October 17, 2007

Joshua Rosner
646/652-6207
jrosner@graham-fisher.com

MLEC – “May Losses Extend Continuously”

The details of MLEC are not yet fully worked out and it is still questionable whether this
‘deal’ can work, will work or if it can be structured in a way that economics would be
attractive enough for investors.

Given the risks involved in rolling losses forward and Congressional silence on the
subject, if this ultimately ends in a taxpayer funded bailout, it will be interesting to see
which Congressmen and Senators become embroiled in the next ‘Keating 5’. Given that
we are not talking about a relatively small institution like Lincoln Savings and Loan it
appears the number could easily exceed 5.

Awaiting further detail, we pose a several questions and comments about the MLEC
structure:

1) It has been suggested that Citi may not have fully driven this MLEC initiative but
rather it was the result of foreign pressures on Treasury demanding they address
problems in the US securitization markets. We have heard from sources that several
British Banks have been large buyers of the mezzanine capital notes of the SIVs at the
heart of this and their concerns are being transmitted back to our shores.

2) The common argument by those in favor of the MLEC structure is that market pricing
does not reflect the underlying credit realities. Shouldn't someone push back on that
notion at least to demand a better basis of support for it?

We live in a world where these same players argue Chicago School " efficient market
theory" works. Wouldn't that suggest that the markets are pricing based on their
expectation of the ultimate levels of credit impairments? In February and March we
repeatedly stated that the structured financed problems were far more critical than
recognized and would get worse, spreading well outside of subprime. It was many of
these same institutions whose analysis suggesting otherwise was wrong.

We still believe they are, as the rating agencies are, primarily considering pipeline losses
as the basis of that justification of market mispricing. We expect that were they to use
and stress test their projected loss assumptions it would be clear that they are merely
rolling the problems forward to the day when no one will touch these assets. At that time
no one will touch them, not because of mispricing, but because of large, clear and real
credit quality issues. At that time we will have come to the end of the “one notch at a
time” downgrading process of many of these structured securities and it will be clear that
a large number of them were, in truth, neither highly rated nor well structured.

Please refer to important disclosures at the end of this report.

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Should our entire economy be placed in the hands of banking oligarchs who have already
made and lost on big bets? Should we facilitate a doubling down? Is this a poker game
that we choose to sit at the table and watch? Shouldn’t it be somewhat more considered
than a "hail Mary pass" in a tied game with a minute to go in the 4th quarter? Perhaps it is
time to consider what "overtime" might look like, even if they get MLEC up and running
but rolling becomes a problem later.

3) If a SIV’s trustee has their primary responsibility to note-holders how are those holders
well served if their lower rated and subprime related assets are essentially stranded?
Moreover the exclusion of subprime assets and unrated or sub-investment-grade rated
assets in this conduit will only shine a brighter light on those excluded assets and result in
greater impairments to their liquidity and pricing.

4) How will subprime or mortgage-related assets be defined? Is it only RMBS? Can

related assets labeled as "other" be snuck in and secured by MLEC? When looking at
some of the multi-seller ABCP conduits, assets are often categorized as “other” when
they appear likely to be primarily collateralized by subprime assets. Would similar
obfuscation rule the day here? Will auditors be willing to support such categorization
when it is time for annual attestations?

5) Given that the 'worst' assets, those most illiquid with the most credit risk, are being left
behind do those get sold at a fire sale or are they consolidated back to the bank in the
event that the SIV can't roll its paper (even with its new holding of MLEC junior notes)?
If they have to consolidate how will those, hardest to value assets, be appropriately
valued?

6) If, when a SIV needs to roll, it cannot find buyers (even though it is holding junior
notes of MLEC) and it has to unwind would those MLEC notes be part of the fire sale? Is
there any guarantee that the sponsors would buy those notes back and, if so, at what
price? Would they be in a capital position to afford to at that time or is that where the risk
of moral hazard becomes the reality of moral hazard?

7) It has been suggested that there may be no good reason, other than the 100bp profit
motive and ultimate investment returns if prices rebound, for BofA and Morgan to
partake in this. While profit may be one motive it is worth considering that both
institutions may want to stave off a fire sale so they can avoid having to change the marks
on some of their own assets. Seemingly more likely, one or both of those firms may have
considerable money market exposures to the SIVs.

8) What are the specific trigger risk dates? Why is this being embarked upon today and
not in August? Are we merely heading down that old and well-worn path of trying to
push losses into the future and not recognize them? That was the approach that often
turns problems into crises as with the S&L and Japanese crises.

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9) MLEC will only take assets that are highly rated, isn't it clear that term is fraught with
problems, inconsistencies and misapplications? Moreover, should investors take comfort
that this is ‘backstopped’ by some of the largest financial firms in the world? Given that
the capital of one of those firms is already dangerously constrained perhaps that comfort
is more emotionally reflexive than rational?

10) Unlike with ABCP liquidity guarantees and their corresponding regulatory capital
requirements, SIV sponsors claim they don't have an explicit obligation to provide
liquidity support to the SIVs. Doesn't this whole rush to create MLEC argue that s a
fallacy?

At inception the SIV has no money yet purchase assets with loans from the banks. The
banks carry those loans on their books, that represents risk. Moreover, if they have to
provide liquidity to the SIV in order to possibly recover on those loan obligations and to,
hopefully, collect fees then it seems that regulatory capital requirements are too low.
Perhaps examiners should be stress test their institutions capital on the assumption they
may have to provide liquidity to fully support the SIV? Shouldn't that become a
calculation measure used in capital requirements?

11) Once again we come back to the rating agencies with another question. Given the
risks to Citi, as a result of their SIV problems (not to mention their trading book risk and
banking risk), shouldn't the rating agencies have recognized Citi's potential exposures and
considered ratings actions? Are rating agencies inactions to act tied to an assumption that
Citi has no obligation to the SIV? Will they change their methods as a result of this
demonstrated reality of support?

12) In structuring the contractual language of MLEC, will there be specific limitations of
the “highly rated” assets it can back or will MLEC’s ‘charter’ be allowed to expand to
absorb any assets that may ultimately need to be ‘bailed out’?

13) Does aggregating all of these problems into one large conduit presuppose that the
government will ultimately be forced to bail this out at the expense of taxpayers? What
will the impact be on the dollar and the shape of the yield-curve?

The precondition which led to MLEC stems from an unfortunate combination of opacity,
mis-modeling, ability of institutions to play three card monte with off balance sheet
exposures and regulator supported games of regulatory capital arbitrage.

If addressed by genuine repair, as opposed to transparent attempts to roll the problems,

this period could serve to reaffirm confidence in securitization as a valuable tool.
Unfortunately, attempts to avoid losses through the creation of such a structure neither
solves for the problem nor requires that risk taking behaviors result in the systemic

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netting of gains and losses. It is unnecessary and more unfortunate that such actions
become an indictment of securitization itself. While Basel II is not yet fully implemented
it seems reasonable to consider, as a result of the current environment, Basel III won’t be
far behind.

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