October 30, 2007

Lets hide the debt problem!

Filed under: Economics, Musings, Observations, Worries — Tags: , , , , , , , , , — conceptualizer @ 5:16 pm

The Master Liquidity Enhancement Conduit (MLEC) fund has been created by several big US banks with between $75bn and $100bn (depending upon who you believe) to buy up debt from Structured Investment Vehicles (SIV) which in simple terms are mortgage providers. The debt is largely in the form of Residential Mortgage-Backed Securities (RMBS) and Collateralised Debt Obligations (CDOs) – i.e. mortgages. SIVs, which own about $400bn of assets, are investment pools used by banks, but most enthusiastically by Citigroup who originated them in the 1980’s. It is now clear SIVs have been too keen to offer debt to financially dubious property buyers. The MLEC is an attempt by the private sector to mitigate some of the risks associated with bad debt incurred during the US property price bubble. That bubble was inflated by the poor lending strategies of the SIVs and ultimately those that initiated them. The MLEC fund will be accepting only the best risks, leaving the worst in the SIVs, so they will flounder rather than the banks. It is interesting to speculate as to why this cause was not taken up by the IMF, whose role it is to promote international financial stability. Perhaps they do not see it as a big enough problem.

So can this fund help? Well as an attempt to reintroduce confidence to the market and hence stability, to some extent that is going to happen, especially as it has the tacit approval of the US treasury. However, ultimately the problem is rooted in lending money on the basis of economic growth that was not there. Now that position has to unwind and the costs of the overestimate will have to be dissipated. This fund can only act as a buffer, trying to spread and slow the normalisation cost, it still has to happen. So in that sense it is more like an attempt to convert a painful punch into a protracted uncomfortable pressure. The problem has to be handled and it seems that somewhere someone has made the decision that the drawn out normalisation approach is the better option. So as we get used to the inevitable slowdown, the remaining market confidence will be subdued rather than demolished. In that sense it is a better strategy as stability and confidence are perhaps the most essential assets of a reliable economy. Ultimately the costs of this failing will be carried by everyone, the banks will ensure that, rather than just their shareholders.



  1. All the TLAs and FLAs notwithstanding, what will happen to the NINJAs in all this?? 😉

    Comment by Shefaly — November 11, 2007 @ 7:42 pm

  2. Hi Shefaly
    I assume you are referring to the No Income, No Job, No Assets – NINJAs.
    I think they have the least to worry about in the short term. Their status might also be described as Nothing to lose, Upside potential, Taxation free – NUTs! In the medium term they need to get into the markets when the current instability has passed.
    The most important feature of an economy is to have everyone working. Over the last few decades and for more to come, the industrialisation of previously feudal economies is strongly increasing their contribution to the world economy. This extra work does not vanish, it adds real wealth to the word economy. This will ultimately feed through to strong markets and so big upsides in shares.
    How one chooses to use this upside is another mater.
    Thanks for reading

    Comment by conceptualizer — November 12, 2007 @ 12:32 am

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