US$80b Fund Planned To Mop Up Bad Mortgage Loans

Source : The Business Times, October 15, 2007

US Treasury, global banks talking to find way out of looming credit crunch

(WASHINGTON) Major banks including Citigroup are looking at setting up a roughly US$80 billion fund to buy ailing mortgage securities and other assets, sources said.

Representatives from the US Treasury have organised discussions among top global banks in a bid to prevent the crunch from further hurting the global economy, the sources said.

Financial institutions are growing increasingly concerned that a certain type of investment funds linked to banks may have to dump billions of dollars of repackaged loans onto financial markets.

A fire-sale of assets could lift borrowing costs globally, trigger big losses from investors and force banks to further write down some holdings on their balance sheets. Such sales could trigger huge losses for banks, and, in the worst-case scenario, tip the US or Europe into recession.

The fund is the latest response to a global credit hangover after at least three years of easy credit that fuelled massive mortgage lending in the US and spurred record levels of leveraged buyouts.

'Banks made unwise business decisions, and now they're scrambling to save themselves,' said Steve Persky, chief executive at Dalton Investments in Los Angeles.

Citigroup, JPMorgan Chase & Co and Bank of America Corp are involved in the discussions, according to people familiar with the situation. The three banks declined to comment.

Though the US Treasury is involved in the discussions, taxpayer money is not expected to be used, they said.

The Financial Services Authority, the UK market regulator, has suggested British banks consider participating in the fund, The Wall Street Journal reported on Saturday, citing a person familiar with the situation.

Details concerning the fund the banks are setting up, including its size, are still being hammered out and may change as other banks and investors become involved, sources said. The fund that is being contemplated would bail out funds known as 'structured investment vehicles' or SIVs.

SIVs bought assets like mortgage securities from banks, and financed their purchases using short-term debt known as commercial paper. They make money by earning more from their investments than they have to pay to fund them.

But if SIVs cannot sell commercial paper, they must sell their assets, and many of the assets do not trade often and would be hard to sell.

The idea for a fund was first broached at a meeting at the US Treasury on a Sunday in mid-September in Washington, DC, according to a person familiar with the details of the meeting.

That meeting was led by Robert Steel, US undersecretary for domestic finance, and Anthony Ryan, US assistant secretary for financial markets.

The informal meeting lasted four-and-a-half hours as banks came up with ideas to jump-start the short-term lending markets. Outstanding commercial paper has dropped since the summer.

According to the US Federal Reserve, there was US$1.865 trillion in commercial paper outstanding in the week ended Oct 10, down from US$2.187 trillion outstanding in July. -- Reuters