Dec. 11 (Bloomberg) -- The tumor in the financial markets known as structured investment vehicles is shrinking, reducing the urgency for a bailout sponsored by the U.S. Treasury.

SIVs, which sell short-term debt and invest the proceeds in higher-yielding securities such as bank bonds and mortgage-backed securities, reduced their holdings by more than 25 percent since August to $298 billion, according to Moody's Investors Service. At least $84 billion more is being restructured by banks that set up the funds, according to data compiled by Bloomberg.

While Treasury Secretary Henry Paulson spends a third month gathering support for a ``SuperSIV'' that would buy assets from troubled funds, HSBC Holdings Plc, bond insurer MBIA Inc. and other companies are arranging their own rescues. The steps are diminishing the threat that SIVs will dump holdings and further roil credit markets contaminated by losses in securities related to subprime mortgages.

``Every day that goes by we are seeing more SIVs being reorganized to avoid a fire sale,'' said Priya Shah, a credit analyst at Dresdner Kleinwort Group Ltd. in London. ``The longer the SuperSIV takes, the less of a need there will be for it.''

SIVs have emerged as one of the biggest threats to capital markets that were rocked by record high defaults on U.S. mortgages made to borrowers with poor credit. Citigroup Inc., Bank of America Corp. and dozens of banks and brokers reported more than $66 billion of losses and writedowns from subprime mortgages. The average net asset value for SIVs has tumbled to 55 percent from 71 percent a month ago and 102 percent in June, according to Moody's.

Florida Teachers

Florida schools and towns pulled more than half their money last month from a $27 billion state-run fund used to pay teachers and other day-to-day expenses after discovering it invested in defaulted and downgraded SIVs. Charlotte, North Carolina-based Bank of America, the second-largest U.S. bank, said yesterday that it will liquidate a $12 billion enhanced cash fund after losses on holdings that included debt sold by SIVs.

The losses and investor confusion about the assets owned by SIVs led investors to shun all but the safest of government bonds, making it harder for funds to roll over maturing debt. SIVs set up by Dusseldorf, Germany-based lender IKB Deutsche Industriebank AG and Cheyne Capital (UK) LLP in London defaulted in October.

The amount of outstanding commercial paper backed by assets owned by SIVs and other companies shrank to a seasonally adjusted $801.2 billion for the week ended Dec. 5 from $1.2 trillion in August, Federal Reserve data show.

Paulson's Plan

``These vehicles continue to face two main problems: fallen market prices for the structured finance and other types of assets in their portfolios and a general drying up of funding options as investor sentiment has severely dampened demand for their liabilities,'' analysts at Standard & Poor's wrote in a Dec. 7 report.

Concerns that forced sales by SIVs would cause wider disruptions led Paulson to broker an agreement on Oct. 15 with Bank of America, New York-based Citigroup and JPMorgan Chase & Co., the biggest U.S. banks, to form an $80 billion ``SuperSIV.'' Paulson said he plans to have the so-called master liquidity enhancement conduit, or M-LEC, running by year-end.

The banks began marketing the SIV to smaller institutions last week, two people with knowledge of the plan said. New York- based BlackRock Inc. is managing the fund.

``Treasury has long said that market participants can and should continue to focus on proactively responding with a range of complementary market-based solutions,'' Treasury spokeswoman Jennifer Zuccarelli in Washington said.

Citigroup Assets

At least half of the 30 or so SIVs have yet to announce bailout plans. Even those that have been disclosed require approval from bondholders, including proposals by HSBC and Rabobank Groep NV.

``You can't say yet M-LEC isn't going to fly,'' said Tom Jenkins, a credit analyst at Royal Bank of Scotland Group Plc in London. ``SIVs are still a concern, and there are enough assets out there to fill M-LEC, even if it is looking increasingly heavily weighted towards Citigroup.''

Citigroup, the biggest manager, reduced the assets of its seven SIVs to $66 billion from $83 billion since September, according to an e-mail from spokesman Jon Diat. Six have redeemed capital notes, including Sedna Finance Corp., Beta Finance Corp. and Five Finance Corp.

The SIVs are funded until the second half of January and haven't decided whether to use the M-LEC fund because final details aren't available, Diat said. He declined to comment on potential restructurings.

Moody's Downgrades

SIV managers aren't waiting to find out. Moody's said Nov. 20 that it was considering downgrading $105 billion of SIVs in the biggest wave of potential rating cuts since mortgage defaults caused credit markets to slump in July. The New York-based ratings company said last week that it will give most of the SIVs until Dec. 19 after receiving information on ``wide-ranging remedial measures.''

S&P lowered the ratings on capital notes of 13 SIVs and placed the ratings of 18 others on ``negative'' outlook on Dec. 7. Orion Finance Corp., managed by asset manager Eiger Capital Ltd. in London, became the fourth SIV to enter ``enforcement mode,'' requiring the appointment of a trustee to protect senior debt holders.

SIV net asset values were 55 percent of capital on Nov.30, according to Moody's. Excluding the three SIVs then in enforcement, the average NAV was 66 percent, according to Henry Tabe, managing director at Moody's in London.

`Outsized' Investments

Citigroup's ``outsized'' investment in SIVs and collateralized debt obligations, bonds based on underlying assets, puts the biggest U.S. bank in a ``precarious position'' that may trigger a breakup or merger with a competitor such as JPMorgan, CreditSights Inc. in New York said in a Dec. 9 report.

Societe Generale SA, France's second-biggest bank by market value, said yesterday that it will bail out Premier Asset Collateralized Entity Ltd. The Paris-based bank will assume $4.3 billion of assets held by the SIV a week after S&P said the fund was close to breaching capital requirements.

Rabobank, the biggest Dutch mortgage lender, agreed Dec. 6 to take on 5.2 billion euros ($7.6 billion) from Tango Finance Ltd. Tango's net asset value, a measure of what would be left after selling holdings and repaying senior debt, fell to 69 percent from 88 percent in September, Moody's said.

``The more SIV-based paper that comes back on banks' balance sheets the better, as it leads to less forced selling pressure,'' Vivek Tawadey, a London-based credit analyst at BNP Paribas SA, the biggest French bank, said in an interview.

Broken Model

Devised by former Citigroup bankers Stephen Partridge-Hicks and Nicholas Sossidis in 1988, SIVs aim to profit by borrowing at least 10 times the initial funding provided by long-term capital or income noteholders. The money is invested in hundreds of securities from asset-backed debt with AAA credit ratings to bank bonds. Mortgage debt made up 23 percent of SIV assets, with most having no direct subprime link, Moody's said in July.

Capital noteholders, who are first in line for losses, received annual returns from 2 percentage points to 2.75 percentage points more than benchmark interbank rates, based on a Moody's survey in 2005.

SIVs profit by using top credit ratings to borrow at low short-term rates. The model had broken down by September when money market investors either stopped buying SIV debt or charged as much as 6.3 percent on 30-day asset-backed commercial paper, the highest rate in more than six years. SIVs were left paying more to borrow than they were earning, Moody's said in a report in September.

Bank Split

``The market is being divided into two camps,'' said Tawadey at BNP Paribas. ``We are seeing a polarization between the banks that have the strength to support their SIVs and take up some of the implicit obligations, and some of the U.S. institutions that are already facing other pressures, such as higher credit card delinquencies and subprime losses.''

London-based HSBC, the second-largest SIV manager after Citigroup, is organizing its own bailout by absorbing the $45 billion of assets in its Cullinan Finance Corp. and Asscher Finance Corp. Capital note investors will be offered the chance to exchange their debt for notes issued by new companies, bearing the risk of losses from those companies rather than the SIVs.

`Best Solution'

``Our plan is not meant as a criticism'' of Paulson's plan, HSBC spokesman Pierre Goad said in an interview from London. ``We simply believe it is the best solution at present because it deals with the SIVs in a comprehensive manner and provides certainty.''

WestLB AG, based in Dusseldorf, agreed last week to provide financing for its SIVs, called Harrier Finance Funding Ltd. and Kestrel Funding Plc, so they can repay their $13.3 billion of senior debt. HSH Nordbank AG in Hamburg restructured the $4.8 billion Carrera Capital Finance Ltd., eliminating the need to sell assets.

Armonk, New York-based MBIA, the largest bond insurer, shrank its $2 billion Hudson Thames Capital SIV to about $400 million by getting capital noteholders to purchase holdings of the SIV in proportion to their stake.

Standard Chartered Plc used the same process, known as vertical slicing, to slash its Whistlejacket Capital Ltd. SIV to $10.8 billion from $18.2 billion.

``This strategy leaves the capital note in a position to ride out the liquidity-tightened markets and wait to see if asset prices eventually rise,'' S&P said in its Dec. 7 report.

-- With reporting by Kevin Carmichael in Washington. Editor: Gavin Serkin, Andrew Reierson

To contact the reporter on this story: Neil Unmack in London at nunmack@bloomberg.net

Last Updated: December 11, 2007 14:07 EST