Banks Drop Plan Aimed At Easing Credit Crunch
Treasury-Backed Fund No Longer Needed, Officials Say

By David Cho and Neil Irwin
Washington Post Staff Writers
Saturday, December 22, 2007

A Treasury-backed plan to stabilize a vital segment of the credit markets has been shelved, the banks involved said yesterday.

The strategy called for banks across the globe to create a $100 billion fund aimed at jump-starting the troubled market for short-term loans, acting like a credit card for companies.

But the architects of the plan, which was developed by Citigroup and other leading financial institutions at series of meetings convened by Treasury officials this fall, struggled to recruit other banks and called it quits this week.

The plan aimed to help the market for short-term loans, or asset-backed commercial paper, which is a major driver of economic activity. Without these loans, companies struggle to issue mortgages and credit cards, and borrow to build automobile plants or hotels.

The fund was a signature initiative of Treasury Secretary Henry M. Paulson Jr. in his efforts to get the financial markets to function more normally.

Earlier this week, Paulson and the banks behind the plan said they were committed to its establishment. That changed yesterday after Treasury officials and the banks, which included Bank of America and J.P. Morgan Chase, said that the fund was "not needed at this time" because market conditions had improved.

Mark Zandi of Moody's Economy.com said, however, that the fund's collapse "may put more pressure on the financial system and ultimately on Treasury to do something more."

The Treasury Department may have to create its own fund backed by taxpayers, he said. "But I don't think that happens unless the economy continues to weaken and we are headed definitely toward a recession," Zandi said.

The plan would have helped major issuers of asset-backed commercial paper called structured investment vehicles (SIVs). These semi-independent funds, set up by Wall Street banks to make complicated investments, have suffered deeply from the credit crunch.

The SIVs issue short-term loans and invest that money in securities backed in many cases by mortgages. But after a wave of defaults and foreclosures swept across the nation, the value of the securities held by the SIVs plummeted. The debt markets panicked, and the SIVs found it impossible to sell off any holdings.

With those large losses and a climate of fear in the marketplace, the SIVs were unable to issue short-term loans.

Since then, many banks, in particular Citigroup, have moved more than $100 billion in troubled assets from their SIVs onto their own balance sheets, alleviating a key rationale for the rescue fund. The transfer means the banks are agreeing to back loans made by the SIVs.

These moves came at a considerable cost to shareholders of these banks, but they also helped bring a measure of stability to the market for short-term debt.

At the time the plan was crafted, it was the Treasury's most extensive action to address the credit crunch that has plagued financial markets since the summer.

Paulson called together leaders of major banks in September and persuaded the institutions, normally brutal competitors, to come together to set up the fund, known as the master-liquidity enhancement conduit.

The fund would have only bought complex securities with the best credit ratings, but that was not enough to attract interest from potential financial backers.

In addition to companies that depend on short-term loans, a wide range of institutions would have benefited from the fund, including money-market mutual funds, pensions, university endowments and hedge funds. But few would support the plan publicly because that would have been tacitly admitting they owned these troubled securities backed by mortgages and sparked concern among their investors.

As recently as Monday, Paulson said he still saw a need for the fund to be created, despite the decision by banks to absorb SIV losses onto their balance sheets.

"I think it's another market-driven response that is a positive," he said of the plan in an interview. "It is about orderly markets."

Paulson praised the decision of Citigroup and other major banks to put the SIVs on their balance sheets but said that many SIVs remain troubled. He was optimistic Monday, saying the fund would be created soon, a view echoed the next day by the institutions involved.

After the announcement yesterday that the fund was not going forward, Treasury spokeswoman Jennifer Zuccarelli said: "The department appreciates the efforts of the financial professionals who brought the conduit together in such a short period of time." She said the fund had been "designed to complement other market solutions."