M-LEC For Dummies

(Conspiracy Nation, 10/16/07) – M-LEC is the acronym for the Master Liquidity Enhancement Conduit, a Super SIV on top of various other SIVs. SIVs (Structured Investment Vehicles) “essentially are private banks” but “without the benefits of deposit insurance or the right to borrow from the Federal Reserve.” (“Big U.S. Banks Try to Restore Confidence in Credit Markets,” by Floyd Norris. New York Times, October 16, 2007)

The “For Dummies” series of books try to explain complicated subjects for the average person. What is now needed is a “M-LEC For Dummies” book.

Oldsters such as the Conspiracy Nation editor are constantly being urged by the AARP magazine to do crossword puzzles, suduko puzzles, etc. Another great puzzle is figuring out the news. Crossword puzzles are okay, but deciphering M-LEC is a more meaningful challenge.

The first step in “M-LEC For Dummies” is to assemble the puzzle pieces. Here is the methodology. A good search engine on Internet will often return several news reports on items such as “SIV”, “M-LEC”, “Money Markets”, “Treasury Secretary”, etc. Many will be duplicates of the same Associated Press report, though even the same AP report can have slight variations. There will also be other independent reports. Wade through about ten of the reports, and copy down whatever strikes your intuition. You will then have the puzzle pieces. Over time and with practice, your intuition will improve for this process.

The next step is to lay out the puzzle pieces in a conspiracy report. Remember the Aristotle dictum: That which is expressed is impressed. Your grasp of things will improve by writing a report. Also, by publishing the report, you will benefit by peer review: readers will give you feedback.

The M-LEC plan was unveiled yesterday, but has been crowded out from the news by Ben Bernanke comments, under the category “Fed rates guesswork.” The SIVs, during the boom phase of the housing bubble, had been issuing commercial paper at low rates, then investing the proceeds at high rates in the sub-prime sector. This is similar to the Yen carry trade, where money would be borrowed from Japan at low rates, then invested elsewhere at high rates. But when the housing bubble reversed course and borrowers began to default, this sent a tidal wave crashing against the commercial paper.

Now some big banks like Citigroup have short-term commercial paper which no one wants to buy, at least not at the “marked to model” (pipe dream) price. There are hundreds of billions of dollars of questionable paper out there. The bankers must sell that paper! It is short-term! How can they issue more commercial paper if people aren't buying the old paper anymore? But if that paper gets dumped onto the market all at once, there will be “fire sale” prices, i.e. “marked to market” (real world) prices. This would mean a crash in value, wounding by osmosis bank portfolios.

“Because commercial paper usually matures within months, not years, it is necessary to sell new commercial paper as the old paper is paid off.” (Norris, op. cit.)

Could the banks themselves purchase the commercial paper? That idea was rejected in favor of a Super Conduit, M-LEC. Here's where it gets tricky. M-LEC is a Bankers' Pool of SIVs into a mega-SIV. It is a buyer of last resort for commercial paper. To be allowed into the paper guarantee, potential sellers have to pay a fee. Any sellers would get 95 percent cash and the rest in “junior securities” issued by M-LEC. Not clear in the Norris (op. cit.) article is whether the fee is in addition to the “junior securities.”

But there are also “senior securities.” The “senior securities” would go on the general market with the assurance that investors will be paid unless losses from the “junior securities” “grew so large that the junior securities were wiped out.” (Norris, op. cit.)

Hmmm... This is like “Lucky Day” in “Three Amigos.” In the El Borracho Tavern, the bartender whispers, “The German says to wait here.” Lucky Day (Steve Martin) responds, “Hmmm...”

The M-LEC scheme “could be thought of as turning SIVs into one big conduit, backed by the banks.” Financial Times concurs with Norris (op. cit.) M-LEC “will fund the purchase of SIV assets with short-term commercial paper but with other features, including a cushion of support from junior layers of capital and liquidity backstops provided by the banks.” (“Banks in quandary on prices for SIV assets,” October 15, 2007)

The “size of the vehicle” (M-LEC) is implicit in the liquidity backstops. M-LEC, in other words, will be “too big to fail.”

Or you could think of M-LEC as “circling the wagons” due to “Indians” attacking.

M-LEC would be a “market of last resort,” suggests the Wall Street Journal. (“Rescue Readied By Banks Is Bet To Spur Market,” October 15, 2007, by Carrick Mollenkamp, et al.) The SIVs, not on the banks' balance sheets, are dancing in “No Man's Land,” the World War I boundary between enemy trenches. The SIVs are not covered by FDIC insurance. Money market investors, who were told by experts that this was a safe area, might discover otherwise. It is like M-LEC is putting a toe on the other side of the line, where FDIC and “Fed” rescue awaits.

The mechanics of M-LEC are being tiptoed into news reports. How exactly does it work? Tentative clues are appearing, but the puzzle pieces have yet to be even assembled. Only then can the mechanics be figured out.

Conspiracy Nation

http://www.shout.net/~bigred/cn.html