The New York Federal Reserve Bank released new details late yesterday about its Maiden Lane entities, which were created to remove the toxic assets from the balance sheets of Bear Sterns and AIG. The information was requested (.pdf) by Rep. Darrell Issa (R-CA), ranking member on the House Committee on Oversight and Government Reform. It reveals more about the assets that take up a lot of space on the Fed's balance sheet. As a result, many outlets are reporting how ugly the Maiden Lane assets look. Of course, that's not a surprise -- they're toxic assets. But I'm not yet convinced they'll create extraordinary losses for the Fed.
As you might expect, some in the media jumped on the par values listed in the newly released detail for each facility -- they're far more than the market value shown on the Fed's balance sheet. In fact, their market values range from 36 to 44 cents on the dollar. Here's how Bloomberg reports it:
Assets in Maiden Lane II totaled $34.8 billion, according to the Fed, which set their current market value in its weekly balance sheet at $15.3 billion. That means Maiden Lane II assets are worth 44 cents on the dollar, or 44 percent of their face value, according to the Fed.
If this approach is generalized for all three facilities, the naïve response is: "Oh my! The Fed is going to lose more than 50% on these assets with a par value of over $165 billion!"
Purchased At A Deep Discount
But that's not true. At all. First, it fails to take into account what the Fed actually paid for these assets. Here's a chart that I created to help explain:
For those unfamiliar with the Maiden Lane transactions, here's what went on. The Fed couldn't just purchase these assets directly. As a work-around, it created some special purpose vehicles (SPVs) to buy them. It then lent them the money to do so. So even though the Fed doesn't technically own these portfolios, it owns these portfolios.
As you can see, the loans provided by the Fed were at a deep discount compared to the current par values of the portfolios. The SPVs also received much smaller loans of $1 billion from JP Morgan for Maiden Lane I (through the Bear Sterns acquisition), $1 billion from AIG for Maiden Lane II and $5 billion from AIG for Maiden Lane III. It's my understanding that these loans are subordinate to the Fed's, which means JPM and AIG would bear any losses up to their investment amount before they hit the Fed. The Fed also gets almost all of all upside for Maiden Lane I and II, and two-thirds for III.
So even if the Fed decided to liquidate these portfolios right now and sell them in the market, its losses would be relatively small. The column above titled "Loss to Fed" explains those losses. $3.7 billion isn't zero, but it's certainly not the $100 billion difference between the assets' par values and market values.
Market Vs. Hold-To-Maturity Values
But the Fed has no intention of liquidating this portfolio at market value. One of the nice things about being the Fed is that it can be extremely patient. So the Fed is selling off these assets gradually, when it makes sense, and retaining others to maturity in order to maximize profit. Most of these assets are still trading in the market at values well below their potential hold-to-maturity values. So the market values above don't necessarily indicate how much will be lost. In fact, the Fed could end up turning a profit on these portfolios.
Of course, if things turn out worse than the market thinks, then the loss to the Fed could be even greater than current market values indicate. So it's impossible to tell just how good or bad a deal this will end up being for the Fed. But considering the fact that the Fed's exposure is limited to its $72.6 billion in loans used to purchase already deeply discounted assets, it's hard to believe it will lose even tens of billions in the transaction, even though the assets certainly are very, very ugly.
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