Doing the rounds is talk of a CDO “liquidity put” that has troubled Citi with billions in extra subprime exposure.
Speculation about the “liquidity put” kicked-off after an interview with Citi president Robert Rubin in Fortune magazine last week. Fortune recounts:
Citi started then to have ominous dealings with CDOs that carried a “liquidity put.” Never heard of a liquidity put? Google will give you a few uninformative references. But it is testimony to the obscurity of this term that Rubin says he had never heard of liquidity puts until they started harassing Citi last summer.
Peter Cohan at BloggingStocks picked up and promptly made it a lead. Felix Salmon also has some questions. Firstly, why hasn’t this got more coverage? And secondly, who else has these “liquidity puts”? Brad de Long wants answers too.
FT Alphaville noted Citi’s massive growth in CDO exposure - bizarrely through the commercial paper market - when the bank reported its Q3s. You can read all the detail here, but in a nutshell, this is the mystery “liquidity put”.
Back in early November, we didn’t know them as “liquidity puts” - just “agreements” in the structuring of Citi’s CDO deals.
Here’s the deal:
Several CDOs were created by Citi in 2005 that borrowed from technology used in designing SIVs- another market in which Citi was a leader. The rationale was that a CDO which could issue short-term commercial debt (alongside its traditional issuance) would have access to a broader funding market and would be able to more dynamically manage its funding portfolio. To mitigate any CP rollover risk, Citi entered into a series of “agreements” which forced it to buy the CDO CP if no one else would. As Mr Rubin calls them, “liquidity puts”.
And those CDO commercial paper “liquidity puts” forced a staggering $25bn increase in Citi’s CDO exposure - at a time when the market was falling apart. Like Salmon, we’re bemused as to why that notion hasn’t been more widely reported.
And it may not just be a Citi problem.
It seems that Bank of America had similarly structured CDO deals in place. In their 10Q, viewable here, there’s an admission that:
The Corporation is obligated under the written put options to provide funding to the CDOs by purchasing the commercial paper at predetermined contractual yields…
And as we understand things, those obligations forced BofA to buy $12bn of CDO CP from off balance sheet CDOs.
