The recent collapse of Lehman Brothers and the subsequent
financial crisis has had far reaching consequences for many
organisations and government bodies worldwide. Australian local
government bodies, many of whom were encouraged to invest in
collateralised debt obligations (CDOs) which were
often promoted as having little financial risk, have not escaped
The US government's recent Emergency Economic
Stabilisation Act 2008 (Rescue Package) could
potentially increase the value of Lehman sponsored CDOs. This
E-Alert looks at the Rescue Package and what it may mean for
Councils who have invested in Lehman sponsored CDOs.
The Rescue Package provides the US Treasury Secretary with up to
US$700 billion to buy illiquid or troubled assets from financial
institutions. Broadly, the Rescue Package aims to restore
liquidity, stability and confidence in the financial system, to
decrease uncertainty, and to reduce the amount of financial loss
that would otherwise be suffered as a result of the financial
A fundamental part of the Rescue Package is the "Troubled
Asset Relief Program" (TARP). TARP allows the
US Treasury to purchase "troubled assets" with the
possibility of selling them back to the market when their market
value has increased. The US Treasury is also investigating other
methods of alleviating pressure on illiquid mortgage backed
securities like CDOs.
It is likely that many of the Lehman sponsored CDOs held by
Councils would qualify for support under the rescue package. If the
US Treasury buys or supports the CDOs, it is likely that there will
be an increase in value in the CDOs. In addition. it is believed by
some industry experts and others that if the Rescue Package
achieves its aim of restoring liquidity, stability and confidence
in the financial system, the market value of Lehman Sponsored CDOs
and other troubled assets should increase over coming years.
Some Australian Councils have recently received some good news
in relation to their investments in Lehman's Federation Notes
– it is understood those Councils will recoup the
original amount invested, plus interest, due to the sale of assets
backing the product.
In a further development overnight, the US Federal Reserve has
announced two new steps to help unfreeze US credit, committing up
to $US800 billion. $US600 billion of that money will be used to
purchase debt issued or backed by government-chartered housing
finance companies (such as Freddie Mac and Fannie Mae) and the
balance to support consumer and small business loans. Although it
is unlikely any of the Lehman sponsored CDOs will directly benefit
from this new initiative, the positive impact that the improved
rescue package is likely to have on the economy should benefit
investors in Lehman sponsored CDOs, if only indirectly.
It seems Uncle Sam is trying to help Australian Councils
(although perhaps not intentionally!). What happens in reality,
however, remains to be seen.
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