The plan for a $75bn superfund to buy assets from cash-strapped structured investment vehicles appears to be gaining support among sceptical institutions, amid concern that SIVs might start dumping bank debt.
Such forced sales could increase the risk that the credit market turmoil could hurt the broader economy.
Almost half the assets in SIVs are financial institutions’ debt and if the SIVs were forced to make big sales to raise cash, it would tend to drive down prices. This would lift funding costs for banks, which could respond by tightening the supply of credit.
“Yields on bank debt are already high and it could put further downward pressure on the economy. The [superfund] could help prevent that and it is gaining wider support,” said an executive at a Wall Street bank that has not been part of the plan.
Investors are demanding much higher yields on bank debt because of concern over the effect on their balance sheets of the subprime mortgage meltdown.
Citigroup, which has said it could face another $11bn of writedowns on its holdings of subprime-related investments, was last week forced to pay its highest yield premium on a 10-year bond issue. The $4bn issue yielded 1.9 percentage points more than US Treasuries, 0.7 points more than a similar sale three months ago, according to Bloomberg data.
Banks, brokers and insurance companies are now paying more to borrow in the bond market than non-financial companies, reversing the historical pattern.
According to Merrill Lynch, yields on financial bonds are on average 1.49 percentage points more than Treasuries, while the premium on industrial bonds is 1.34 points.
For the first time, credit default swaps on financial companies are now trading in line with, or even wider than, industrial companies. In other words, it costs more to insure financial debt against default.
The planned superfund, which is being put together by Citigroup, Bank of America and JPMorgan Chase with the backing of the US Treasury, would buy assets from SIVs that are facing funding problems.
Although attention has been on their mortgage-related holdings, institutions’ debt accounts for about 43 per cent of SIV’s total assets, according to Moody’s, the rating agency, or more than $150bn.
