Three Banks Move To Loosen Credit Markets

Three major U.S. banks announced on Monday that they were responding to some week-end jaw-boning by the Treasury Department and forming a consortium to address the beleaguered credit markets.

Citigroup, Bank of America, and J. P. Morgan unveiled the broad outlines of a plan to buy troubled assets in exchange for new short-term debt. The Treasury Department had met with representatives of the three financial giants over the weekend to help them set up what industry insiders hinted might be as much as a $100 billion fund which the Treasury hopes will increase demand for commercial paper which went into a steep decline this summer.

Companies depend on commercial paper for their day-to-day operations and such paper are generally considered to be a safe investment but since mid-summer investors have not been comfortable with many types of commercial paper that are not asset-backed.

According to the Wall Street Journal, "the high-stakes plan to rescue banks from losses on mortgage securities amounts to a big bet" that the banks can persuade investors to pour more money into the troubled markets.

The target of the proposed plan, called the Master-Liquidity Enhancement Conduit, (M-LEC) are funds called structured investment vehicles or SIVs which banks set up as a way to keep riskier investments off of their balance sheets. SIVs are independent of the banks and issue their own short-term debt, usually benefiting from the high credit ratings of the banks themselves. They then use the low interest proceeds to buy higher-yielding assets such as mortgage backed securities or receivables from businesses trying to improve cash flow.

The big banks own billions in these SIV's, many of it in mortgage backed securities. Citibank's affiliates own $80 billion and is confronting the possibility of either having to unload them at fire-sale prices or moving them onto its books which will require the bank to set aside reserves to cover the assets. The bank apparently took the lead in pushing for the rescue plan.

Details are still being worked out but the oversight committee of the three banks will set criteria for the assets that the fund will buy. For now that probably will not include assets backed by subprime mortgages.

Treasury Secretary Henry Paulson said on Monday that it might be necessary to change some regulations to prevent future problems involving SIVs but he said he's pleased with the major banks' initiative in creating M-LEC which is expected to be operative within 90 days.

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