M-LEC: The Investor Bailout That Wasn't

An October 2007 plan to bail out SIVs, or Structured Investment Vehicles, hasn't turned out quite the way it was planned. These risky investments have been among the most vulnerable to the market turmoil caused by the sub-prime lending debacle, struggling as the liquidity in the markets declined. The potential implications of a widespread sell-off of investments by SIVs on the economy spurred a plan by several of the largest United States banking institutions to create a fund to keep them afloat, or at least slow their decline to avert a crisis. However, many banks and SIV organizations have been reluctant to participate in such a plan, in spite of its endorsement by Treasury Secretary Paulson. For several months, rumors of difficulties in setting up this pooled liquidity fund have been circulating, and the amount to be set aside in the proposed fund has gradually decreased. Finally, as of December 21st, 2007, the has been scrapped altogether.

SIVs are basically off-sheet balance funds held by banks, not qualified for FDIC insurance, which sell short term debt to investors and use the proceeds from these sales to purchase high yield, longer term asset backed securities. Among the selection of investment vehicles purchased by SIVs are bank debt, mortgage bonds, and other complex securities. A significant portion of these transactions over recent years have included sub-prime mortgage backed securities, many of which, of course, have depreciated during the sub-prime meltdown. As investors became aware of the the developing sub-prime crisis, demand for the short term debt sold by SIVs declined, substantially reducing the flow of funds needed by for the SIV's to conduct their day to day business. This liquidity crunch was the catalyst for the development of the Master-Liquidity Enhancement Conduit, a pool of funds to which a variety of banking institutions would contribute to relieve the liquidity crisis, reportedly to be used to purchase securities held by SIV's that were not in financial difficulty, thus restoring confidence in the market.

However, it seems that many of the big banks and investment experts had little faith in the market themselves, showing reluctance to enter into such a plan from the beginning. Even many who advise these SIV's were skeptical of the wisdom of the plan, expressing doubts that it would be effective in its goals and choosing to solve their problems independently. Some critics of the plan stated that at best, the fund would postpone the inevitable re-pricing of the most precarious of these assets, making matters worse for the credit markets in the long run by extending market insecurity. From the original proposal of a fund of up to $200 billion, the projected amount to be raised gradually diminished over time, as enthusiasm for the plan failed to build. A month after the announcement of the proposed Master-Liquidity Enhancement Conduit, Citigroup, the institution that first broached the idea of the fund, had downgraded the amount it expected to raise to $60 billion, and now, a month after that, has announced that it no longer sees the need for a bailout of SIVs at all.

Apparently, no bailout plan will be forthcoming for SIV investors in the immediate future. As it has turned out, many banks have simply bailed out their affiliated SIVs on their own, buying out their holdings to prevent forced sales. Other SIVs have had to unwind, taking their losses. Overall, the market has begun to work itself out without a "Super SIV" to ease the way, the amount of SIV assets reduced from $340 billion in senior debt outstanding at its peak, to $265 billion as of the first week of December. So, it seems that adding yet another level to the grand pyramid of risky investment paper was not necessary after all, showing that perhaps, those who bet on risky investments may be better left to take their lumps when that gamble doesn't pay off.

Sharon Secor writes regularly on a variety of financial topics, and is a staff writer at Direct Lending Solutions and Lenders Mark.