Monday, July 20, 2009

A walk down Maiden Lane

Posted in the Financial Times by Willem Buiter:

A reader of this blog drew my attention to the informative Fed publication, the Federal Reserve System Monthly Report on Credit and Liquidity Programs and the Balance Sheet . The most recent installment is that for July 2009. This provides a wealth of information (not enough, of course, but more than is provided by most other central banks) relating to the quality of the assets contained in the special purpose vehicles the central bank has created to house the often distressed assets it has acquired from or funded on behalf of a number of always distressed private counterparties. I will focus here on the three Maiden Lane vehicles created by the Fed to park some of the wonky assets it acquired from Bear Stearns (Maiden Lane (which I shall refer to as Maiden Lane I)) and from AIG (Maiden Lane II and III).

Maiden Lane I contains a portfolio of mortgage-related securities, residential and commercial mortgage loans, and associated hedges from Bear Stearns. It is valued on the Fed’s balance sheet at US$ 25.96 billion on July 8, 2009. I vaguely recall the Fed making a US$29.0 billion loan to this vehicle around March 2008, at the time Bear Stearns fell into the maw of JP Morgan Chase. The Fed document refers to both a senior loan (balance outstanding om 31 March 2009, US$29.1 billion) and a subordinated loan (balance outstanding on 31 March 2009) US$ 1.2 billion) so there obviously are some gaps in my powers of recollection.

Maiden Lane II contains residential mortgage-backed securities (RMBS) from the securities lending portfolio of several regulated U.S. insurance subsidiaries of AIG. These are valued on the Fed’s balance sheet at US$ 15,74 billion on July 8, 2009. On December 12, 2008, the FRBNY loaned about US$19.5 billion to Maiden Lane II.

Maiden Lane III holds asset backed collateralized debt obligations (ABS CDOs) from certain counterparties of AIG Financial Products Corp. on which AIG Financial Products had written credit default swap and similar contracts. These assets are now (July 8 2009) valued at US$18,8 billion. On November 25, 2008, the FRBNY loaned about US$24.4 billion to Maiden Lane III LLC. Both the garbled rationale given by the Fed for this bailout of AIG’s counterparties, and the lack of clarity about the exact circumstances, conditions and modalities of this bailout contribute to it remaining probably the most controversial financial intervention by any monetary or fiscal authority during this crisis. It is bound to be revisited and investigated in the future by law makers and other interested agencies.

By any measure, the Fed is in the hole with all three SPVs. Its own estimates are that the amount by which the fair value of the net portfolio assets of each vehicle falls short of the outstanding balance of the loans extended to each of these vehicles (including accrued interest) is US$ 3.77 billion for Maiden Lane I, US$ 1.97 billion for Maiden Lane II and US$ 2.82 billion for Maiden Lane III. This is likely to be an underestimate of the true loss, because the reported fair value of the assets in the Maiden Lane vehicles is likely to overstate the present value of their held-to-maturity net cash flows. Much of the assets is illiquid, especially those in the AIG-related SPVs, Maiden Lane II and III.

In an earlier post on this subject I wrote “The Bear Stearns-related assets are likely to be rubbish. Maiden Lane II and III I know less about.” Thanks to the Monthly Report on Credit and Liquidity Programs and the Balance Sheet I now know that I may have overstated the degree of awfulness of the Bear Stearns legacy assets. I almost surely also overestimated the quality of the AIG legacy assets.

Consider the three charts that follow, all three cut and pasted from the Fed’s Monthly Report on Credit and Liquidity Programs and the Balance Sheet, July 2009:

Maiden Lane I

Maiden Lane I

Maiden Lane II

Maiden Lane II

Maiden Lane III

Maiden Lane III

Most of the assets in the Maiden Lane I vehicle are securities issued or guaranteed by the federal government or federal agencies. But AIG stuck the Fed with a portfolio of RMBS 59.5 percent of which was subprime backed, with most of the remainder, 26.9 percent of the total, backed by Alt-A mortgages. I sincerely hope my retirement fund is better invested than that.

As regards Maiden Lane III, 71.7 percent of the portfolio is rated BB+ or lower - junk in normal language. That is not surprising, as 70.8 percent of the portfolio is supposed to be in ‘high grade’ ABS CDO. A high grade ABS CDO is like a nice schoolyard bully. They may exist, but they are few and far between. We can expected further significant write-downs and ultimately write-offs on these portfolios. The US$ 8.56 shortfall reported by the Fed thus far is likely to be only the tip of the iceberg.

I know that US$ 8.56 billion won’t get anybody in Washington DC or Wall Street out of bed an our earlier any more, but as a US tax payer and partisan of the US Constitution, I am deeply worried about the way the Fed sprinkles around quasi-fiscal resources to benefit selected targets of opportunity without any semblance of ex-ante approval by the Congress or ex-post accountability to the Congress.

Certain noble ends may sometimes justify certain rather ignoble means. But even noble ends cannot justify any means. If the nobility of the ends is questionable, the means used to achieve the potentially ignoble ends deserve the closest possible scrutiny.

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