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Banks Set Plan to Revive Credit Market

Posted on: Monday, 15 October 2007, 12:00 CDT

By JOE BEL BRUNO

NEW YORK - The nation's three largest banks said Monday they will team up to buy tens of billions of dollars in investments that lost value after global credit markets seized up.

The plan is designed to inject more confidence into the market, and increase investor appetite for the short-term debt known as commercial paper. The market for commercial paper, which is crucial for companies to fund short-term borrowing needs, locked up this summer.

That followed a crisis in the mortgage industry, as people defaulted on their home loans at a skyrocketing rate. It caused a widespread aversion to risk and led the Federal Reserve to pump money into the financial system, though the latest plan relies more heavily on the banks themselves.

The Treasury Department introduced the idea of a bailout in recent talks with Citigroup Inc., Bank of America Corp., JPMorgan Chase & Co and others. It was not known how much money would be put into the fund, but there have been reports it could be between $80 billion to $100 billion.

"This proposal will complement other solutions investors and asset managers may utilize in committing and deploying capital to support more efficient markets," the Treasury Dept. said in a statement Monday

The government's role in coming up with a private-sector solution to the nation's credit problems is similar to the bailout of hedge fund Long-Term Capital Management in 1998. The Fed approached Wall Street's biggest banks to rescue LTCM before its wrong-way financial bets set off a financial shockwave.

This time around, the banks hope to not only prevent credit problems from spreading - but also are bailing themselves out. They operate structured investment vehicles, known as SIVs, that reportedly have as much as $400 billion worth of assets. Those could plunge in value unless the credit markets are stabilized.

The SIVs used short-term commercial paper, sold at low interest rates, to buy longer-term mortgage-backed securities and other instruments with higher rates of return. With the seizure of the credit markets, many SIVs had trouble selling new commercial paper to replace upcoming obligations on older paper.

The new fund - called the Master Liquidity Enhancement Conduit or M-LEC - would launch in the next 90 days and be used to buy distressed securities from SIVs. That would in turn give them the capital to pay off their commercial paper obligations, and ultimately extricate themselves from what otherwise might have been substantial losses.

By buying SIVs' distressed investments, the new fund would inject enough liquidity into the market to make investors more confident in buying commercial paper.

The funds' backers said they will shy away from risky instruments and buy only highly rated, asset-backed debt - a market that is already beginning to show signs of life.

Source: Associated Press/AP Online

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