Officials from the three biggest U.S. banks announced Oct. 16 the creation of a rescue fund of up to $100 billion to buy “troubled assets” such as mortgage-backed securities. Investment funds, known as structured investment vehicles, set up by Citigroup Inc., the biggest of the three banks, hold close to $100 billion of such assets, or about 25 percent of the total held by these and other SIVs.
Citigroup and other banks set up these formally independent funds as a way to make money without taking the risk
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Enron before it crashed in 2001 set up similar entities offshore to keep loss-making operations off its books and its stock price elevated.
The popularity of SIVs in banking circles has boomed since two Citigroup bankers, Nicholas J. Sossidis and Stephen Partridge-Hicks, invented the strategy in the late 1980s. They later left to form their own London-based company, aptly named Gordian Knot, which operates the world’s largest SIV.
A worldwide credit market meltdown in August and September was triggered when banks and other financial institutions began parking their surplus funds in lower yielding but safer U.S. Treasury bills in preference to commercial paper, much of it mortgage-backed.
This “flight to safety” was only prudent. Many homeowners were being hit by soaring monthly payments as low “teaser” interest rates on mortgages were resetting higher. In consequence, home foreclosures and mortgage delinquency rates were, and are, skyrocketing.
To make matters worse, a large sum of the commercial paper issued by Citigroup’s SIVs was coming due in November. A recent Citigroup research report noted, “SIVs now find themselves in the eye of the storm.” (Wall Street Journal online, Oct. 15)
In short, the seven SIV affiliates of the world’s biggest bank, if unable to roll over their billions of dollars’ worth of commercial paper coming due, were faced with the prospect of having to unload their mortgage-backed securities in a fire-sale fashion, taking huge losses—if the securities could be sold at all. The very solvency of the parent financial behemoth, along with other financial institutions holding large quantities of mortgage-backed debt, was in jeopardy.
The state intervenes
Last month, Treasury officials convened a meeting of some 10 banks, including Citigroup, to discuss a “private-sector solution.” What they came up with was, in essence, a super SIV, called the “Master-Liquidity Enhancement Conduit.”
Under the proposed rescue package, Citigroup, J.P. Morgan Chase & Co., and Bank of America Corp. will set up a new fund to act as a “buyer of last resort.” It will buy up SIV assets that would otherwise have to be dumped on the market at distress prices.
J.P. Morgan and Bank of America haven’t created SIVs, but they were enticed to participate in the rescue effort by the prospect of large fees for helping to set up and operate the new “conduit.” It was also in their interest, of course, to head off a wider financial collapse.
The government supposedly is not putting up any money, but the role of the U.S. Treasury could be crucial in luring investors to buy debt issued by the rescue fund as part of the plan, according to the online Wall Street Journal.
Secretary Paulson expresses ‘concern’
Treasury Secretary Henry Paulson, formerly chairman and CEO of Goldman Sachs, one of the world’s largest and most profitable investment banks, didn’t join the bankers announcing the rescue plan. That would have detracted from the effort to portray it as strictly a “private-sector” affair.
The next day, however, he gave a speech at Georgetown University in which he discussed the housing crisis: “The ongoing housing correction is not ending as quickly as it might have appeared late last year. And it now looks like it will continue to adversely impact our economy, our capital markets and many homeowners for some time yet.” (MarketWatch.com, Oct. 16)
That may well turn out to be an understatement, as the U.S. and world economy sinks into a new and potentially vicious downturn.
Paulson called for various band-aid measures, even as he admitted that over one million foreclosure proceedings will start this year, with 620,000 of those in the sub-prime category. These numbers are certain to grow as interest on more adjustable-rate mortgages reset higher. “The Bush administration has rejected a bailout of homeowners, however,” Robert Schroeder of MarketWatch reported.
The slogan of finance capital: Rescue the world’s biggest bank, yes! Rescue millions of homeowners facing loss of their homes, no!
Citigroup’s rescue and credit market stability remain in serious question, however. A few days after the rescue plan was announced, the bank’s stock price had fallen to a new low—down more than 20 percent from its all-time high at the end of 2006—and the flight to safety by investors into U.S. Treasury bills, as well as gold, had resumed.
What is called for to meet the needs of working people in this crisis is a moratorium on home foreclosures and evictions. But we can’t count on the politicians of either capitalist party—beholden as they are to finance capital—to enact such a measure.
