Secret Meetings Held With Fed and Major Banks to Avert Disaster

Based on a series of articles that appeared in the Wall Street Journal that did not garner much coverage in the mainstream CNBC and network airings, I wanted to highlight a secret meeting that the Fed facilitated a few weeks ago ON A SUNDAY with executives to top U.S. banks, which may have been necessary to avoid a new round of credit liquidity problems and perhaps massive troubles for Citigroup (C), a financial institution critical to the U.S. and the world.

Here are the facts, as reported across the past few days primarily in the Wall Street Journal:

• Citigroup has nearly $100 Billion in seven affiliated SIVs, or Structured Investment Vehicles. This is one quarter of all SIVs that exist globally, according to Moody's. The way they work is that they issue their own short term debt at low interest rates with the presumption that they have high credit ratings. They then use those funds to purchase higher yielding long term assets such as securities tied to mortgages (do you see where this is going?).

• SIVs are intentionally omitted from balance sheets of banks to which they are affiliated so they can reduce the capital requirements governed by existing regulations (IT GETS BETTER...)

• Because of this off-balance sheet "minor detail", investors are in the dark regarding the potential risks involved. As a corollary, off balance sheet liabilities were a defining factor in the Enron collapse.

• Indirectly, as a result of the ability to forgo these annoying capital requirements, guess what? That avails a company to more LEVERAGE. (Be Afraid. Be Very Afraid).

• Between the leverage and the spread between Citi's flows out (low interest rate) and flows in (high interest on risky mortgage backed securities), they were temporarily enjoying a bonanza that was destined to come crashing down. And it did.

• On Sunday, September 16, the Fed convened a meeting with high ranking executives from 30 of the largest U.S. banking institutions to create a "superconduit" whereby these securities could be purchased instead of allowing the prices to drop out from under them, due to lack of liquidity, since nobody knows how to value them and nobody wants to touch them. The superconduit would serve as a "buyer of last resort" and would pay market prices to prevent a downward spiral, which would send additional tremors through the financial markets.

• This superconduit is to be funded by Bank of America (BAC) and JP Morgan (JPM) among others, even though they have distanced themselves from the mortgage backed securities mess. What's in it for them? Fees for helping to arrange the superconduit.

• In essence, the Fed wanted a corporate solution rather than a government backed bail-out to help resolve this messy situation. Time will tell how this experiment fairs. According to a source present at the meeting, the consensus was that an "unorderly unwind" in the course of the next year would be damaging to the financial markets.

Apparently, a somewhat amusing part of this secret meeting was that all the Fed members were donned in traditional suits, while the Bank Executives came in dressed in their Sunday best - dressed for the beach.