documents. It might give you nightmares, but you might understand what the financial institutions are actually saying in their filings (a lot of this is relatively arcane, but the original pronouncements can provide a sort of Rosetta Stone).

While quarterly reports are not audited, it is apparent that the new guidance led several institutions, including Merrill Lynch, to make more conservative estimates in anticipation of the year end audit. It is highly likely, in my opinion, that when Merrill made their original estimates they had not yet read (and/or implemented) the October 3rd guidance.

In a way, it appears that E. Stanley O'Neal lost his job over the timing of a change made by a new audit industry governing body. Of course the magnitude of the losses might have created the same environment, even if they had been part of the pre-announcement. Reports, however, seem to point to concerns due to the huge difference from the initial estimate within such a short period of time.

Oh well. He got a good severance package.

I'm really looking forward to reading/skimming these documents together with the SEC filings to get a better picture of actual exposures (at least what is disclosed).

I figured it would be better to provide this information now and give readers a chance to make their own assessments rather than waiting for me to read all that material.

Enjoy. If nothing else, I highly recommend that you read Rachel Beck's article and the Fitch report.

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Join the club!

So why spend so much time writing/blogging about it?

The reason that I spent time blogging about M-LEC and SIVs was that these were obscure, interesting, financial structures that were creating market disruptions (dislocations, or whatever other tag you'd like to use).

I focused on them to get a better understanding of how these structures worked and how they would ultimately effect the markets.

While the credit markets have calmed down, there is still some uncertainty. That said, in my opinion the SIV situation is relatively under control.

We still face potential disruptions in the RMBS and CDO markets as variable rate mortgages reset. These will also impact the SIVs.

The timing of these disruptions are somewhat predictable, so I expect that most investors with exposure will use other structured products to hedge their risk.

Undoubtedly there will continue to be problems in the consumer market, and these will filter into the overall economy, but the markets appear to have adjusted for the credit risk (for now).

I'll, therefore, leave the discussion of SIVs and M-LEC to others until there are developments that I think are worth discussion.

Here are two articles from Tuesday's FT that give good descriptions of M-LEC and Citi's SIV exposure and a discussion of the proposed RBS refinancing of the Cheyne Finance SIV.

I will continue to comment on issues that impact the markets and, hopefully, discuss some things that will make money.

I hope that readers will feel free to comment.

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There seems to be a great deal of confusion as to what SIVs are, how they work, and how M-LEC may provide time for the market to regain confidence in the commercial paper market.

To start off with, SIVs are not vehicles that provide banks with the ability to manipulate earnings, misappropriate funds, or to do anything else that is illegal. Comparisons to Enron are way off base.

I can understand people's willingness to assume the worst of businesses in the wake of Enron, WorldCom, etc., but that simply is not the case here.

I highly recommend the following articles/publications that are available on-line:

1. This article from Hedgeworld (requires free registration) that gives a good explanation of what is known about M-LEC;
2. This Wikipedia article, which gives a decent explanation of SIVs; and
3. This DerivativesFitch report (requires free registration) that speaks to seven specific SIVs that Fitch rates, including information on the assets and capitalization of each SIV.

I hope you find these helpful in getting a better feel for what is currently a little understood aspect of our financial markets.

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Friday's WSJ reports (for subscribers) that Citicorp, through asset sales and commercial paper placements, has arranged funding for the SIVs that it manages.

The article states:

Executives of Citigroup Inc. say the giant bank has secured funding through year end for the $80 billion in structured investment vehicles it manages after selling $20 billion in assets since the midsummer credit crunch.

This does not seem to effect efforts to establish M-LEC, but it should significantly reduce market fears of asset fire-sales.

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I had an opportunity to speak with some people on Wednesday that have been directly involved with Structured Investment Vehicles (SIVs).

After that discussion, and further review of published information, I thought it would be helpful to summarize what I know about M-LEC:

1. The first thing that needs to be understood is that M-LEC is a proposal. There is an agreement in principal, but the lead banks are still looking for partners and have not settled (at least as reported) on the specific structure and how M-LEC would interact with the SIVs.


2. I cannot stress this enough, but I have been assured that lenders to the SIVs have no legal recourse to the banks! There is no obligation for the banks to bail out the SIVs. There ARE lines of credit that were intended to provide liquidity, but they generally require that the banks would lend 10% of the SIVs' assets (and we don't know what, if any covenants there are related to these "back-stop" lines of credit). Even if the banks were to provide the backstop, they wouldn't be taking the SIVs' assets onto their balance sheet.
   
   That said, there are reputational and client relationship issues that might be judged to be important enough to justify one or more banks taking on the assets of related SIVs, despite their lack of obligation.


3. Unlike what some have been saying in the blogosphere (and in at least one newspaper), M-LEC would be intended to solve one problem and one problem only - revive liquidity in the asset-backed commercial paper market. SIV commercial paper is held by, among others, money market funds that are not supposed to be taking risks with the capital that is provided to them. Should the SIVs start to default, the problem would quickly spread to other fixed-income, and probably equity, prices - perhaps removing a great deal of liquidity from the economy. That scenario would touch a LOT of Americans (and Europeans and Asians, etc.).


4. News reports have been sketchy (as previously mentioned) on whether, and to what extent, the participating banks would guarantee the solvency of M-LEC. The original Wall Street Journal article implied that there would be a guarantee from the banks. The press release does not speak to that issue.


5. M-LEC, if implemented, will give time for the SIVs to liquidate their assets, as necessary, in an orderly fashion. If nothing is done, there is a lot of fear as to what would happen.

My personal belief is that, without bank guaranties, M-LEC would have great difficulty surviving and/or providing effective relief to the commercial paper market.

I believe that, if the banks guarantee M-LEC's borrowings, then the plan could work. I don't know if the fund needs to be $80 billion, $100 billion, or some other amount.

I believe that, for investors to purchase the SIVs' debt, there needs to be a greater degree of confidence that the investors will be repaid. Without the banks standing solidly behind this "super" SIV, it is not clear to me how confidence could return to the marketplace.

Clearly, there is a lot that we do not know about M-LEC. Hopefully we'll find out more in the coming weeks.

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In contrast to some other news sources, the Financial Times has been providing some of the best coverage of the SIV/Commercial Paper situation.

In today's FT, Gillian Tett and Saskia Scholtes (two reporters who have been doing excellent work on this subject), wrote a very good article summarizing the M-LEC concept.

If you have today's copy of the paper, there is a graphic on page 18 (in the US edition) that does a explains the situation very well.

Another article on that page by David Wighton and Deborah Brewster gives a good explanation of the pricing aspect of executing M-LEC transactions with the SIVs.

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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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I miss Slim Pickens and Peter Sellers!

There has been a lot of rhetoric being tossed around in the news outlets and in the blogosphere about M-LEC.

Some have called it a "Ponzi Scheme." Others have made similar statements.

SIVs are complex entities. Many on Wall Street have just become familiar with them over the last two months.

The plan is also, necessarily, complicated. Furthermore, there is only an agreement in principal, so the details are sketchy at best.

That said, there are clearly suspicions that have been raised.

After Enron, Worldcom, etc. it is easy to understand the source of these suspicions.

Furthermore, this is tied - however tangentially - to the mortgage mess that we will be cleaning up for the foreseeable future.

All that said, M-LEC is meant for a very specific purpose; and it isn't to resolve all the excesses of the last few years.

Mark Palermo has posted some reasonable questions relating to M-LEC on his blog. Others have similar questions.

I have posted my comments from his blog below:

As per your request: This is not the plan!

You have the outline somewhat correct, but you're getting tied up in the
hyperbole being spread in the blogosphere (I will not attempt to describe the motives of those spreading it) and, surprisingly, in some of the news outlets.

There is a lot that we don't know.

What we do know is that SIVs have been around for nearly 20 years (the first one was established by Citi in 1988). They have functioned, under the radar, without any real problems until now.

Another thing we know is that these off-balance sheet vehicles are off-balance sheet for a reason - they are not owned by the banks. The banks have, as far as we've been told, no obligation to support the SIVs other than agreements that have been written to provide short-term back-stop funding.

The banks are under no legal obligations to take SIV assets on their balance sheets, even if they sponsored them.

The risk the banks face, if they don't deal with this problem, is reputational (both tangible in the form of angry customers, and intangible in terms of future business).

A continuing theme of those who denigrate the idea of M-LEC is that the underlying assets of the SIVs are "bad" and that this is a way to avoid taking a hit.

We DON'T know what assets are in the SIVs. The publicly available information indicates, however, that the holdings are primarily in structured securities.

It just so happens now that structured securities have fallen into disfavor (and that's an understatement). SIVs issue structured commercial paper that is backed by structured securities.

In other words, the opacity of both the SIVs and their underlying assets is reducing demand for these securities.

One thing that needs to be remembered is that there is often a difference between Price and Value.

Since there are no reasonable bids for the underlying assets, forced sales of the SIV's assets could, in the current environment, only be transacted at severely distressed levels. Prices will almost certainly be below, and perhaps significantly below, the values of the assets.

Furthermore, given that many other owners of the same securities must mark their assets to market, there could be a fire sale of assets - regardless of their quality. THAT would be a significant threat to the financial markets.

The idea of M-LEC is to act as a bridge so that the assets can be sold in an orderly fashion (with gains and losses being recognized by the appropriate parties at that point).

The Treasury and the banks are hoping that an entity that will have the explicit backing of the banks (regardless of the value of the underlying securities) will comfort investors enough so that they will continue to purchase the asset-backed
commercial paper of the SIVs (and M-LEC).

I have been discussing this subject at some length on my blog, and you can find links there
for some reports and other material that may give you greater comfort (one posting with a number of supporting documents is here).

This is a complex topic. We're effectively dealing with derivatives of derivatives.

I intend to discuss some of the broader issues in the near future on my blog.

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Now we have something to discuss.

Here's the press release from 8:30 AM EST 10/15/07:

Global Banks Announce Plans for Major Liquidity Facility to Bolster Asset-Backed
Commercial Paper Markets

NEW YORK, Oct. 15 /PRNewswire/ -- A consortium of leading global banks today announced an agreement in principle to create and provide liquidity support to a master conduit to enhance liquidity in the market for asset-backed commercial paper and medium-term notes issued by structured investment vehicles ("SIVs").

Bank of America Corp. (NYSE: BAC), Citigroup Inc. (NYSE: C), JPMorgan Chase & Co. (NYSE: JPM) and several other financial institutions have reached an agreement in principle to create a single master liquidity enhancement conduit ("M-LEC"). Once established, M-LEC will agree, for a set period of time, to purchase qualifying highly-rated assets from certain existing SIVs that choose, in their sole discretion, to take advantage of this new source of liquidity. Access to such liquidity is intended to allow participating sellers to meet pending redemptions and
facilitate asset-backed commercial paper rollovers.

M-LEC will issue new short-term credit instruments to finance its purchase of eligible assets from participating sellers. The instruments issued by M-LEC are intended to benefit from various features, including a cushion of support from junior layers of capital and liquidity backstops. The size of the vehicle, the scope of the liquidity backstops, and the underlying cushion of capital are intended to enhance the liquidity and marketability of the short-term obligations of M-LEC.

The three major banks and other participating financial institutions will coordinate on a process, the terms of which are still being finalized, for determining asset eligibility for M-LEC. A syndication process is currently underway to identify the liquidity backstops to include several additional financial institutions, in order to
scale M-LEC to a size and funding structure deemed appropriate by the consortium. M-LEC could be operational within 90 days. Multiple investment management firms have been engaged in discussion with the consortium and expressed support for the
plan.

Recently, refinancing in the asset-backed commercial paper markets has been difficult despite the high quality collateral underlying many of these securities. The objective of M-LEC is to facilitate these re-financings and to complement other
market-based solutions in supporting an orderly and efficient market environment.

The Department of Treasury facilitated the discussions among the consortium of banks and investment managers.

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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.

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While Bloomberg is reporting that only Citi and B of A are putting together a fund of $80 billion; The Wall Street Journal is still reporting that JP Morgan Chase would participate in the creation of a $100 billion fund.

The Journal article adds quite a bit of useful background and a good framework for understanding the intent of this effort. Among the statements in the WSJ article is the following:

According to people familiar with the matter, the Treasury hopes the plan, which could be announced as early as this morning, will jump-start demand for commercial paper, which froze up this summer amid the credit crunch that roiled global financial markets.

Companies depend on commercial paper to finance day-to-day expenses like payroll and rent. Some financial commercial paper -- known as asset-backed paper -- has been able to find buyers in recent weeks. But investors have remained skeptical of other types, including paper issued by certain bank-affiliated investment funds.

The lack of buying signaled that the markets weren't working properly, despite the efforts of central banks, and that investor confidence was low, since commercial paper typically is considered a safe investment.

We will see what is reported later today.

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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
loans).

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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The Wall Street Journal is reporting, in its October 13th edition (for subscribers), that a number of large banks are discussing a plan to create a "superconduit," tentatively named "Master-Liquidity Enhancement Conduit" (or M-LEC). This pool would be capitalized at $100 billion and funded by the issuance of short-term debt that would be backed by the big banks themselves. M-LEC would purchase assets from Structured Investment Vehicles (SIVs) that are affiliated with the participating banks.

There are a number of hurdles to implementing this plan. They include how the assets purchased by M-LEC would be priced and the reluctance of some banks to participate in, what some banks apparently consider, an effort to bail out Citigroup (it is called a "Citigroup plan" in the article).

According to Moody's (also has a good overview of SIVs), SIVs had $400 billion in assets at August 28th (of which Citigroup is the largest sponsor). According to Bloomberg's article (cited below) Moody's believes that a more current number is $320 billion.

According to the above-referenced Moody's report, SIV assets are, in general, composed as follows:

43% Debt from Financial Institutions

23% of Residential Mortgage Backed Securities (RMBS) - all geographies (Sub-Prime RMBS consist of 2% of total assets, included in the 23)

11% of Collateralized Debt Obligations (CDOs) - including 1% of RMBS CDOs

23% are primarily other asset backed securities

This article, by Paul Davies of the Financial Times, gives a good explanation of how the SIVs have been unable to fund themselves.

Bank sponsors need to resolve the funding problems of their SIVs because, while the SIVs have no recourse to the banks' assets, the sponsor of a failed SIV would likely damage both their relationships with some of their large clients and their reputation.

One underlying problem is that these SIVs were structured to fund long term assets with short term funds (reminds me of Continental Illinois, which relied on short-term CDs to fund their balance sheet). Given that the markets are now particularly risk-averse towards structured investments, the SIVs have had difficulty placing the asset-backed commercial paper that they typically use to fund their balance sheet.

The inability to roll over their ABCP means that the SIVs are faced with a need to liquidate the structured assets in their portfolios to meet their obligations. These assets, of course, have the same liquidity issues that the ABCP has, and would result in a cascade of losses if they were liquidated (other SIVs holding similar securities would have to recognize the deterioration in value and liquidate their securities, and so on).

Another, related, underlying problem is the opaque nature of the SIVs and their assets, which is largely the reason for the lack of liquidity.

By creating a conduit to purchase assets from the SIVs, or otherwise relieving the pressure on the SIVs, a much larger liquidity squeeze may be averted.

The bank sponsors have, apparently, been hoarding reserves in case they needed to take the assets on to their own balance sheets. This reserve hoarding (see Reserves versus Required Reserves, which has improved significantly from August 15th) has put strains on the capital markets. By reducing the potential of the SIV problems having an effect on their balance sheets, banks should be able to end the liquidity squeeze by loaning against their reserves.

When considered in comparison to the size of the overall market for private and government sponsored mortgage securities of $6.9 trillion and overall mortgages outstanding of $14.0 trillion, $100 billion is relatively small. If there isn't a significant shock in the mortgage market, however, then M-LEC may work. Given the upcoming resets, this may be optimistic. In my opinion, however, it is a good step.

According The Wall Street Journal, the Financial Services Authority (the UK's markets regulator) has suggested that UK banks consider participating in the plan. Increased participation could increase the odds of success.

Here are some other articles on M-LEC from the FT, Bloomberg, and Reuters.

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In case you haven't run across these terms (and there was little discussion of them until a few weeks ago), banks and other financial institutions created conduits. These conduits, under a variety of names (including Structured Investment Vehicle), were created as separate entities. They purchased CDOs and other asset-backed securities and were funded, primarily, through the issuance of Asset-Backed Commercial Paper.

It was concerns about the value of the conduits' assets that led to a freeze in the commercial paper market; and the possibility that the conduits' bank sponsors would have to bail out the conduits that led to problems in the inter-bank market.

There were other factors, but it seems that these conduits were at the root of the recent liquidity crisis (together with mortgages, again).

This opinion piece from last week's Financial Times gives a good explanation of how increased opacity has led to risk concerns and troubles in the inter-bank markets. Bill Fleckenstein's commentary from Monday is also worth reading for a further discussion of off-balance sheet conduits and how they have contributed to the turbulence.

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