Global Policy Forum

‘Shadow’ Lenders’ Emergency Fed Loans Benefited Biggest Banks

Big banks risky bets, which used increasing amounts of leverage and off-balance sheet banking vehicles - funds that operate in debt markets often with insufficient capital - were decisive factors in the build up to the global economic crisis. In spite of this, the Federal Reserve has supported the "shadow banking" sector in the aftermath of the catastrophic meltdown by providing billions of dollars to fund these clandestine entities. This demonstrates an unwillingness to reform an esoteric sector that threatens to bring down the global financial system again.


By James Sterngold, Donal Griffin and Jody Shenn

December 13, 2010


The Federal Reserve gave more support to the world's biggest financial companies, including Barclays Plc, Citigroup Inc. and Royal Bank of Scotland Plc, than the direct loans it disclosed this month in response to congressional mandates.

That's because about $140 billion, or 20 percent of the Fed's Commercial Paper Funding Facility, went to affiliates of four firms that provided financing to banks and other companies: Hudson Castle, BSN Holdings, Liberty Hampshire Co. and Northcross, central bank data show.

Banks around the world benefited. The affiliates were vehicles known as conduits -- part of what a Fed report in July called the "shadow banking" system that removed assets from companies' balance sheets and turned toxic debt into top-rated securities. At least a dozen banks had promised to provide conduits financing or other support in an emergency, reports by Standard & Poor's show. Some also tapped the conduits for loans, according to people with direct knowledge of the firms' dealings.

The shadow banking system "contributed significantly to asset bubbles in residential and commercial real-estate markets prior to the financial crisis" by obscuring risks, the Fed itself said in the study. The Fed's disclosures on Dec. 1 didn't identify borrowers from the four conduits. The funds were repaid.

Spokesmen for New York-based Citigroup, London's Barclays and Royal Bank of Scotland, based in Edinburgh, wouldn't say whether their firms borrowed money from conduits that tapped the commercial paper facility. Representatives of the conduits either declined to comment or didn't respond to messages.

'Repaid in Full'

"Like most global banks, we utilized central bank liquidity schemes during the crisis in financial markets," said Pholida Phengsomphone, a spokeswoman for the Royal Bank of Scotland, in an e-mailed statement. "Since then we have significantly reduced our borrowing from central banks and all money borrowed from the Fed has now been repaid in full with interest."

General Electric Co.'s finance unit was among firms that borrowed from one of the conduits, a person with direct knowledge of the transactions said. Russell Wilkerson, a spokesman for Fairfield, Connecticut-based GE, declined to comment on the amount.

These types of conduits operate by selling commercial paper and then providing inexpensive short-term financing to banks or banks' customers, often through repurchase agreements, in which the seller of a security agrees to buy it back in the future.

'Like Mini-Banks'

Some transactions can help companies remove assets from their balance sheets and reduce capital requirements, said Henry Tabe, co-founder of Sequoia Investment Management Co. in London and author of a book, "The Unraveling of Structured Investment Vehicles: How Liquidity Leaked Through the SIVs" (Thoth Capital, 2010).

"These vehicles grew quite large and away from the gazes of regulators," said Tabe, a former analyst at Moody's Investors Service. "These conduits are like mini-banks, making available billions in loans to banks."

Companies' dealings with conduits can take a variety of forms. Bank of America Corp., for instance, acted as an intermediary for BSN's sales of commercial paper to the Fed, a person briefed on the transaction said. At the same time, the bank provided BSN with assets from its own balance sheet, the person said.

"We have had a small but ongoing relationship with BSN," said Robert Stickler, a spokesman for the bank. The Charlotte, North Carolina-based lender directly borrowed $22.9 billion in aggregate from the Fed's CPFF, according to Fed data.

'Shadow of the Shadow'

The conduits' borrowing took place from September 2008 through January 2010, the data show. Some of the loans matured as late as April 2010.

"If securitization was shadow banking, then this was in the shadow of the shadow," said Joseph Mason, professor of finance at Louisiana State University in Baton Rouge. "This was even further down the line."

Other components of the shadow banking system include money-market funds, mortgage-backed securities and government- sponsored companies such as Fannie Mae, according to the Fed report.

The total loaned by the Fed under its commercial paper facility was $738 billion. While BSN didn't need the funding from the Fed, it did "bolster profits in 2009," according to an annual statement filed earlier this year by a London-based affiliate of the firm.

Keeping Tabs

A banker who deals with conduits said that, because the funding vehicles were not well known, the Fed grew curious about why they needed to sell so much commercial paper. He said an executive at one of the four firms contacted him to say the Fed had asked for information about what the conduits did and how they loaned money to customers.

"We maintained contact with all firms accessing the facility at some level in order to better understand our risk exposure," said Jeffrey Smith, a Federal Reserve Bank of New York spokesman. "The range of programs and the creation of programs like the CPFF reflect the Federal Reserve's ability to create broad and democratic lending programs."

The conduits, several of which were formed as the securitization markets surged after 2004, had little permanent capital. Some were run by parent companies founded by former bank executives. By turning to conduits, companies can expand their sources of financing.

According to a report by S&P from 2005, customers of conduits used them to gain "access to a pool of funding in excess of $700 billion, flexibility, and alternative sources of funding."

Shareholders' Capital

Hudson Castle's Ebbets Funding conduit, which is registered in Dublin, said in its accounts for the year ended March 31, 2009, that it had investments of $7.4 billion, borrowings it had to repay within a year of $7.5 billion, and shareholders' capital of $48,896. It paid a management fee of $18.4 million to Hudson Castle for the year.

Credit ratings assigned to the conduits were based solely on the strength of the financial companies pledging to support them. Assistance included agreements to purchase the conduits' commercial paper if others balked or to buy back assets serving as collateral for their loans. Other types of conduits were sponsored by single banks, including Citigroup and Barclays. Such conduits needed to hold assets of a certain quality to obtain a high rating.

Hudson Castle had no comment, a spokeswoman who declined to give her name said. Jeffrey Kelley, a spokesman for Guggenheim Partners LLC, the owner of Liberty Hampshire, declined to comment. Albert Cheong, co-founder of BSN and the company's representative in New York, also declined to comment. Phone calls and e-mails to Northcross founder Steve Anthoney weren't returned.

Off Balance Sheets

Before changes in accounting rules sparked by the financial crisis, the assets of all conduits and similar companies called special investment vehicles, or SIVs, were typically held off of the balance sheets of U.S. banks that sponsored or supported them, said James Mountain, a partner in New York at Deloitte & Touche LLP. That meant they didn't need to hold capital against those assets, he said.

Banks still needed to hold some capital against various forms of guarantees they provided to the conduits, he said. Assets sold with repurchase agreements usually remain on banks' balance sheets, he added.

Conduits managed by New York-based Hudson Castle received an aggregated total of $53.3 billion from the Fed program, with at most $16 billion outstanding at any one time. Support providers for its Elysian Funding LLC conduit included Citigroup and Royal Bank of Scotland, according to a September 2009 report from Standard & Poor's. Companies serving in that role often also received loans from the conduits, according to people familiar with the market.

Liberty Hampshire

Hudson Castle described Chief Executive Officer Kyle L. Miller in 2007 as a former managing director with Lehman Brothers Holdings Inc., according to ZoomInfo, a search engine that archives executive profiles from companies' websites.

Liberty Hampshire affiliates drew $41.4 billion from the CPFF, with $16 billion its maximum outstanding. Barclays was among 11 financial companies that provided support to Liberty's Crown Point Capital conduit, according to a 2009 S&P report.

The executive chairman of Guggenheim, which also runs an investment bank along with Liberty Hampshire, is Alan Schwartz, former chief executive officer of Bear Stearns Cos.

Northcross is headed from London by Anthoney, who led JPMorgan Chase & Co.'s European commercial paper operation until the bank left the business in 2004, according to the company's website. Anthoney set up Northcross in 2005, the website says. He founded the business with David Hynes, an Irish money manager who previously worked with Morgan Stanley, Gartmore Group Ltd. and Goldman Sachs Group Inc.

BSN Holdings

BSN Holdings took a total of $42.8 billion and Northcross borrowed $8.6 billion, peaking at $15 billion and $3 billion, respectively, Fed data show. BSN's London-based operation, BSN Capital Partners Ltd, was founded in 2005 by an ex-Deutsche Bank AG managing director, John Burgess, according to a 2008 company filing. Two other ex-Deutsche Bank officials, Jeremy Nye and Albert Cheong, also run BSN, according to the firm's website.

BSN's Chesham Finance vehicle, which had $23.6 billion of commercial paper outstanding as of mid-2007, is among conduits still in business, with $1.5 billion of borrowing as of Sept. 30, according to Moody's Investors Service data.



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