Bankers from Citigroup (NYSE: C ) , JPMorgan (NYSE: JPM ) and Bank of America (NYSE: BAC ) have cleared a huge hurdle in the ongoing credit crunch. They've reportedly agreed upon the terms and structure of a to-be-raised gigantic fund that will help alleviate the funding problems plaguing several structured investment vehicle (SIV) sponsors.
What does it all mean?
If the "super SIV" works as intended, it will prompt an enormous sigh of relief from the capital markets. Some of the world's largest banks, including Citigroup (which manages an estimated $83 billion in SIVs), HSBC (NYSE: HBC ) , Societe Generale, and Bank of Montreal, have provided liquidity backstops to their SIV funds.
Because the asset-backed commercial paper markets (ABCP) have effectively frozen up, many of those banks are now on the hook to buy billions of dollars of SIV assets.
Let the contagion begin
In the financial markets, one problem can quickly cascade into a domino-pattern of unintended consequences. For example, because the ABCP market froze, banks now may have to buy each others' SIV assets. Because of that, banks are both trying to dump other assets to raise cash, and they're being much more restrictive with lending standards.
As several banks try to dump assets at the same time, they incur severe mark-to-market losses on collateralized debt obligations (CDOs) and asset-backed securities (ABS). This, in turn, causes banks like Merrill Lynch (NYSE: MER ) and Bear Stearns (NYSE: BSC ) to take big hits on their CDO and ABS holdings. Now, nobody wants to touch ABS or CDOs.
Unfortunately, SIVs hold many of those CDO and ABS securities, so investors no longer want to hold SIV commercial paper, either. As you can see, it's a vicious cycle.
Hopefully, the super SIV will provide a temporary respite. If it works, the super SIV will allow banks to get rid of some of their SIV exposures, giving them more breathing room. As a result, those banks will feel more comfortable with their capital structures, removing their need to fire-sale their ABS and CDO holdings.
If that happens, then hopefully everyone will stop running for the exits at once, and the big banks won't have to keep taking billion-dollar write-downs every quarter on ABS and CDO exposure. The banks hope that the super SIV can facilitate a softer landing for banks caught red-handed with SIV, CDO, subprime, ABS, and leveraged-loan exposure.
Now the scary part: What if it doesn't work? We've already seen the fear and panic that can happen when the credit markets cause fear and consternation. If the super SIV fails, big banks with large SIV exposures might be in for a lot more pain.