Boeing bends the plane truth

This is a terrible idea proposed for a terrible reason that sadly exemplifies the level of mendacity among financial leaders today. Just how stupid do they think we are? (Answer: Pretty stupid.)

Satyajit Das, the derivatives and risk-management expert to whom I introduced you back in September in this column, calls it the banking equivalent of the "hair of the dog" cure for overindulgence of alcohol, in which you are supposed to drink some more in the morning to cure your hangover. The new vehicle proposed by Citigroup (C, news, msgs), Bank of America (BAC, news, msgs), JPMorgan Chase (JPM, news, msgs) and Treasury Secretary Hank Paulson, who formerly was top honcho at Goldman Sachs (GS, news, msgs), would supposedly buy AAA- and AA-rated collateralized debt obligations from banks' faltering SIVs, and then use those holdings as collateral to buy other, higher-yielding securities.

Huh? This so-called Master Liquidity Enhancement Conduit, or M-LEC, would simply be the largest special investment vehicle in the world and would likely serve no other purpose than to get bad paper out of its founders' thinning hair. As Das points out, "Wall Street seems to believe that if something doesn't work, then you should just do it in larger size."

The plan is somewhat similar to an entity created by the New York branch of the Federal Reserve after the demise of Long Term Capital Management hedge fund back in 1998 -- but with a key difference. Back then, the Fed was dealing with a single broken hedge fund that had foreign government bonds that were largely liquid and easily priced. In this case, the superfund would deal with thousands of illiquid, exotic debt derivatives whose value will be a matter of great debate. Although that $80 billion sounds impressive, it doesn't actually represent any cash; it's just the value of the bad paper that this entity would initially obtain at discounts.

The notion that the banks, who are archrivals, will agree with each other or their European counterparts on how to realistically price the securities -- a process known as "marking to market" -- is absurd on its face and countermands everything we think we know about how market participants act independently to determine values. And the idea that the Treasury is proposing to have some kind of unprecedented role in this charade is mind-blowing.

Normally the government would prevent companies from conspiring in this fashion due to suspicions they will serve their own interests, not those of the securities' owners. The fact that the Treasury has stepped in at all is a stunner because banking-system matters are usually handled by the Federal Reserve, which presumably wants nothing to do with this anti-capitalist craziness.

Das figures that the banks are teaming up for a reason much different than the one stated: to prevent the securities from being sold at a discount on the open market, pushing down prices on other securities to which they are linked and causing significant losses throughout the food chain. He points out that such losses would require prime brokers -- who provide funds to hedge funds -- to revalue collateral held against loans, triggering margin calls on already cash-strapped investors.

In other words, Das suggests the superfund idea is simply tarting up the banks' need to salvage their own reputations and balance sheets as a systemic rescue. This serves no one but the executives who made mistakes in the first place. Fortunately, it will never fly -- but the fact that it was even proposed goes one more step toward showing us how perniciously the system has been rigged lately.

• Video: Superfund to the rescue

Speaking of ruses, I would like to call your attention to my column early last month, titled "What the big banks aren't telling you -- yet," in which I said that the financial institutions needed to come clean about their gigantic losses.

They finally started to do that in the past week -- Merrill Lynch (MER, news, msgs) has preannounced a $4.5 billion writedown -- much to shareholders' chagrin. Just goes to show there's never a bear market in delusion. They can get away with that once, but you need to be aware that they can't do it again next quarter -- and that is a key reason that the banks will be in a hurry to get the Super SIV created by the end of the year. Dangers are mounting. Beware.

If you want to bet against the financial industry in the easiest way next year, buy the exchange-traded fund UltraShort Financials ProShares (SKF), which returns the inverse of the Dow Jones U.S. Financials Index.

Fine print

Two weeks ago, in my column "For home builders, the worst is to come," I noted Citigroup recommended that investors buy residential-construction companies' stocks because the bottom was near. That view would surprise people in Southern California, where DataQuick Information Systems reported Tuesday that sales of houses and condominiums fell 29.9% from the previous month and 48.5% from last year. After a brief rally after the Fed's rate cuts of mid-September, the home builders' shares are now back to new lows. . . . Das' latest book is "Traders, Guns & Money," an amusing exposé of high finance, published last year. . . .

A lot of people are coming to the conclusion that growing corn to create ethanol is a bad alternative for our fossil-fuel addiction, as reported in my column last week. If you have a subscription to the Wall Street Journal, check out the lead editorial Wednesday, titled "Ethanol's Water Shortage." The editorial says, in part: "Heavily subsidized and absurdly inefficient, corn-based ethanol has already driven up food prices. But the Senate's plan to increase production to 36 billion gallons by 2022, from less than 7 billion today, will place even greater pressure on farm-belt aquifers. Ethanol plants consume roughly four gallons of water to produce each gallon of fuel, but that's only a fraction of ethanol's total water habit. Cornell ecology professor David Pimentel says that when you count the water needed to grow the corn, one gallon of ethanol requires a staggering 1,700 gallons of H2O."

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