HSBC Holdings has announced a $35 billion bailout of its structured investment vehicles (SIVs). The move puts a damper on the plans of a group of rival banks - led by Citigroup, Bank of America and J P Morgan Chase - to create a ''''superfund'''' that would buy some of the SIVs'''' highly rated assets, and provide a ''''broader solution'''' to one of the major sources of this year''''s global credit crisis.
HSBC said on Monday 26 November that it is moving SIVs Cullinan Finance and Asscher Finance onto its balance sheet to prevent forced sales of ''''high-quality assets''''. Britain''''s largest bank by market value will provide up to $35 billion in funding for the move, and its balance sheet will expand by $45 billion.

A $300 billion business, SIVs are at the centre of the worldwide credit crisis. These bank subsidiaries borrow money in short-term loans and use the cash to buy longer-term debt. The longer-term assets usually pay higher interest rates than the short-term debt, and money is made on the difference.

SIVs invest in a variety of fixed-income products, but most have had heavy exposure to securities partly backed by US sub-prime home loans, such as mortgage-backed securities and collateralised debt obligations (CDOs).

As defaults surged on sub-prime mortgages this year, confidence in these products wilted and SIVs struggled to refinance short-term debt. That sparked concerns that the vehicles would be forced to sell hard-to-value assets like CDOs into illiquid markets at severely depressed prices. Such a move could, in turn, damage the value of similar assets held by others, such as banks, brokers, hedge funds, insurers and pension funds.

On 15 October, Citigroup, Bank of America and J P Morgan Chase - under the guidance of the US Treasury - unveiled a joint plan to mitigate this potentially damaging scenario.

The three banks agreed to create a superfund called the master liquidity enhancement conduit (M-LEC) that would buy some of the SIVs'''' most highly rated assets and help them avoid having to sell assets quickly to pay off their short-term debt.

The plan was scheduled to be up and running by mid-January 2008, and was expected to provide stability and liquidity to credit markets. But HSBC''''s decision to deal with its SIV problems alone suggests that M-LEC is being set up too late and may accomplish too little.

It may also suggest that some banks would prefer to retain 100 per cent control over the destiny of their SIVs and could be wary of getting involved with M-LEC. That''''s a problem because other banks have to take part if it is to be big enough to have an effect on the broader credit markets.

Citi created the first SIV in 1989, and is now the largest bank sponsor of SIVs, with roughly $90 billion of exposure. The problem for M-LEC''''s backers, say some analysts, is that HSBC has the balance sheet to allow them to do this, but Citigroup and Bank of America don''''t. But others say Citi and Bank of America may not want to allocate so much capital to one area.

Citi shares have been hit hard in recent weeks by concerns about whether the bank has enough capital. Analysts say Citi may have to raise more than $30 billion by selling assets, slashing its dividend or a combination of measures.

Citi has already bought $7.6 billion of its SIVs'''' maturing short-term debt but said in a recent quarterly regulatory filing that such support would stop at $10 billion. Any additional support may increase the likelihood of a downgrade, as Citi''''s capital ratios are already under pressure.

Publicly available details on the American banking triumvirate''''s plan are scarce. Some haven''''t even been finalised yet, so it''''s still unclear exactly what M-LEC will be or do.

At one extreme, M-LEC could be a vulture fund that buys only the best assets from SIVs and then unwinds once the liquidity crisis is over. This means it might make a big profit. But it won''''t solve the potential problem of SIVs being forced to sell the rest of their lower-quality holdings at heavy discounts.

At the other extreme, M-LEC could be a bailout fund that will buy a lot of SIV assets to stabilise the broader credit markets. But this will probably mean that M-LEC and the three sponsoring banks are left with large losses.

But losses or profits are in the future, and not the present priority on the agenda. Stability remains the prime short-term objective of M-LEC. Broad stability sooner rather than later produces many more profit-making opportunities in so many markets for banks. That goes beyond just making M-LEC profitable. The question now is with HSBC walking the path less travelled; will the superfund have the critical mass for its stabilising mission?