Structured Investment Vehicles’ Role in Crisis
August 13th, 2007This is the most frightening financial story I’ve come across in a long time.
Hundreds of billions of dollars worth of what, exactly? Nobody seems to know. Well, somebody probably knows, but investors, the financial press and government regulators have no idea WTF is going on. Yep. Situation normal. You know the rest.
There is one sentence in the piece below that really stood out in my mind:
“No investors are sure exactly what assets SIVs and conduits are holding, or how damaged those holdings might be.”
Becky and I have no stock, bond or mutual fund holdings. (As you know, we are holding, cash, guns, gold, beer, cows, goats, open pollinated seeds, etc.) But I know that many of you could get hit by this, and sooner, rather than later—uh, today and Wednesday, actually, according to the article. Because whatever this toxic waste nonsense ponzi scheme crap is, lots of it needs to be refinanced now. Whether or not there’s enough funny money out there to do it is the big question at the moment.
But just wait until you get to the part about faith. Yes, friends, faith. And, no, we’re not talking snake handlers at a down home Pentecostal revival meeting.
Via: Financial Times:
Policymakers and investors have been obsessed in recent years about the potential for a hedge fund collapse to spread financial panic. But it seems one of the biggest threats to stability is coming from the age-old risk of short-term borrowing to fund investments in illiquid long-term products.
In a corner of the market few people knew existed, regulators are scrambling to understand what is happening in structured investment vehicles (SIVs), a breed of often huge, mainly bank-run, programmes deÂsigned to profit from the difference between short-term borrowing rates and longer-term returns from structured product investments.
These have proliferated in recent years and control assets worth hundreds of billions of dollars. Depending on whether they are fully rated by credit rating agencies and on how strictly they have to conform to certain rules, they are known as SIVs, SIV-lites, or conduits.
They are typically quite opaque, invest in complex securities and often do not need to be displayed on a bank’s balance sheet.
It seems they have played a key role in last week’s liquidity crunch.
“We are in the middle of a mini-crisis in the commercial paper market, at least half of which is related to the SIV conduits,†says Robert McAdie, global head of credit strategy at Barclays.
These programmes typically invest in credit market instruments, such as US subprime mortgage-backed bonds and collateralised debt obligations. These assets tend to be the highly rated, supposedly safe versions of such debt, but in the recent fear-driven turmoil have shown just how illiquid and hard to value they can be.
The profit for those who run such programmes comes from the fact that the assets pay fairly high yields, while the conduits and SIVs fund their purchases with short-term borrowings in which interest and principal payments are backed by financial assets that are deemed to have stable cash flow. Collectively this so-called “asset-backed commercial paper†– or ABCP – lasts for anything between a few days and a few months before needing to be refunded.
The problem could be thrown into relief when billions of dollars of ABCP mature today and on Wednesday, with great unÂcertainty as to whether this can be refinanced.
Everything in this market depends on investors in the ABCP market maintaining their faith in the programmes and the assets they hold. With the current rush for the exits in many structured credit markets, this faith has been evaporating wholesale. No investors are sure exactly what assets SIVs and conduits are holding, or how damaged those holdings might be.
Research Credit: GP
