When the inevitable wave of mortgage defaults set off a larger credit crunch over the summer, one area especially hard-hit -- and slow to recover -- was "conduit" and related "Structured Investment Vehicle" (SIV) financing. Essentially, this was a fancified and (in the latter case) leveraged-up way of borrowing short to lend long, with the issued commercial paper backed by home loans, consumer debt, and other stuff that no one seems to want to buy. Oh, and to make things even more exciting, this was usually kept off the balance sheet. (Hey, why keep potential bad news on the books where nosy investors might see it?)
As banks and other potential buyers of this paper lost faith in quality of the backing assets, as well as the balance sheets of the issuers (often their peers), this trade ground to a halt. Problem is, many companies built too much of their business on this iffy source of funding, and the sudden squeeze came back to kill a few banks and severely wound some others.
It could get worse
What the so-far-unscathed banks still fear, however, is that everyone in this game will try and dump these impaired mortgage and consumer-credit assets all at once, killing prices and forcing everyone who's been marking these to "model" (valuing them at what they figure they're worth) to instead mark them to the market (valuing them at that potentially devastating, low, actual-market price). As a buddy of mine in the biz of selling fine art once explained to me, there's nothing people in the illiquid asset-hawking biz fear more than a public auction. When prices are paid where everyone can see them, all that secret, back-room hopefulness is tossed out the window.
So, banks are having trouble finding buyers for this stuff, with the result that prices may crash. If that happens, a lot of those paper profits of the past few years may vanish in broad swaths of the financial industry. Now, we can't allow a free market to work if it means unpleasantness, can we?
Magic wands and bubbling cauldrons to the rescue
How's this for a clever solution? Arrange for the banks to be able to sell those questionable SIV assets back to themselves (or a thinly veiled version of themselves). This would support prices and keep that nasty reality from impinging upon bank profits. You could call it a way of "providing liquidity" so that no one will suspect you're just shifting money from one pocket to the other in an effort to avoid selling these financial assets on a real market.
Well, if the Treasury Department -- headed by former Goldman Sachs (NYSE: GS ) honcho Henry Paulson -- and big banks have their way, the proposed solution to recent lending excess may well be more excess. The New York Times reported this weekend on the formation of a crummy-credit superfund of sorts, a $75 billion buyout pool designed do what I described above in order to ... to protect banks from ... well, from each other, which is to say, themselves. Mentioned in the story are JPMorgan Chase (NYSE: JPM ) , Citigroup (NYSE: C ) , and Bank of America (NYSE: BAC ) , as well as Barclays (NYSE: BCS ) and HSBC (NYSE: HBC ) . Today, the Treasury confirmed it, calling it a step toward "orderly financial markets."
Foolish final thoughts
Ah yes, "order," but at what expense? Can bigger, government-sponsored kinds of financial alchemy rescue banks from the mess they've made with their big, bad financial alchemy? When you're whiffing as hard as they are nowadays (cough, Citigroup, cough), and you're trying to keep a bubble-dependent economy afloat, (cough, Paulson, cough), I suppose anything seems worth a try.
But to this simple Fool, this smacks as the ultimate in housing-related desperation. It's sort of like everyone in the neighborhood borrowing on home equity, then pooling those funds to buy houses that come up for sale at the current, lower market price. It doesn't really fix the fact that potential buyers simply don't want to pay the old, high prices for the tainted asset. Some might even call it price fixing. (Are they allowed to do that?) In my opinion, it only puts off the inevitable reckoning.