Behind Banks' Credit Rescue Fund

Wachovia Will Chip In
Toward $80 Billion Aim;
Who's Hanging Back?

By RANDALL SMITH, CARRICK MOLLENKAMP and ROBIN SIDEL
October 17, 2007; Page C1

A planned king-size investment pool to acquire mortgage assets and bolster sputtering credit markets is gaining participants, despite hesitation from some banks and securities firms about joining the effort.

The three lead banks, Citigroup Inc., J.P. Morgan Chase & Co. and Bank of America Corp., are aiming to round up commitments totaling at least $80 billion to make the plan fly, according to people familiar with the matter.

While some people briefed on the plans say that target is fluid, others say that without the kind of critical mass of that large a fund, "it's unlikely to happen," as one put it. The three lead banks expect to ante up less than half the total, the same person said.

The plan, which has been supported by the Treasury Department, is aimed at breaking a logjam in the market for the short-term debt of investment vehicles that hold mortgage-related assets. Those assets have declined sharply in value amid a credit crunch touched off by a downturn in the value of subprime mortgages, or home loans to borrowers with weak credit.

The fund, dubbed the master-liquidity enhancement conduit, would issue short-term notes to investors and use the proceeds to buy securities from the specialized funds, known as structured investment vehicles, or SIVs, that are being forced to wind down their businesses. This could help prevent asset sales at fire-sale prices from triggering a market meltdown. There are some 30 SIVs with about $400 billion in assets, according to Moody's Investors Service.

Broad participation in the plan is important to raise sufficient sums of money to produce the jolt of market confidence needed to boost trading in some parts of the credit markets, those involved in the discussions say.

Yesterday, Wachovia Corp. said it will participate in the fund. "While it's not a significant issue for us, we plan to participate at an appropriate level because we want to help improve the stability of the markets," a spokeswoman said.

Among the firms offering support for the plan are Fidelity Investments and Federated Investors Inc. Both hold debt issued by an arm of Gordian Knot Ltd., one of the SIVs that could benefit from the fund.

Fidelity's $10.4 billion Prime Money Market Portfolio owned $402 million medium-term notes from Gordian's Sigma Finance Inc. arm as of the end of August. A spokesman said he believed that such holdings "continue to represent minimal credit risk" and said the firm's "money-market funds continue to perform strongly."

Some other financial-services firms said they plan to steer clear. Rick Waddell, the new chief executive of Northern Trust Corp. in Chicago, said in an interview yesterday his company has no interest in participating in the superfund as lender or investor, particularly since it has no exposure to the kind of investment vehicles that hold the mortgage securities in question.

Mr. Waddell also described the creation of the fund as an aid to Citigroup, which has the greatest exposure of any bank to such structured investment vehicles. "It really is J.P. Morgan and Bank of America helping out Citibank," he said.

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A spokeswoman for Citigroup's capital-markets division, Danielle Romero-Apsilos, called the characterization "nonsense." She added in a statement, "This is not a bailout of any kind. It is an optional source of liquidity to support this segment of the market."

Four Wall Street firms, Goldman Sachs Group Inc., Merrill<TH>Lynch & Co., Lehman Brothers Holdings Inc. and Bear Stearns Cos., all participated in the exploratory talks about the plan, according to participants, but haven't yet indicated they would join. Morgan Stanley is studying the plan, one person on Wall Street said.

Despite the symbolic importance of the participation of major Wall Street securities firms, their absence might be less significant to the outcome than would the absence of big European banks, which have greater credit capacity and had been expected to join the group.

European banks such as HSBC Holdings PLC, Barclays PLC, Deutsche Bank AG, UBS AG and Credit Suisse Group are hanging back, according to people on Wall Street. Such banks have both the big balance sheets and track records in structured finance needed to help generate the broad participation.

Some of those hanging back may be angling for a greater role in the deal, more details, or even higher fees.

Bank analyst David Hilder of Bear Stearns said he believed the backing of the big three U.S. banks would probably get the program off the ground. While Mr. Hilder said he wasn't sure whether the plan would actually mend the ailing markets for mortgage-related securities, he compared its possible impact to "gunboat diplomacy," in which merely "seeing the gunboat on the horizon causes people to behave differently."

Although they have backed the plan -- and even hosted some recent discussions about it -- Treasury officials insist that the fund is strictly voluntary. "We think that people who think it's a good idea should participate," a Treasury official said.

While Treasury officials think the fund will help alleviate stress in the markets and improve liquidity, they said there are other alternatives under way in case the conduit fails to have an impact. "There are lots of other things going on already, such as SIVs being monetized or wound down or refinanced," this official said.

Also, Sen. Charles Schumer of New York, a supporter of Wall Street, said the "superconduit may be a good short-term response, but it's not going to solve the problem in the long run. In a certain way, it's taking money out of one pocket and putting it in another."

The big banks have been concerned from the beginning about the participation of their smaller rivals. "It's a very good framework, but this is a complicated deal and not everything is finished," said one person involved in the plan. "It's very easy to say we will deal with this later but now it's later."

The banks are now grappling with a slew of logistical problems, from setting the requirements for the type of assets that the conduit will buy to how to handle an asset being sold into the conduit that carries a hedge.

Still, the preliminary nature of the plan, which was unveiled hastily after an early news leak, has prompted questions about the participant lineup. On Monday, J.P. Morgan representatives didn't participate in a call for investors held by bankers from Citigroup and Bank of America. Although their absence prompted questions, the J.P. Morgan bankers wanted to focus on setting terms first, according to a person familiar with the call.

--Deborah Solomon, Valerie Bauerlein and Tom Lauricella contributed to this article.

Write to Randall Smith at randall.smith@wsj.com, Carrick Mollenkamp at carrick.mollenkamp@wsj.com and Robin Sidel at robin.sidel@wsj.com