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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 debt vehicles.
Citigroup is leading a consortium of financial institutions that will create a new US$80 billion ($105 billion) to US$100 billion 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 finance 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 deal reignited concerns that the global debt markets, far from returning to normal after summer's convulsions, 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 US$80 billion in assets, although European banks such as Barclays and HSBC have also created such vehicles in recent years, and there is an estimated US$400 billion invested in SIVs in total.
HSBC sources said it had not decided whether to join; 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 to buy longer-term investments, mainly mortgage-related securities, which pay a higher interest rate.
The value of the longer-term assets collapsed when Americans started defaulting on mortgage debts in record numbers, and as the short-term debt comes due in the coming months, SIVs are finding it hard to find outside investors to refinance them. 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 was 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, said talks to create M-LEC were overseen by the US Treasury, headed by former Goldman Sachs chief Hank Paulson, rather than by the Federal Reserve, which is responsible for financial market stability.
"Everyone is thinking ... that if Citigroup has problems then they will all have problems. But if Citigroup took the US$80 billion 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?"
- Independent
