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Structured investment vehicles and a bailout.




Structured investment vehicles, or SIVs are at the heart of another financial rescue plan private banks are dealing with under government supervision. From the Wall Street Journal:

Over the weekend, the Treasury hosted talks to help a group of banks set up a $100 billion fund to buy troubled assets in exchange for new short-term debt. The banks hope to have the fund up and running within 90 days.

According to people familiar with the matter, the Treasury hopes the plan, which could be announced as early as this morning, will jump-start demand for commercial paper, which froze up this summer amid the credit crunch that roiled global financial markets.

Some influential investors think the Treasury-backed strategy might work. Other object to the Treasury's role in seeking to help banks avoid a big financial hit for making bad bets.

The problems stem from affiliated funds called structured investment vehicles, or SIVs, which Citigroup and others set up as a way to make money without taking the risk involved onto their balance sheets. Such vehicles are formally independent of the banks that create them. They issue their own short-term debt, usually at relatively low rates that reflects their high credit rating. Then, they use the proceeds to buy higher-yielding assets such as securities tied to mortgages or receivables from midsize businesses seeking to raise cash.

The popularity of SIVs has boomed since two Citigroup bankers, Nicholas J. Sossidis and Stephen Partridge-Hicks, invented the strategy in London in the late 1980s. (They later left to form their own company, London-based Gordian Knot, which operates the world's largest SIV.)

Behind Treasury's concern were banks like Citigroup, whose affiliates owned $80 billion in assets backed by mortgages and other securities. The world's biggest bank, by market value, held the assets off its balance sheet and was facing the prospect of either having to unload them in a disorderly fire-sale fashion or moving them onto its books.

Either scenario would have hurt financial markets and could have damped the economy by curtailing banks' ability to make new loans to consumers and corporations. Treasury envisioned a potentially "disorderly" unwinding of assets that could worsen the credit crunch, said a person familiar with the matter.

Under the proposed rescue package Citigroup, J.P. Morgan Chase & Co. and Bank of America Corp. will set up a fund, or "superconduit," to act as a buyer of last resort. It will pay market prices for SIV assets in an effort to prevent dumping.

J.P. Morgan and Bank of America don't have SIVs, but they plan to participate because they would earn fees for helping arrange the superconduit, whose lifespan, according to people briefed on the plan, is expected to be about a year. The superconduit can buy assets from any bank or fund around the world.

Details are still being worked out but the oversight committee of the three banks will set criteria for what the new fund, to be called the Master-Liquidity Enhancement Conduit, will buy.

Citigroup took the lead in pushing for the rescue plan. Large sums of SIV debt were coming due in November. And increasingly debt analysts were forecasting a tough future for SIVs. A Citigroup research report, issued two days before the banks and Treasury met for the first time, noted, "SIVs now find themselves in the eye of the storm."

Some bankers objected to the plan, calling it an escape hatch for Citigroup, which has more SIVs than any other bank, according to people familiar with the situation. The bank has accounted for about 25% of the global SIV market. As of August, assets held by SIVs totaled $400 billion

Auditors in recent weeks also had taken a hard-line when it came to assessing losses within SIVs. As the credit crunch worsened in August, many financial institutions argued that losses due to market volatility didn't reflect the assets' long-term value.

But on Oct. 3, the Center for Audit Quality, backed by the Big Four accounting firms, issued analysis that said market prices were real and couldn't be ignored. One paper argued that banks must periodically reassess the condition of off-balance-sheet funding vehicles and take account of market prices and any resulting losses, even if these were seen as an anomaly. If the losses become so great that a bank sponsoring one of these vehicles may have to shoulder some of their cost, "the sponsor would be required to consolidate" the vehicle, the paper said.

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