A rainy-day fund for liquidity squeeze?

Jill Barshay Oct 15, 2007

A rainy-day fund for liquidity squeeze?

Jill Barshay Oct 15, 2007


KAI RYSSDAL: The banks in question are Citigroup, JP Morgan and Bank of America. They’ve been chatting amongst themselves about how to make sure the liquidity squeeze doesn’t get any worse — and they’re decided it’s time to put up or shut up. Our New York bureau chief Jill Barshay is here to explain… Hi, Jill.


RYSSDAL: Before we get to the “whys,” let’s get to the nuts-and-bolts here… How is this thing going to work?

BARSHAY: Well, they’re calling it a “master conduit” — it’s basically a special fund, and they’re going to put up tens of billions of their own dollars, maybe as much as $100 billion. And they’re going to take that money, and they’re going to use it to buy securities that nobody else wants right now.

Many of the big Wall Street banks, including some of the ones establishing this fund, are holding these mortgage securities — and they don’t want to have to dump them at fire-sale prices and take even more losses on their books. And these banks, they compete against each other, so it’s very unusual for them to cooperate like this — and it may be a violation of anti-trust rules…

So the Treasury Department got into this and helped them coordinate it. They’ve been talking quietly for a month now, even got together on a Sunday, trying to figure out how to put it together. But there’s no tax dollars in it — it’s all the Wall Street banks’ own private money.

RYSSDAL: All right, but Jill, help me understand something: I thought — and we’ve certainly been saying on the program — that the credit squeeze was easing and these deals were getting done now because people were more comfortable spending money. If that’s the case, why do we need this fund?

BARSHAY: You’re right, Kai, most of the credit markets have gotten back on their feet. But there are still parts of them that have not returned to health, and there’s fear that these “stuck” parts may trigger yet another market tumble.

So this master conduit, this fund, it starts buying more securities — it can establish a price floor for bonds that are still in trouble, so that the floor doesn’t drop out again and the other markets follow with it. I talked with Peter Wallison at the American Enterprise Institute, and this is what he told me:

Peter Wallison: It’s not exactly a bailout… It’s more like the banks taking a risk to get a market started that would be good for them and for everyone else, including buyers of homes.

BARSHAY: …and not just home buyers, but ordinary investors. Because if a tumble in the mortgage bond market starts triggering a tumble in the equity markets, we could all be losing money in our portfolios.

RYSSDAL: Jill, let me back you up to something Peter Wallison said about the market getting restarted: What happens if those markets don’t restart — or if it comes to worse, the markets start and it doesn’t go well, and this fund has to step in?

BARSHAY: So what’s going on right here is that the banks owe a lot of money that’s coming to short-term debt. And this debt comes due in November. And if the investors ask for their money back, the banks don’t have that money immediately — they’re going to have to come up with cash. And what they need to sell are their mortgage securities… And the fear is that there will be this huge fire sale, that when banks have to get rid of mortgage securities, nobody wants it.

That’s where the rescue fund fits in — it will buy up these mortgage securities. Now, if there is no rescue fund there, the prices will just go spiraling downwards, and it will depress prices across the board. And it could eventually affect the rest of the credit markets, and make people more reluctant to lend money to one another. And that could eventually touch the whole economy.

RYSSDAL: Jill Barshay at the Marketplace bureau in New York City — thank you, Jill.

BARSHAY: It’s been a pleasure.

We’re here to help you navigate this changed world and economy.

Our mission at Marketplace is to raise the economic intelligence of the country. It’s a tough task, but it’s never been more important.

In the past year, we’ve seen record unemployment, stimulus bills, and reddit users influencing the stock market. Marketplace helps you understand it all, will fact-based, approachable, and unbiased reporting.

Generous support from listeners and readers is what powers our nonprofit news—and your donation today will help provide this essential service. For just $5/month, you can sustain independent journalism that keeps you and thousands of others informed.