Are we seeing SIVs with new clothes?

Wednesday, October 15, 2008 | posted by RedApple
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So Banks used to make a lot of money by packaging "worthless" assets into a "special purpose vehicle" and funding it with short term money. As long as it is rated AAA, it will get funded easily (at least they hoped).... Anyway, that's the old story. Now, let's think what we are seeing now. All the governments in the world are buying 1. banks preferred shares 2. distressed mortgages 3. single companies CDs and 4. other "assets". They are going to fund it with Treasury bills. and so far they are still rated AAA. Do you guys see the same parallel with the exception we are hopefully not creating a new "Govt-backed SIV" every week and these funds are not planned to be tranche-ed out so each countries' tax-payers will hold the same slice (rather than from different credit tranche). The tax-payers of the world are playing the biggest carry game without them knowing at the moment.

My early thoughts are there can be 2 outcomes:

1. the asset value holds or goes up -> reduce Treasury funding needs. -> carry is King!

2. the asset value diminishes -> while the rating agency may question the credit quality of this special SIV, the overall country credit rating will depends on the economic cycle. -> say we hit recession/depression -> then we will hit the triple whammy, asset value down + credit rating in question + currency downfall. -> interest rate will go up massively to cover the debt and credit drop -> further hits recession and depression.... carry blows the bubble again.

A friend of mine wrote to me:


The key issue is did we avoid a complete run on the bank? So far, yes. As we enter into recession, will we continue to trust the banking system? My guess is yes. I think we are in for a deep recession. It will be painful, with unemployment maybe even doubling, real estate continuing to go down for another couple of years, lending limited, etc. But, savings will go up, and they’ll go into the banking system. OPEC countries will be screwed as oil continues to hover lower and their spending habits catch up with them. Asia will be the big winner. It will continue the biggest wealth transfer in history from west to east. Asia doesn’t need us as much as we need them.

I’m not happy about any of the plans. The govn’t as buyer seems to me like they’ll have to distribute down the line. If all goes well, govn’t will unload overvalued securities to investors (tax payers). If all goes poorly, govn’t will be screwed. But at least it helps us avoid immediate ruin."

My response was:

"Run on bank is a different issue to what I am trying to point out- ie G7's are saving the banks/SIV with bigger sovereign SIV, in other words moving from what deemed to be AAA to what is still AAA (but for how long). Basically, possible runs on bank (BTW if one makes a run at a bank now, this person is now implicitly putting no faith in his Govt (for example in US, we have the new FDIC guarantees. Other countries have similar guarantees). Recession and other negative events you have pointed out will eventually hurt the asset valuation of these SIV, therefore will lead to downgrade of Govt credit. Our Govt is as good as its taxpayers' future income. And in the end, if credits of these Govts go down, there will be a run on the currencies and therefore the banks (re Iceland ). Only Asia and Japan seems to come out of this without bailing out with a sovereign SIV... But in the long run, we are just using a different wrapper to lengthen this SIV game. The "best thing" is that you don't need to have a secondary market to transfer risk of this new SIV, since every taxpayer already owns a piece of it. "