The solution to the commercial paper and subprime credit crisis was supposed to be joint deal between major banks that would fund a new SIV structure that would buy subprime debt from other bank SIV’s. The Treasury was behind this project as a market solution and helped broker the deal, yet on Friday it was announced that the M-LEC deal would not take place.
Cooperation could not be found between the major banks, but the real reason is probably less complex. Swapping funding from one SIV to another does not change the underlying collateral which is where the problem lies. Until the value of the collateral is determined at a market clearing price the sales and funding could not be made. And what is the value of subprime debt? Who knows? The price suggested by buyers is nowhere close to where sellers are willing to part with the debt. The crisis has caused pricing to be made with a broad brush which means that both good and bad debt is lumped together. The only solution is for each piece of debt to be reviewed which takes time. This is the ultimate problem and the issues that will have to be determined as we enter year-end. Unfortunately, there are still too many sellers and not enough buyers and Wall Street does not want to provide liquidity or be an intermediary for this process. Many money funds will have to live with these investments in 2008, so this will be the problem that will keep giving even with the adjustments that have already been made.
Additionally, M-LEC became obsolete because the entire crisis is also moving too fast. Banks are finding their own solutions of placing paper back on their balance sheet. Commercial paper is being retired so that the SIV CP market has shrunk significantly since August. The process is getting done slowly without coordination but through the tedious process of matching buyers and sellers.
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