The prospective SIV bailout plan, officially called the Master Liquidity Enhancement Conduit (MLEC) or informally called The Entity, retreated a bit from the public eye yesterday as the perps, whoops, organizers, seemed to be focusing their energies on firming up arrangements so that they can announce progress and have the appearance of momentum. (if you are new to this topic, this post provides some helpful background).

But aside from all the open and troublesome issues we’ve discussed in previous posts (the biggest one being pricing of the assets to be sold to the MLEC, since the interests of current SIV owners and prospective funding sources seem hopelessly in conflict), the biggest obstacle the organizers, Citigroup, JP Morgan, and Bank of America face is finding bagholders, meaning investors that will buy either the commercial paper or the senior debt of the MLEC. Our understanding, based on a short and rather amusing post at Conglomerate, is that the junior debt will be held by the SIVs that sell assets to the MLEC (ah, the ways of Wall Street).

The finding of bagholders is an interesting exercise, since (from what little we have seen to date), the credit support provided by the perps appears to be non-existent (note that the original reporting gave the impression there would be guarantees of some form). Reader Bernard pointed out a passage that I had overlooked in New York Times story yesterday :

The new conduit will offer to buy many of the securities owned by SIVs, but at a cost to those vehicles. First they will have to pay a fee for the right to sell anything to the conduit, and part of that fee will be passed on to the banks, increasing their profits. Most of the proceeds will be paid to the conduits in cash, which they can use to redeem commercial paper. But a part of the payment, perhaps 5 percent of it, will instead be in junior securities issued by the conduit. Because those securities would bear the first losses suffered by the conduit, it is the SIVs, as a group, that will take the first risk that the securities turn out to be worth less than the conduit pays.

From what we have been able to discern, historically SIVs have had either two or three tiers, with the vast majority of the debt funding coming from “senior notes” which are in fact commercial paper. The junior notes are generally the equity layer.

Now since the structure of The Entity has yet to be disclosed, it isn’t clear whether there will be a senior-subordinated layer. If so, someone (the perps) will have to round up investors to take that risk. If not, and if the Times is correct, there is only a 5% loss cushion for the commercial paper investors. (Note that it is possible there will be credit enhancement, almost certainly for a fee; we simply haven’t seen any confirmation).

If anyone had any faith in this paper, that might be adequate. But CP investors are loss intolerant, this program is untested, and highly respected people in the fixed income game like Bill Gross at Pimco, are already calling the MLEC bad names:

There’s a lot of dead bodies off balance sheets that we still can’t find. This SIV idea is a little lame, in my opinion. And let me twist an old phrase and suggest that a SIV by any other name is still a SIV.

In the interview, Gross calls the SIV “sieve” to underscore his point.

Even a politician (and one who ought to be supporting this program) depicted the program as a band-aid at best. From the Wall Street Journal:

Sen. Charles Schumer of New York, a supporter of Wall Street, said the “superconduit may be a good short-term response, but it’s not going to solve the problem in the long run. In a certain way, it’s taking money out of one pocket and putting it in another.”

With such ringing endorsements, the search for bagholders, um, supporters is going slowly. Again, from the Journal:

Yesterday, Wachovia Corp. said it will participate in the fund. “While it’s not a significant issue for us, we plan to participate at an appropriate level because we want to help improve the stability of the markets,” a spokeswoman said. Among the firms offering support for the plan are Fidelity Investments and Federated Investors Inc. Both hold debt issued by an arm of Gordian Knot Ltd., one of the SIVs that could benefit from the fund. Fidelity’s $10.4 billion Prime Money Market Portfolio owned $402 million medium-term notes from Gordian’s Sigma Finance Inc. arm as of the end of August. A spokesman said he believed that such holdings “continue to represent minimal credit risk” and said the firm’s “money-market funds continue to perform strongly.”

So at least so far, only one bona fide end investor who doesn’t have ulterior motives has put up his hand and said it will go along, and that is for public-minded reasons. If Wachovia really is just showing support, that means it will only buy a token participation.

Now other names are also being bandied about as “participants,” but they do not look like the really scarce part of this equation, the prized bagholders who will buy the debt of the MLEC, either commercial paper or any senior-subordinated notes. But the help of these other participant would be useful if nothing else, to increase perceived legitimacy.

Wall Street firms are considering signing on, presumably as placement agents (and perhaps sharing any credit support) on a fee basis. Thus for them, the tradeoff is fee potential versus any reputational (and possible credit) risk the venture might entail. As the Journal notes, wide-scale participation from the Street isn’t essential, so if one or two firms sign up to validate the idea, that will probably do: