The three largest U.S. banks will create a rescue fund of sorts - potentially as large as $100 billion (70.3 billion EUR) - to help bail out troubled global credit markets.
Citigroup Inc., Bank of America Corp., and JPMorgan Chase & Co., at the prodding of the Treasury Department, will buy distressed debt from markets roiled during the summer's financial crisis. The joint effort is the result of more than a month of talks mediated by the government.
The plan is designed to inject more confidence into the market and increase investor appetite for the short-term debt known as commercial paper. The market for commercial paper, which is crucial for companies to fund short-term borrowing needs and which has historically been considered very safe, locked up this summer.
That followed a crisis in the mortgage industry, as people defaulted on their home loans at a skyrocketing rate. It caused a widespread aversion to risk and led the Federal Reserve to pump money into the financial system, though the latest plan relies more heavily on the banks themselves.
It was not known how much money would be put into the fund, but there have been reports it could be between $80 billion (56.2 billion EUR) to $100 billion (70.3 billion EUR). Each bank will put up an unspecified amount of its own capital into the fund.
"The problem is festering and I think they are trying to get ahead of it," said Professor Scott Stewart of the Boston University School of Management. "This is exactly what they should be doing - accepting responsibility instead of asking the government to bail them out."
Treasury Secretary Henry Paulson, who met personally with chief executives from all three banks, said he's pleased with the plan and "that it will have real benefits to the marketplace."
The government's role in coming up with a private-sector solution to the nation's credit problems is similar to the bailout of hedge fund Long-Term Capital Management in 1998. The Fed approached Wall Street's biggest banks to rescue LTCM before its wrong-way financial bets set off a financial shockwave.
This time around, the banks hope to not only prevent credit problems from spreading, but also to bail themselves out. They operate structured investment vehicles, known as SIVs, that reportedly have as much as $400 billion (281.2 billion EUR) worth of assets. Those assets could plunge in value and set off a worldwide fire sale unless the credit markets are stabilized.
The SIVs used short-term commercial paper, sold at low interest rates, to buy longer-term mortgage-backed securities and other instruments with higher rates of return. With the seizure in the credit markets, many SIVs had trouble selling new commercial paper to replace upcoming obligations on older paper.
The new bailout fund - called the Master Liquidity Enhancement Conduit or M-LEC - would launch in the next 90 days and be used to buy distressed securities from SIVs. That would in turn give them the capital to pay off their commercial paper obligations, and ultimately extricate themselves from what otherwise might have been substantial losses.
By buying SIVs' distressed investments, the new fund would inject enough liquidity into the market to make investors more confident in buying commercial paper. The funds' backers said they will shy away from risky instruments and buy only highly rated asset-backed debt - a market that is already beginning to show signs of life.
JPMorgan Chase and BofA do not operate SIVs, but will put money into the fund because they'll earn fees for helping arrange transactions. However, Citigroup has about $100 billion (70.3 billion EUR) tied into SIV investments, and took the lead during discussions with the government.
Citigroup Chief Financial Officer Gary Crittenden said Monday the plan "could provide reassurance to the market and make the funding of very high-quality assets a little easier."
The choice of the city of Helsinki is not incidental as the capital of Finland had hosted US-Soviet negotiations on the limitation of nuclear stockpiles in 1969