Full circle
It seems we've come full circle. In October 2007, just as the credit crisis was starting to look really nasty, Bank of America, Citigroup and JP Morgan unveiled a plan to launch the master liquidity enhancement conduit (MLEC). The vehicle was intended to buy highly rated assets from structured investment vehicles (SIVs) struggling to refinance in the asset-backed commercial paper market - and by doing so, avoid the need for SIVs to sell assets at fire-sale prices and restore some level of confidence to the sector.
A year later, the US government proposed its Troubled Assets Relief Program (Tarp). This $700 billion fund was designed to buy up mortgage assets from the balance sheets of troubled financial institutions - aiming to draw a line beneath banks' losses. Both got little further than the discussion phase. MLEC saw little take-up by banks and was quietly ditched, while Tarp instead used its funds to recapitalise the US banking sector. The failures were partly due to a lack of consensus on how the assets would be valued. Banks were reluctant for the assets to be valued at market prices (in the rare occasions market prices were available), noting distressed conditions and a lack of liquidity had pushed prices for these assets far below their intrinsic value. Others tore into suggestions prices be based more on a theoretical value, arguing the vehicle risked paying over the odds for what might turn out to be worthless assets.
However, economic conditions are deteriorating and the threat of further losses looms. Governments around the globe have poured billions of dollars into their banks, but the problems have continued to get worse. It's difficult to know what would have happened without the capital injections - it seems safe to assume Lehman would not have been the only institution to collapse in September and October. But this crisis will not go away until problem assets are moved off balance sheet - or, in the case of some recent proposals, banks are insured against losses above a certain threshold.
Transferring toxic assets into a 'bad bank' will generate some certainty around valuations, create transparency, and hopefully improve confidence. Valuing the assets will not be easy, but various methodologies have been touted - see Charles Smithson's Class notes article in Risk November 2008, for example.1 Recent initiatives by UBS and ING have shown it is possible to offload assets, providing all parties are realistic and banks aren't afraid to realise further losses if necessary. If the problem assets aren't sorted out, it seems likely this crisis will just run on and on.
Nick Sawyer, Editor
1. www.risk.net/public/showPage.html?page=823938.
Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.
To access these options, along with all other subscription benefits, please contact info@risk.net or view our subscription options here: http://subscriptions.risk.net/subscribe
You are currently unable to print this content. Please contact info@risk.net to find out more.
You are currently unable to copy this content. Please contact info@risk.net to find out more.
Copyright Infopro Digital Limited. All rights reserved.
As outlined in our terms and conditions, https://www.infopro-digital.com/terms-and-conditions/subscriptions/ (point 2.4), printing is limited to a single copy.
If you would like to purchase additional rights please email info@risk.net
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. As outlined in our terms and conditions, https://www.infopro-digital.com/terms-and-conditions/subscriptions/ (clause 2.4), an Authorised User may only make one copy of the materials for their own personal use. You must also comply with the restrictions in clause 2.5.
If you would like to purchase additional rights please email info@risk.net
More on Risk management
To liquidity and beyond: new funding strategies for UK pensions and insurance
Prompted by policy shifts and macro events, pension funds and insurance firms are seeking alternative solutions around funding and liquidity
More cleared repo sponsors join Eurex ahead of cross-margining
End of TLTROs for banks and pension fund search for liquidity management tools drives uptake
Reimagining model risk management: new tools and approaches for a new era
A collaborative report by Chartis and Evalueserve on how the use of automation can combat the growing complexity of managing model risk due to regulation and market volatility
What Goldman’s appeal victory means for Fed stress tests
Decision could embolden more banks to appeal, analysts say. But others believe result is one-off
Clearing members rattled as CME approved to launch its own FCM
National Futures Association registration sharpens concerns about conflict of interest with CCP
CME files application for US Treasury and repo clearing
New entrant believes direct user access model will avoid accounting problem that hampers rival FICC
UST repo clearing: considerations for ‘done-away’ implementation
Citi’s Mariam Rafi sets out the drivers for sponsored and agent clearing of Treasury repo and reverse repo
Gensler to stick to Treasury clearing timetable
SEC chief promises to keep up the pressure for done-away trades