There's been plenty of negative comment by analysts, regulators and the mainstream financial press about the new Master Liquidity Enhancement Conduit (MLEC) proposed last month by Bank of America, Citigroup and JP Morgan (see page 8). This amounts to a bail-out, say some - a way of getting bank sponsors off the hook by buying up assets at higher than market prices. Others have claimed that, as the bank with the largest conduit programme, Citigroup would benefit most from this plan. Why then should they participate and help it out?
However, the MLEC is a good idea - if it does what it says on the tin: improve liquidity in the credit market by buying assets from structured investment vehicles (SIVs), and thus avoid the forced sale of assets by these vehicles at bargain-basement prices. But details of exactly how the conduit would work are not public.
One of the central pieces of the puzzle yet to be disclosed is how the assets held by SIVs would be valued. This has led to the main criticism: the conduit might buy asset-backed securities and collateralised debt obligation assets at higher than market value, therefore reducing losses for SIVs - a bail-out by the back door, say critics.
It's worth noting that the MLEC would not necessarily have to pay above market prices for the assets to help SIVs out - just improving liquidity and allowing the SIVs to sell assets in an orderly way, rather than having to endure forced sales, would be a plus. Also, market prices are currently being driven almost entirely by investor fear and subsequent illiquidity of the market. Outside the subprime mortgage market, and specifically the 2006 and 2007 vintages, default rates have remained stable at historically low levels and downgrades have been few and far between. In other words, if investors have the capital base to withstand the mark-to-market volatility, these instruments should perform well. Would it be so bad if the conduit were to buy these assets at a little closer to theoretical values, easing the current crisis, yet still making money if it holds the assets to maturity? After all, market values hardly reflect the fundamental credit quality of many of these assets.
It is often said that the debate between market and theoretical value is meaningless. Assets are only worth what someone is willing to pay, and if an investor were to default today and was forced to sell its assets, it would only be able to sell them at today's market price, regardless of theoretical value. This is true. But there's also little doubt that mark-to-market valuations have exacerbated the current crisis by forcing SIVs to sell at fire-sale prices.
There may turn out to be other solutions - better solutions than the MLEC, even. But until final details of how the MLEC will work have been published, the industry should keep an open mind.
Nick Sawyer, Editor.