A plan by top U.S. banks to set up a fund preventing the forced sale of billions of dollars of hard-to-value securities faces some serious obstacles.
The nation's three largest banks said on Monday that they were setting up a pool to prevent certain investment funds from having to sell off assets. Any forced selling could set off a chain reaction, ultimately slowing economic growth in the United States and Europe.
The banks' new pool is meant to bail out funds known as structured investment vehicles, which have invested in assets linked to subprime mortgages and other debt.
But analysts said the pool might end up hurting existing SIVs even more by stripping them of their best assets. Nor is it clear who would manage the new pool.
It's all a bit of a shell game, said Bill Cunningham, head of global fixed income research State Street Global Markets in Boston.
Details of the new pool, known as the master liquidity enhancement conduit, or M-LEC, are still being worked out.
Citigroup, Bank of America and JPMorgan Chase & Co are setting up the pool, which could be about $80 billion. Wachovia Corp said on Wednesday that it was also participating.
The M-LEC will buy high-quality assets from existing SIVs and finance itself in part by issuing short-term debt known as commercial paper.
SIVs, which controlled some $370 billion as of September 14, generally finance their asset purchases with commercial paper and medium-term debt.
These funds make money by earning more from their investments than they pay to fund them.
But selling commercial paper has grown increasingly difficult as investors in the market became jittery. If SIVs cannot refinance maturing commercial paper, they typically have some backup lines of credit to draw on, but they may also have to sell off assets.
The new pool will probably have a complete backup line of credit from multiple banks, according to an investor who has spoken to those involved in the deal and has requested anonymity.
Any backup lines may help the new pool sell commercial paper, but it may buy the highest-quality assets and leave the SIVs with the weaker ones.
As a result, the SIVs' funding troubles could end up being even more acute, said State Street's Cunningham.
Another potential problem is that managing a SIV requires skill and discipline, said Janet Tavakoli, a structured finance consultant.
Current SIV managers may have a conflict of interest if they also manage the M-LEC, but new managers may not have the experience the pool needs, Tavakoli said.
And the price that M-LEC pays to buy the assets is crucial, noted analyst Bert Ely of Ely & Co. in Alexandria, Virginia. It's not clear how losses on the instruments will be shared.
It may be that it's in everybody's interest that everything works out, Ely said, but I'm not convinced this will.
Investors say avoiding forced SIV asset sales is a laudable goal. Failure to do so would depress debt prices, lift borrowing costs and tighten credit globally, potentially slowing economic growth, especially in the United States and Europe, where most SIV assets are from.
I think fire sales would be the worst thing that could happen in this market, said Patrick Ledford, chief investment officer at the Reserve Fund, which manages more than $82 billion.
The proposed M-LEC could help prevent that from happening, he added.
Others agree, saying they do not see the problems as insurmountable.
Several investors noted that Citi, JPMorgan Chase, and Bank of America were expert at putting complicated deals together. And the source who invests in commercial paper said SIVs had very high-quality assets, and moving a few of the better ones into the M-LEC could still leave the existing funds strong.
But State Street's Cunningham said U.S. consumers might face further trouble, and many SIV assets that had seemed safe may appear less so next year as the mortgage crisis spreads.
In the latest reminder that the pain is far from over, U.S. home construction starts fell 10.2 percent in September to their lowest level in more than 14 years, a government report showed on Wednesday.
Cunningham said a better solution might be to restructure individual SIVs as problems arise, instead of concentrating assets in a larger vehicle like the M-LEC.
All these smart people set up the system as it is, he said, and the system has broken down.