Shadow hangs over future of SIV funds

By Andrew Hurst, European Banking Correspondent - Analysis

ZURICH (Reuters) - U.S. banks may pull off a plan to help revive mortgage securities markets but the huge and shadowy investment vehicles at the heart of a global credit crunch face an increasingly uncertain future.

Fuelled by a cheap credit boom which has gone sour, structured investment vehicles, known as SIVs, set up by banks over the past 20 years have mushroomed in size and now hold some $370 billion in assets.

SIVs were created to profit from the difference in returns between short-term and long-term debt. They have grown ever larger in recent years as they vacuumed up financial and asset-backed debt in a market awash with cheap money.

But they have borne the full brunt of a credit crunch because of heavy reliance on short-term commercial paper.

As a liquidity crisis -- set off by a meltdown in U.S. subprime mortgages intended to borrowers with patchy credit histories -- intensified over the summer, the willingness of investors to buy paper issued by SIVs all but dried up.

Banks including Citigroup, JP Morgan and Bank of America said on Monday they were establishing a fund to bail out the SIVs, many of which are struggling to raise the short-term financing they need to stay afloat.

"I think there are certainly serious questions over the whole structure of these types of investment vehicles," said Simon Adamson at CreditSights, a London-based credit risk research house.

"The only way they can exist is if investors are willing to buy securities issued by those vehicles. But what has happened in the last few months will make some investors very reluctant to want to buy those sorts of securities again," he said.

LIQUIDITY

The fund, called the master liquidity enhancement conduit, or M-LEC, will buy assets from the SIVs, thereby sparing them from having to dump assets at distressed prices into an illiquid market.

"All this is doing is putting the SIVs in that structure," said Ian Harnett, a strategist at Absolute Strategy in London. "People are recognizing that the SIV structure is not stable."

Banks led by Citigroup, which manages a number of SIVs holding more than $80 billion in assets, would have to bring these assets onto their balance sheets if SIVs were no longer able to fund themselves.

"They (the banks) either have to bring them onto their balance sheets or they have to finance a different vehicle," said Harnett.

Some Europeans have expressed skepticism that the U.S.-led fund will take off even if the subprime crisis has hit European banks' profits and forced several bailouts of smaller banks.

But others say that European banks would remain on the sidelines at their peril as the U.S. banks forge ahead and try to clear up the subprime mess.