By Daniel Griffith, Carnegie Mellon University
April 6th, 2011 saw the first auction of mortgage backed securities that the Federal Reserve Bank of New York acquired from AIG in mid-2010, amidst skyrocketing subprime mortgage defaults and subsequent MBS pricing failures.
Maiden Lane
Following the collapse of the Residential Mortgage Backed Security (RMBS) market in late 2008, the Federal Reserve Bank of New York created three Limited Liability Companies (LLCs) to purchase toxic assets from failing financial institutions. In March of 2008, the New York Fed facilitated the acquisition of the then-failing Bear Stearns by J.P. Morgan. However, when J.P. Morgan refused to buy nearly $30 billion in assets it considered too risky, the Fed created its first Special Purpose Vehicle (SPV) to deal with RMBS, Maiden Lane, LLC. Special Purpose Vehicles are legal entities established by governments or corporations to absorb debt or facilitate financial transactions off the balance sheet of the original company or government. Maiden Lane, LLC was given a $30 billion credit line from the New York Fed, with the goal of acquiring Bear Stearns’ toxic assets to dispose of over time, once prices were stable. As of October 2010, the Fed reported Maiden Lane, LLC’s portfolio's fair market value was approximately $28.478 billion. The entity is expected to be included in next week's Fed debt auction, which analysts predict to be as well recieved as last week's.
Maiden Lane II
Following the downgrading of AIG’s credit rating in September 2008, the firm was forced to pay higher rates and faced liquidation issues, specifically relating to its issuance of Credit Default Swaps (CDSs). In order to alleviate some of AIG’s debt issues, the New York Fed created Maiden Lane II, LLC (the second of the Maiden Lane series of Special Purpose Vehicles), with a credit line of $20.5 billion in order for the SPV to take toxic RMBS assets off of the insurer’s balance sheet. This added liquidity helped AIG regain stability, although questions regarding the use of AIG’s bailout funds began to arise.
Maiden Lane III
As AIG began to feel the effects of their CDO and CDS debt burdens, the government was forced to acquire a significant portion (79%) of AIG’s equity. In an effort to help lessen the financial impact of the costly securities insurance, Maiden Lane III, LLC was created. The goal of the third Maiden Lane Special Purpose Vehicle was to enable AIG to discontinue its multi-sector collateralized debt obligations, which was accomplished by buying the CDOs from AIG’s counterparties. Essentially, Maiden Lane III was buying the debt that AIG was too illiquid to cover.
What the Fed’s Issuance Means
The Fed has been unloading debt from Maiden Lane, LLC for the past few weeks with an initial positive response. This continued through the April 6th auction of AIG RMBS debt. The current fair market value of Maiden Lane II was projected to be $31 billion, and as of last month AIG offered to buy the entire portfolio for $15.7 billion. The offer was immediately shot down by the Fed, which claimed that the auction would benefit taxpayers through higher prices. The Fed had bet correctly - the April 6th auction successfully sold $1.3 billion of the planned $1.5 billion in securities on the table.
This successful issuance of Maiden Lane II is a positive signal for investors, proving that demand is once again returning to the MBS market, and assets considered to be toxic may now be worth holding. In last week'ss Fed auction (an aggregate MBS auction, not just Maiden Lane II assets), 42 of 52 bonds were sold. Prices were close to fair value market (with some cover prices being around 90 cents on the dollar), which is another indicator of strength in the market.
The Fed aims to continue its MBS issuance at a rate of around $10 billion a month until its nearly $140 billion in mortgage backed assets are back in private hands. So far, the auctions have been met with eager investors looking for new opportunities, and given the current sentiment, there is little reason to believe in a slowdown any time soon.
