Getting Liquidity to the Choke Points

Recently, in a post titled Can Policymakers Keep Credit Markets from Freezing Up?, I said:

Getting liquidity to the choke points, many of which are outside the traditional banking system, is a tough problem for the Fed to solve since most of its tools operate within the traditional banking system. It has been creative, e.g. changing collateral rules so that banks could act as intermediaries between mortgage lenders and the discount window, but there are limits to what it can do within the existing regulatory structure.

The Fed has now taken another creative, and likely useful step in getting liquidity to the "choke points" outside the traditional banking system:

Fed Joins Other Banks in Measures To Inject More Funds Into Markets, by Greg IP, WSJ: The Federal Reserve has joined with four other major central banks to announce a series of measures designed to inject added cash into global money markets in hopes of thawing a credit freeze that threatens their economies.

The Fed said today it would create a new "term auction facility" under which it would lend at least $40 billion and potentially far more, in four separate auctions starting this week. The loans would be at rates far below the rate charged on direct loans from the Fed to banks from its so-called "discount window." But the new loans can still be secured by the same, broad variety of collateral available that banks pledge for discount window loans.

The European Central Bank, Bank of England, Bank of Canada and Swiss National Bank simultaneously announced parallel measures. "This is not about particular financial institutions with particular problems. It is about market functioning," said a senior Federal Reserve official...

The Fed also said it had created reciprocal "swap" lines with the European Central Bank, for $20 billion, and the Swiss National Bank, for $4 billion. These will enable the ECB and SNB to make dollar loans to banks in their jurisdiction, in hopes of putting downward pressure on interbank dollar rates in the offshore markets, principally the London Interbank Offered Rate, or Libor, market. The inability of foreign central banks to inject funds in anything other than their own currency has been a factor creating the squeeze on bank funding in those markets.

The Fed has worried that banks' growing reluctance to lend either to other financial institutions or to businesses and consumers could cause the flow of credit to dry up and drag the weak economy into recession. ...

The new loans will be auctioned off with a minimum rate linked to the expected actual federal funds rate over the duration of the loan. Since the federal funds rate is expected to decline over the next two months, when the loans will be outstanding, the loan rate could end up being close to or even below the current federal funds rate. ...

The Fed indicated that the new facility could become a permanent addition to its monetary policy toolkit. ...

It remains unclear whether the new operation will do the trick. But the early reaction was favorable: Treasury bond prices plunged and their yields shot up in early trading, a sign that investors are abandoning the relative safety of Treasurys and preparing to bid up riskier debt. Futures markets suggested stocks would rise at the opening.

I'm sure we'll hear the usual bailout and moral hazard objections, but this sounds like a good idea to me. Think of it this way, if the economy does go into a recession, it will be far more costly than the 40 billion the Fed plans to loan financial firms, and the costs will not be limited to those who bear responsibility for the problems, they will be widely felt. Thus, if this works, it will be money well spent.

Update: Steve Waldman at Interfluidity with his first reactions to the plan. [Apologies to Steve for the confusion on the name which has since been corrected.]

Comments

[Bruce Wilder]

Just thought I would oblige by raising the "usual bailout and moral hazard objections". Or, maybe they are not the usual objections, exactly.

I note this from Floyd Norris:

I’d love to see which assets are pledged, and how much the Fed lends against them. But the Fed won’t disclose those facts. Nor will it let us know which banks borrow using the new facility.

Clearly, the Fed is worried that the "signal" sent by going to the usual Federal Funds window. But, is secrecy a wise policy? Can it be a wise policy in such a matter?

If Citigroup or E-trade is willing to brave the "signal" of going to Arab loan sharks for convertible preferred paying 11% or 12%, why is the Fed worried?

[Winslow R.]

"The Federal Reserve has joined with four other major central banks to announce a series of measures designed to inject added cash into global money markets in hopes of thawing a credit freeze that threatens their economies.

The Fed said today it would create a new "term auction facility" under which it would lend at least $40 billion and potentially far more, in four separate auctions starting this week."

This is a step in the right direction that has the potential to remove bias in the system towards large, connected banks.

The question is who will be invited to these auctions, small, medium sized banks, and nonbanks?

It sounds as though the word 'inject' is proper in this context as the Fed is using its power to force money into the economy's circulation of at least 40 billion. This would be an 'injection' as it implies a set amount of asset purchases by the Fed at rates that may hit zero percent.

It will be interesting to see how close to the zero bound this auction gets or even worse, if the Fed slams up against it.

[Michael Davey]

The Fed is acting like a teenage girl who does not want to go to the prom with you, but doesn't want to reject you either. Last night's text-message via Steve Leisman on CNBC and today's 'wait - wait, we didn't really want a 300-pt reaction' announcement show they are continuing to react immaturely to every adverse market repsonse stemming from a Fed action.

Either they are deliberate or they are just idiots - neither of which is very impressive and all of which is a concern for when things are more challenging and the general market is not but a few %-points from highs.

Wow.

[kharris]

From the Fed's fact sheet:

Collateral -- Any collateral eligible to secure discount window loans. Reserve Bank's standard valuation and haircut procedures apply.

Setting aside my objection to "haircut" being used in this context - we do know the real words, right? - I think this answers a lot of the conspiracy whispers about the Fed opening the door to stupid risk takers. Treasury collateral at par. All others undress a little before entering the room. These are also borrowers who would have been eligible at the discount window, and the discount window doesn't tell tales, either. No names (locations, though, help to guess names). No valuations on collateral, either. How is the Fed doing something less responsible now than it has long done, or been willing to do, anyhow, at the discount window?

[johnchx]

From the Fed's press release:

By allowing the Federal Reserve to inject term funds through a broader range of counterparties and against a broader range of collateral than open market operations, this facility could help promote the efficient dissemination of liquidity when the unsecured interbank markets are under stress.

If I follow this, the idea seems to be that, in "normal" times, the Fed injects liquidity into the banking system via open market operations in transactions with the major money center banks; those banks then lend additional reserves to smaller banks who need liquidity via the unsecured inter-bank lending market. This means that the Fed doesn't have to be in the business of evaluating the credit-worthiness of every commercial bank in the country; the judgment is left in the hands of the money center banks (along with the risk of default).

So the claim seems to be that these aren't "normal" times -- i.e. that perfectly sound commercial banks are being charged irrationally high risk premia on unsecured short term loans, and that, under these circumstances, direct lending from the Fed, at what must be sub-market interest rates (else why bother), is justifiable.

Hmmm....

One thing to watch over the next couple of months is whether the Fed "sterilizes" these liquidity injections by scaling back on open market operations transactions with the big banks. In other words, is the Fed really "routing around" the money center banks, as the press release suggests, or is it also increasing the total volume of liquidity injection?

[paine]

"Think of it this way, if the economy does go into a recession, it will be far more costly than the 40 billion the Fed plans to loan financial firms, and the costs will not be limited to those who bear responsibility for the problems, they will be widely felt. Thus, if this works, it will be money well spent."

well said

pay the f-in' ransom

------
but i say

never again

why did we get here
where
the global economy
is in effect
held hostage
by ..... elements of the earth's leading "private capitals"

their message
to the public credit bac ked central bankers:

"bail us out...or else "

can this be avoided ???

of course it can

and without smooooothering
the innovative hi fi dynamo's
big mo

[Jim Lowe]

The primary problem facing credit markets is not lack of liquidity but rather a combination of capital inadequacy and fears of credit/counterparty risk. I don't see how another liquidity injection addresses these problems.

Can anyone tell me why I'm wrong here?

[paine]

johnchx
"is the Fed really "routing around" the money center banks, as the press release suggests, or is it also increasing the total volume of liquidity injection"

what do u care ???

are you worried about ... higher inflation ???

wind fall risk profits
on risk-free intermediations ???

or are you just playing pundit ???

i realize
sometimes folks
manage the fed
from the bleechers so to speak...

like you might
manage the chicago cubs

[RW]

Mark and all,
I frankly have difficulty figuring out what Fed "injecting liquidity" means after reading posts like the above and commentary such as John Hussman's at http://tinyurl.com/yvvhfe ; Hussman says for e.g.,

"My greatest concern at present is that investors are being bombarded with empty hope that the Fed will save them by “injecting liquidity” into the banking system. Time spent examining these false perceptions is not time wasted.

Very simply, the impact of Fed actions is sorely exaggerated. The amount of liquidity that the Fed provides is minuscule in relation to the U.S. banking system, and also in relation to the volume of capital inflows (about $2 billion daily) that the U.S. relies on from foreigners, thanks to our massive fiscal deficits and low savings rate.

What strikes me as particularly absurd is that the analysts who wax rhapsodic about “Fed liquidity” speak in a way that makes it obvious that they have no understanding of how these Fed operations work. Then again, it's precisely because we do understand how they work that we're convinced that they're irrelevant (aside from boosting short-term market psychology and accommodating short-term spikes in the demand for currency).

Let's start with a basic fact. There is only one monetary aggregate that the Fed directly controls: the monetary base – consisting of currency in circulation plus bank reserves. Here's the data. ..."

Can someone clarify; assuming Hussman is correct, is he discussing a different aspect of Fed action or ...?

[paine]

jim l

"Can anyone tell me why I'm wrong here?"

is not just an injection of liquidity
its an implicit public assumption of private risks

you're right of course its not lack of
adequate private liquidity but flight of adequate private liquidity
flight into riskless holding bins
like t notes
while uncle's ultimately
national wealth backed credit
is substituted

its like sending in the marines

[Mark Thoma]

The Fed agrees to hold the bag for awhile, so to speak, and they hope they don't get left holding it.

On another question, what you control (MB) and what you target (FF, MB, M2, R, NBR, etc., etc., currently it's FF) are different. The MB moves endogenously to satisfy the policy rule for setting FF.

In this case it's not just the quantity of credit - there's plenty of that - but also its distribution that is at issue. The Fed hopes to move liquidity/risk assumption where it is most needed.

[paine]

husssman
as you sample him
is a gas bag

number one this is obviously global
and its relevent to put this crisis
"in relation to the volume of capital inflows .."
only not the huss factor reasons
but new ones
flows of funds into safety zones
like ... here and despite the dollars swoonery

so far the leading global CB's have acted
only in miniature
... gestured...
but the signal is clear
"if bail we must
then we must bail "

[paine]

the credit system must supply all fields
but like a patient in shock
the blood right now
is spontaneously
rushing back toward the heart
the torso has funds but not the limbs
and the system only really does work
with its limbs

[paine]

"The Fed agrees to hold the bag for awhile, so to speak, and they hope they don't get left holding it."

hey mark
you and i both know
the fed will be left holdin the bag
the question
how big will the bag have to get
before the private sector credit system
acts in all foelds as it must
and that'll come
when the heads involved
"feel " each others
private pools
are purged of their poisons

[Mark Thoma]

Yes, some 'bags' will likely remain in the Fed's hands. I suppose the hope is that it will be small enough in number to be cleaned up easily and disposed of properly rather than overwhelming the system and stinking up the place. But there's always that chance.

[paine]

and regardless of the sour deal
its still better then the whole
credit system seizing up
like a runner with a huge leg cramp

[Winslow R.]

johnchx: "One thing to watch over the next couple of months is whether the Fed "sterilizes" these liquidity injections by scaling back on open market operations transactions with the big banks. In other words, is the Fed really "routing around" the money center banks, as the press release suggests, or is it also increasing the total volume of liquidity injection?"

I don't think there will be any change in total volume just a change in flows of funding. Fed funding will now be supplied to the auction attendees rather than the money center banks.

There will be better circulation as money will be accessed on one side (auction attendee) and taken out the other (money center bank). In the past, money came out the same place it went it (money center bank).

I'd like to know if Citigroup/Dubai/Paulson were involved in this plan (I doubt it) as it strikes me as a major change in the right direction. How much in the right direction depends who can attend the auction. I'd like a seat :)

I don't see why all the grim faces as the Fed/Gov ultimately ends up holding the bag. This change provides more democratic acess - potentially a very good thing and what I've been posting about for the last 2 years.

Perhaps I'm being too optomistic given the lack of details but this just may be that ray of light in a long dark tunnel.

[Don]

I've really nothing to add except that I believe I finally understand Paine, and while illuminating, it's also a bit scary....

Oh well, I'm sure the fed can print some more money for that, too.

[robertdfeinman]

Well JP Morgan tried to alter events in 1929. He failed. The Fed is bigger, but is the problem a loss of confidence (what Morgan thought) or is there some real, fundamental, problem that can only be "fixed" by prices being readjusted on a massive scale?

Judging by the wild gyrations in the stock market recently there is no consensus among the "smart money" as to where the economy is headed and whether government policies can alter the trajectory.

I'm guessing we are going to see a continuation of the recession that I claim we are already in (I use my own criteria) and a rise in the stock market in the not too distant future. Gamblers thrive when the conventional wisdom coalesces.

[Winslow R.]

One other thing, that 40 billion minimum limit is set to make sure the room is full of bidders as no one knows how low the price will go to meet that quantity.

I would not be surprised if even surrogates of money center banks will attend, sent to bid up the price to help make sure the auction a 'failure'. A small price to pay to keep one of the most profitable monopolies alive.

[One Salient Oversight]

I love the assumption that policymakers and the market are making - that there is a possibility that the damage from the credit crunch can be mitigated somehow.

Personally I believe the car has crashed. Trying to make it go faster is not helping.

[skeptonomist]

Is there a "liquidity" problem because banks are not getting enough cheap or free money from the Fed? If so, this should help. Or is there a problem because nobody knows what anything is worth, or because they know it is no longer worth what they thought it was? Will banks have an understandable fear of throwing good money (if low-interest) after bad?

[paine]

btw
despite some unzippy bird dogs
from the "kill all anti free market infidels" flea pack
anne
your comments on the treasury sec's "...plan..."
back a few posts
were very good indeed
thank you and thank .....tanta
yes tanta

[anne]

Thank you, Paine.

I think, mind you, think, the liquidity problem is that private bankers have not been sure who is holding bad debt, and now know they don't know who holds bad debt. Bankers seem wary of lending to any other financial institution that they suspect may actually need the loan. In 1998, there was a sense that bond values underlying derivatives were secure and the liquidity squeeze was cleared quickly, now so now.

[gordon]

So now you can borrow $40b. on the security of a dead cat. I like the word "borrow" in this context. I assume there is an automatic rollover at the discretion of the borrower. And no, this time I'm not bothering to go and look.

[gordon]

I suggest this website sponsor a new economic award to be called the Hjalmar Schacht Award, to be presented annually to the central banker who shows the most startling combination of financial ingenuity with economic and political indifference. I would propose Ben Bernanke as the inaugural winner, his award to be inscribed with the following quote from Hjalmar Horace Greeley Schacht (from his Nuremberg testimony):

"But if there is an emergency, then it has always been customary, and it has always been a policy recommended by all experts, that the issuing bank should furnish cheap money and credits so that the economic system can, in turn continue to function".

[ndd]

borrowers who would have been eligible at the discount window, and the discount window doesn't tell tales, either. No names (locations, though, help to guess names). No valuations on collateral, either.

Under such conditions, please write me down in the "usual bailout and moral hazard objections" camp. Sorry, professor.

This is an economy which desparately needs a big, risktaking player to go bankrupt. Otherwise, the system just keepa providing heroin to the addicts.

[Mojo]

"Think of it this way, if the economy does go into a recession, it will be far more costly than the 40 billion the Fed plans to loan financial firms, and the costs will not be limited to those who bear responsibility for the problems, they will be widely felt. Thus, if this works, it will be money well spent."

And if it doesn't (which it has no compelling reason to, since the problem is widespread insolvency rather than system illiquidity), we'll be in the hole even deeper and longer.

Think of it this way, better to cut the rot out quickly than enable it to fester.

[calmo]

Ok, the moral hazard ndd, right.
What about paine's point that following this high and mighty road that stomps out all moral hazard, actually self-destructs before they can stage their next "fix"?
IOW, in the short term, the request for air and water (sounds so desperate but we will see), for the severely wounded (those collateral holders who are testing the banks failing 'Too Big to Fail') at some cost ($40B/mo) and then some serious remedial and repair work.
"You want to see what LTCM X 1000 looks like?" expands paine's "held hostage" ...and I'm just the kind of guy who would return the ransom note for further clarification, maybe and you'd call their bluff?
I bet this operation becomes clearer soon.

[Robinia]

Well, it is indeed hard to know what to think of this. Am inclined to give the Fed a gold star for creativity-- at the very least, this is innovative. When I was just recently commenting about the Cat in the Hat ("This mess is so big and so wide and so tall... there is no way to clean it, no way at all..."), and suggested that the Cat needed to pull something out of his hat... well, I did not think it would be something so interesting as this.

A blind auction, in which we are, generally, able to grope about and get the sense of the size of the toxic waste, without revealing any individual institutional details to spur a panic. Ain't pretty, and we will, as noted above, end up holding a bag, but the auction mechanism could be argued to be designed to size the bag that we must hold to be only as large as necessary for shoving that toxic-waste-of-unknown-proportion into. I could easily be missing lots of important stuff, but, it seems a clever attempt, at least, to stabilize. Stabilizing, I think, is what central banks do, after all ("I always pick up all my things" said the Cat).

Now, as to Paine's "never again"-- that is not a job for the creativity and innovation of the Fed, or even the Fed and all the other central bankers together. That is a job for you and me, brother and sister. "Financial innovation" went the wrong way in a big way through the subprime lending crisis. It's time that financial innovation was led by a less-greedy, more honorable kind of genius. I always thought my brother-in-law qualified for that kind of laurel, so, I sent him an email and invited him over to talk macroeconomic wonk-shop. You know, we just gotta start someplace, if we are going to get to someplace better.

[calmo]

Izit? [A blind auction?] No, only the public cannot know (will be blinded) who is getting the cheap interim financing...somewhat silly, this (a bit like w facing the crowd, knowing he might have 1 friend in 5...pretending it ain't so).
So, nice to have a brother wonk...did he say how the Fed was going to determine the elgibility of the commercial banks bidding on these short term notes?...and how the "collateral" was to be valued when no other banks would touch it?...but of course we can't disclose their names (like Citi for instance) [who jumped the gun and won't be one of these players, yes?], because reputation is everything when it comes to banking (and execution?...speaks for itself)
So the auction begins and the players all raise their hands until the highest is chosen...and he gets $20B at that rate? I don't think so...not much "dissemination" with that...but to be honest I think the tbill "auctions" are not the same thing as the public auctions we are accustomed to either.
No, somehow some commercial banks get some of the financing they need ...to pay bills incurred over the last 6yrs of reckless gambling last few quarters where there has been this unfortunate downturn in house prices. Being short term, they'll be back next month to pay that loan off and bid for financing for the next month's bills.
After a couple of quarters, what does this picture look like? The commercial banks survive possibly and with a new lease on life start banking again?...or facing dwindling revenue streams on mortgage related business?
So that is where I lack vision...imagination being poked out by affordability issues and other realities...like the dwindling kindness of strangers (UBS parting with a serious chunk to Singapore is not the same thing as Singapore buying tbills. It isn't.)

[Lafayette]

From Bloomberg: SIVs Shrink, Easing Concerns About Fire-Sale, Rescue

So, why all this bother?

[Lafayette]

From Bloomberg (Dec. 11):

SIVs Shrink, Easing Concerns About Fire-Sale, Rescue

By Neil Unmack

The tumor in the financial markets known as structured investment vehicles is shrinking, reducing the urgency for a bailout sponsored by the U.S. Treasury.

SIVs, which sell short-term debt and invest the proceeds in higher-yielding securities such as bank bonds and mortgage-backed securities, reduced their holdings by more than 25 percent since August to $298 billion, according to Moody's Investors Service. At least $84 billion more is being restructured by banks that set up the funds, according to data compiled by Bloomberg.

While Treasury Secretary Henry Paulson spends a third month gathering support for a ``SuperSIV'' that would buy assets from troubled funds, HSBC Holdings Plc, bond insurer MBIA Inc. and other companies are arranging their own rescues. The steps are diminishing the threat that SIVs will dump holdings and further roil credit markets contaminated by losses in securities related to subprime mortgages.

``Every day that goes by we are seeing more SIVs being reorganized to avoid a fire sale,'' said Priya Shah, a credit analyst at Dresdner Kleinwort Group Ltd. in London. ``The longer the SuperSIV takes, the less of a need there will be for it.''

SIVs have emerged as one of the biggest threats to capital markets that were rocked by record high defaults on U.S. mortgages made to borrowers with poor credit. Citigroup Inc., Bank of America Corp. and dozens of banks and brokers reported more than $66 billion of losses and writedowns from subprime mortgages. The average net asset value for SIVs has tumbled to 55 percent from 71 percent a month ago and 102 percent in June, according to Moody's.

Florida Teachers

Florida schools and towns pulled more than half their money last month from a $27 billion state-run fund used to pay teachers and other day-to-day expenses after discovering it invested in defaulted and downgraded SIVs. Charlotte, North Carolina-based Bank of America, the second-largest U.S. bank, said yesterday that it will liquidate a $12 billion enhanced cash fund after losses on holdings that included debt sold by SIVs.

The losses and investor confusion about the assets owned by SIVs led investors to shun all but the safest of government bonds, making it harder for funds to roll over maturing debt. SIVs set up by Dusseldorf, Germany-based lender IKB Deutsche Industriebank AG and Cheyne Capital (UK) LLP in London defaulted in October.

The amount of outstanding commercial paper backed by assets owned by SIVs and other companies shrank to a seasonally adjusted $801.2 billion for the week ended Dec. 5 from $1.2 trillion in August, Federal Reserve data show.

Paulson's Plan

``These vehicles continue to face two main problems: fallen market prices for the structured finance and other types of assets in their portfolios and a general drying up of funding options as investor sentiment has severely dampened demand for their liabilities,'' analysts at Standard & Poor's wrote in a Dec. 7 report.

Concerns that forced sales by SIVs would cause wider disruptions led Paulson to broker an agreement on Oct. 15 with Bank of America, New York-based Citigroup and JPMorgan Chase & Co., the biggest U.S. banks, to form an $80 billion ``SuperSIV.'' Paulson said he plans to have the so-called master liquidity enhancement conduit, or M-LEC, running by year-end.

The banks began marketing the SIV to smaller institutions last week, two people with knowledge of the plan said. New York- based BlackRock Inc. is managing the fund.

``Treasury has long said that market participants can and should continue to focus on proactively responding with a range of complementary market-based solutions,'' Treasury spokeswoman Jennifer Zuccarelli in Washington said.

Citigroup Assets

At least half of the 30 or so SIVs have yet to announce bailout plans. Even those that have been disclosed require approval from bondholders, including proposals by HSBC and Rabobank Groep NV.

``You can't say yet M-LEC isn't going to fly,'' said Tom Jenkins, a credit analyst at Royal Bank of Scotland Group Plc in London. ``SIVs are still a concern, and there are enough assets out there to fill M-LEC, even if it is looking increasingly heavily weighted towards Citigroup.''

Citigroup, the biggest manager, reduced the assets of its seven SIVs to $66 billion from $83 billion since September, according to an e-mail from spokesman Jon Diat. Six have redeemed capital notes, including Sedna Finance Corp., Beta Finance Corp. and Five Finance Corp.

The SIVs are funded until the second half of January and haven't decided whether to use the M-LEC fund because final details aren't available, Diat said. He declined to comment on potential restructurings.

Moody's Downgrades

SIV managers aren't waiting to find out. Moody's said Nov. 20 that it was considering downgrading $105 billion of SIVs in the biggest wave of potential rating cuts since mortgage defaults caused credit markets to slump in July. The New York-based ratings company said last week that it will give most of the SIVs until Dec. 19 after receiving information on ``wide-ranging remedial measures.''

S&P lowered the ratings on capital notes of 13 SIVs and placed the ratings of 18 others on ``negative'' outlook on Dec. 7. Orion Finance Corp., managed by asset manager Eiger Capital Ltd. in London, became the fourth SIV to enter ``enforcement mode,'' requiring the appointment of a trustee to protect senior debt holders.

SIV net asset values were 55 percent of capital on Nov.30, according to Moody's. Excluding the three SIVs then in enforcement, the average NAV was 66 percent, according to Henry Tabe, managing director at Moody's in London.

`Outsized' Investments

Citigroup's ``outsized'' investment in SIVs and collateralized debt obligations, bonds based on underlying assets, puts the biggest U.S. bank in a ``precarious position'' that may trigger a breakup or merger with a competitor such as JPMorgan, CreditSights Inc. in New York said in a Dec. 9 report.

Societe Generale SA, France's second-biggest bank by market value, said yesterday that it will bail out Premier Asset Collateralized Entity Ltd. The Paris-based bank will assume $4.3 billion of assets held by the SIV a week after S&P said the fund was close to breaching capital requirements.

Rabobank, the biggest Dutch mortgage lender, agreed Dec. 6 to take on 5.2 billion euros ($7.6 billion) from Tango Finance Ltd. Tango's net asset value, a measure of what would be left after selling holdings and repaying senior debt, fell to 69 percent from 88 percent in September, Moody's said.

``The more SIV-based paper that comes back on banks' balance sheets the better, as it leads to less forced selling pressure,'' Vivek Tawadey, a London-based credit analyst at BNP Paribas SA, the biggest French bank, said in an interview.

Broken Model

Devised by former Citigroup bankers Stephen Partridge-Hicks and Nicholas Sossidis in 1988, SIVs aim to profit by borrowing at least 10 times the initial funding provided by long-term capital or income noteholders. The money is invested in hundreds of securities from asset-backed debt with AAA credit ratings to bank bonds. Mortgage debt made up 23 percent of SIV assets, with most having no direct subprime link, Moody's said in July.

Capital noteholders, who are first in line for losses, received annual returns from 2 percentage points to 2.75 percentage points more than benchmark interbank rates, based on a Moody's survey in 2005.

SIVs profit by using top credit ratings to borrow at low short-term rates. The model had broken down by September when money market investors either stopped buying SIV debt or charged as much as 6.3 percent on 30-day asset-backed commercial paper, the highest rate in more than six years. SIVs were left paying more to borrow than they were earning, Moody's said in a report in September.

Bank Split

``The market is being divided into two camps,'' said Tawadey at BNP Paribas. ``We are seeing a polarization between the banks that have the strength to support their SIVs and take up some of the implicit obligations, and some of the U.S. institutions that are already facing other pressures, such as higher credit card delinquencies and subprime losses.''

London-based HSBC, the second-largest SIV manager after Citigroup, is organizing its own bailout by absorbing the $45 billion of assets in its Cullinan Finance Corp. and Asscher Finance Corp. Capital note investors will be offered the chance to exchange their debt for notes issued by new companies, bearing the risk of losses from those companies rather than the SIVs.

`Best Solution'

``Our plan is not meant as a criticism'' of Paulson's plan, HSBC spokesman Pierre Goad said in an interview from London. ``We simply believe it is the best solution at present because it deals with the SIVs in a comprehensive manner and provides certainty.''

WestLB AG, based in Dusseldorf, agreed last week to provide financing for its SIVs, called Harrier Finance Funding Ltd. and Kestrel Funding Plc, so they can repay their $13.3 billion of senior debt. HSH Nordbank AG in Hamburg restructured the $4.8 billion Carrera Capital Finance Ltd., eliminating the need to sell assets.

Armonk, New York-based MBIA, the largest bond insurer, shrank its $2 billion Hudson Thames Capital SIV to about $400 million by getting capital noteholders to purchase holdings of the SIV in proportion to their stake.

Standard Chartered Plc used the same process, known as vertical slicing, to slash its Whistlejacket Capital Ltd. SIV to $10.8 billion from $18.2 billion.

``This strategy leaves the capital note in a position to ride out the liquidity-tightened markets and wait to see if asset prices eventually rise,'' S&P said in its Dec. 7 report.

[ndd]

Calmo:
To be absolutely clear, I am 100% in favor of killing at least one of the hostages.

The ransom notes will stop.

[ndd]

Let me point out to those aghast at my suggestion we need to let a big bank or investment house fail,
WHERE in these proposals are any of the opium addicts -- er, financial houses -- submitting to regulation? Why isn't Uncle Sam getting part of the action in return for holding the bag?

You want me to rescue you? Here's my price. Otherwise, go ahead and shoot yourself.

[Robinia]

Yes, indeed, Calmo, the auction is only blind to the herd, not the auctioneer. But, the herd has the real potential to trample (as per Northern Rock). It is, I think, a major responsibility of the Fed to make sure that does not happen-- nothing more dangerous than a big bunch of dumb bulls who just suddenly got nervous.

My brother-in-law wonk may well agree w/you about questioning how the Fed will determine the eligibility of commercial bank bidders-- he is an outsider-wonk, with the Community Development Finance Institution movement. There is, as in any secretive governmental operation, also the potential for corruption, for real: take, for instance, Adirondack Trust, the favored bank-of-choice for the near-bankrupt New York Racing Association (proven-corrupt-in-past state franchisee in charge of NYS horseracing).

This is a longish tale, but not as OT as it might seem at first. NYRA (NY Racing Assoc.) is currently in hot-and-heavy negotiations with NYS government's famous three-men-in-a-room government troika, and the Chair of Adirondack Trust is very heavily invested in one of those men, having contributed nearly 50K (with his wife's help) in campaign funding in recent years to the Republican Senate leader and his friends. What does this erstwhile banking leader say about how gambling should be run?

"Mr. Wait, whose father and grandfather were also presidents of Adirondack Trust, advanced his own somewhat unorthodox analysis of the debate. He said people do not want casinos partly because they are convinced the modern corporate proprietors could not match the quality operations of their Saratoga predecessors. "We had gambling," said the bank president wistfully, "when it was the best it could be, when it was run by the Mafia." (source: http://query.nytimes.com/gst/fullpage.html?res=9E03E0D81339F933A15751C0A960958260&sec=&spon=&pagewanted=all
)

Why does the corruption of NYS racing, NYS's secretive governmental system, and the attitude toward casinos of some hereditary small-bank president matter? Well, the State Senator and some of his close associates from the Thoroughbred racing world are being investigated currently by the FBI for possible "undue influence" on NYS government, and the small-bank president is on the board of directors of the NY Fed (http://www.ny.frb.org/aboutthefed/orgchart/board/wait.html).

Will Adirondack Trust get some sweetheart deal at this new Fed auction? Will I know if they do?

And yet, still, on balance... something must be done. I'm not seeing a lot of substantive suggestions of what that something might be. This offering is, at least, a possibly more creative way to pay the ransom. Is the creativity in calming the system worth the risk of tyranny? Gee, I'd need help from smarter folk in puzzling that out.

[hari]

From a policy perspective, I suspect the Fed has looked rather gloomly into the abysss - unfolding with Subprime credit crunch, and, perhaps sees no alternative to a recession - otherwise this avalanche of five majour central banks credit facilitation cannot be explained.

Recall, also, we started 2007 with global liquidity in the markets. Where has that global liquidity disappeared...
and why?

[Dickeylee]

I ask simply, has the Fed ever responded to a liquidity "crisis" in this manner before? These do seem to be very, very unchartered waters we are in. The talking heads on CNBC, Bloomberg, etc...just seem to have that teleprompter hypnotic, glassy eyed stare right now. Am I the only one who gets the feeling that Bernake watches these shows WAY, WAY too much? Since when does the Fed Chair seem to be scared of some screaming crazy like Cramer?

[Bruce Wilder]

rdf: "Well JP Morgan tried to alter events in 1929."

The elder, legendary Morgan did play important roles in 1895 and 1901/1902, and acted dramatically and effectively in 1907, but, he died in 1913, preventing any role in the Great Crash. His son and heir, who shared his name, was not so influential, and played no particular part in the events of the Great Crash.

The Morgan bank was one of a group of leading New York City banks, also including Chase and National City, which, famously, sent Richard Whitney out onto the floor of the Exchange on the Friday after Black Thursday to buy blue chip stocks, in an effort to calm the Market, in frank imitation of J P Morgan's tactics in the second crash of 1907, of buying large blocs of U.S. Steel and other leading companies. It had worked in 1907, but did not work, of course, in 1929 and Black Monday and Black Tuesday followed. The face of Morgan in the crisis was Thomas Lamont, Jr. (he appeared on the cover of Time Magazine in November 1929), the great grandfather of Ned Lamont, the late liberal hope of Connecticut.