Friday, August 28, 2009

Kicking the tires of Maiden Lane

So we know there are these curious entities called "Maiden Lane, I, II, and III", respectively, wherein a rather large amount of taxpayer money has paid for the slightly speculative notion that "toxic waste" assets bought from various banks who needed to sell anything they had in order to remain a going concern represented a wonderful opportunity to save the financial system and in the process make a few bucks for John Q. Public.

I am going to ignore my usual observations regarding the angular momentum of power and its tendency to concentrate - there have been tacit and explicit bailouts dispensed by the Fed, but that is another story.

So let's look under the hood of these entities.

There are three different Maiden Lane companies. I will address the companies in separate posts.

The first, aptly named "Maiden Lane" was, according to the Fed, formed to facilitate the merger between Bear Stearns and JP Morgan. Its financial statements can be found here.

Maiden Lane borrowed $29 Billion from the Fed (a senior loan in priority) and an additional $1 Billion from JP Morgan (a subordinated loan to the Fed's claim) to buy $30 Billion of securities that comprised a portfolio of Bear Stearns assets. The Fed has done this under the auspices of Section 13(3) of the Federal Reserve Act of 1932. Section 13 (3) allows the Fed to discount certain notes under "exigent" circumstances and the status of the Fed as "lender of last resort". Setting up an LLC is a convenient way to sidestep any reluctance by ombudsmen and the like to object to what appears to be an outright purchase of toxic assets.

Since the assets in the portfolio are collateral for the Fed's loan, and Mr. Bernanke does not forsee any losses on these securities (of course, "loss" is a realized accounting event that manifests upon the actual sale of these securities), concerns from nervous taxpayers are misguided.

Unfortunately, Maiden Lane's portfolio has "lost" (the difference between the "fair market" value and the book value of the securities) nearly 10% of the value of its portfolio:

Account name                                                                                    Aug 26, 2009           Net portfolio holdings of Maiden Lane LLC (1)                                                       26,014  Outstanding principal amount of loan extended by the Federal Reserve Bank of New York (2)           28,820 Accrued interest payable to the Federal Reserve Bank of New York (2)                                   362 Outstanding principal amount and accrued interest on loan payable to JPMorgan Chase & Co. (3)        1,227   1. Fair value. Fair value reflects an estimate of the price that would be received upon selling an asset if    the transaction were to be conducted in an orderly market on the measurement date.  Revalued quarterly.     This table reflects valuations as of      June 30, 2009.  Any assets purchased after this valuation date     are initially recorded at cost until their estimated fair value as of the purchase date becomes available. 2. Book value.  This amount was eliminated when preparing the Federal Reserve Bank of New York's statement    of condition consistent with consolidation under generally accepted accounting principles.  Refer to    the note on consolidation accompanying table 10. 3. Book value.  The fair value of these obligations is included in other liabilities and capital in table 1     and in other liabilities and accrued dividends in table 9 and table 10.

But not to worry, we are still in the "accumulation" period wherein the portfolio of assets and their associated interest rate risks are being managed. Any sale of the portolio can only be invested in Treasuries or U.S. Agency securities. Without knowing when and what prices any sales were, its difficult to ascertain wether or not Treasuries or Agencies have become a significant portion of the overall portfolio. The money will be there at the end, and if it somehow comes up short, then the Fed owns the underlying collateral. This makes the loss figures somewhat puzzling in an environment where Agency securities and Treasuries are generally doing quite well.

But what is that collateral? Is it ANY asset in the portfolio (that may include, as stated above, Treasuries and/or Agency Securities) or is it only those securities as that constituted the Bear Stearns portfolio? The specific language states the "Asset Portfolio" is:

mortgage related securities, residential and commercial mortgage loans and associated hedges (Asset Portfolio)

I identify this issue because it is my belief that the Fed will end up owning a significant portion of the collateral once it becomes obvious that full repayment of principal and accrued interest is impossible considering the quality of these assets. There is some indication of the composition of the assets in Maiden Lane, but details are lacking.

From the "cheap seats", this appears to be a game of park the asset, and to buy time until some sort of reflation of the economy (either by organic GDP growth or by more nefarious monetary measures) occurs.

Thus, The Fed has set up a company, provided that company with a loan, had that company pay a bank (JP Morgan) $29 Billion for a portfolio of securities the value of which can charitably said to be "uncertain". These loans were then secured by the assets of the company, which are largely comprised of securities guaranteed by the Fed. The company can sell some of the portfolio, but can only park the proceeds in securities guaranteed by the Fed. The interest payments from the loans are paid to the New York Fed at prime rates, which are set by the Fed.

...all the Kings Horse, and all the Kings men...where oh where is our Alexander?

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