Citigroup, Bank of America and JPMorgan Chase have announced plans to raise up to $80 billion (£39 billion) for a new bailout fund to combat the effects of the credit crunch.

The fund - the master liquidity enhancement conduit, or M-LEC - will buy mortgage-backed bonds and related securities from structured investment vehicles (SIVs). These are affiliated to the banks but do not appear on their balance sheets because they are financed by their own short-term debt.

It was set up after Henry Paulson, the US Treasury Secretary, put pressure on America’s leading banks at a meeting last month. He said that the souring of assets at some SIVs had raised questions about transparency that needed to be addressed. “Regulators didn’t have clear enough visibility with what was going on in terms of these off-balance-sheet SIVs,” he said. The fund will be the biggest bailout on Wall Street since 1998, when the New York Federal Reserve pushed seven American investment banks into preventing the Long-Term Capital Management hedge fund from collapsing under the weight of bad bets on the currency markets.

M-LEC is intended to put a floor under the price of sub-prime bonds, which are declining rapidly in value as defaults on the underlying mortgages surge and the credit markets tighten.

These conditions have made it far more difficult for so-called SIVs to issue “commercial paper” as lenders become increasingly nervous.

The SIVs have been forced to sell about $75 billion of assets into a declining market to finance their daily operations, flooding the market and pushing prices down even further. Despite these fire sales, about 40 SIVs still hold about $400 billion. More forced sales would further reduce the market value of these mortgage-backed bonds and force banks to take fresh writedowns on the value of the remaining securities held on their books. This would increase investors’ and financial services companies’ nervousness and fuel the credit crunch.

Citigroup is thought to have the biggest SIV exposure, owning about $80 billion in mortgage-backed securities through its affiliates, after off-loading about $20 billion of such bonds in recent months. JPMorgan and Bank of America do not operate SIVs but they plan to participate because they would earn fees for helping to set up and run the conduit, which is expected to operate for about a year. The fund, which will issue short-term debt to finance its purchases, can buy assets from any bank or fund around the world and will pay market prices in a bid to prevent dumping.

British banks are eligible to join it but as of yesterday none had done so. HSBC, which runs two SIVs with assets of about $45 billion, said that it was “aware” of the plan.

Some banks are concerned that the terms on offer are unattractive and that it is more about bailing out Citigroup, the biggest SIV operator, than helping other banks. The fund would have the full backing of Citigroup and other founder banks, which would be obliged to buy its commercial paper themselves if necessary. Ordinary SIVs do not provide that guarantee.

The initiative is the second time that the US Government has convened Wall Street’s top banks in a bid to avert an escalation of the credit crunch. The first convention, in August, resulted in Citigroup, JPMorgan, Bank of America and Wachovia jointly borrowing $2 billion from the Federal Reserve in a bid to reduce the stigma attached to its so-called “discount window” and encourage smaller banks to use it and so boost liquidity.

Paper trail

— SIVs (structured investment vehicles) account for about 6 per cent, or $63 billion (£30.9 billion), of the outstanding $1.2 trillion in US asset-backed commercial paper; traditional corporate financing accounts for about $890 billion of asset-backed paper

— SIVs have invested in mostly non-sub-prime mortgage assets, along with other types of debt

— SIVs rely on cash borrowed from third-party investors. They do not depend entirely on banks to provide back-up credit in times of trouble, but must place a value on their investments on a regular basis and sell assets to repay investors during bad times

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