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Hey, Buddy, Can You Spare a Dime for the SIV Superfund?
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By Editorial Staff
Fri, 07 Dec 2007 15:15:00 ET |
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$80 billion to $100 billion – those were the numbers bandied about when Treasury Secretary Hank Paulson and the heads of three major Wall Street banks first floated the idea of a "superfund" to save the banks' off-balance sheet entities, known as structured investment funds (SIVs), that include lots of subprime-backed securities. The problem for global banks with these SIVs whose total assets now equal about $400 billion? The SIVs are now largely illiquid thanks to the credit crunch.
However, as the weeks have dragged on, it looks like the banks won't be able to raise $80-$100 billion. The Wall Street Journal reports this week that the bankers are now shooting for a $50 billion superfund. Strange to see that Wall Street – which had no trouble raising money before the subprime mess and the ensuing credit crunch – is now scraping for "spare change." Bob Prechter foresees tough times for these banks – not to mention the economy. Here's an excerpt from his recent Theorist, in which he explains why the superfund is a good idea for a few people but a bad idea in general.
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The Big Bailout Bluff
"This time around, the banks hope to not only prevent credit problems from spreading but also are bailing themselves out." (Associated Press, 10/16/07)
This idea is the equivalent to trying to levitate yourself by pulling on your legs. These banks are going to offer more commercial paper to buy mortgage assets; in other words, they are going to borrow more short-term money in order to buy long-term assets from themselves! That is, if they can borrow the money in the first place. One of the casualties in the rout was the commercial paper market; investors are realizing that it backs a lot of lousy mortgage debt, so they are backing away from investing in the commercial paper that backs the mortgages.
The last time banks colluded to hold up an entire market was October 1929. It didn’t work.
If you have any exposure to illiquid mortgage investments, look upon this superfund as a gift. As soon as these banks pledge to buy one of your long-term, mortgage-backed securities, sell it to them.
What collateral will these banks use to back the $80 billion [Editor's note: now down to $50 billion] in commercial paper they hope to sell to finance this scheme? They can’t use mortgages, because the market doesn’t want them. As one article says, “Analysts say that investors have all but stopped buying SIV-affiliated commercial paper.” Will the new commercial paper become obligations of the banks? There appears to be no other alternative. In other words, depositors’ money may end up backing this paper. One thing seems certain: the banks are digging themselves deeper into a hole. If you still have deposits in debt-laden banks despite our entreaties, you might want to take this late opportunity to move them. For suggestions on where to deposit funds for safety, see Conquer the Crash.
On July 9, the CEO/Chairman of Citigroup said, “When the music stops, in terms of liquidity, things will be complicated.” Now wait a minute. We keep hearing that the Fed will shore up all their debts with perpetual liquidity, so how do you explain this comment? Answer: The bankers know better. Liquidity, formerly the solution, is now the problem, and the bankers know it.
The only solution that bankers, regulators, politicians and the Fed can think of is to do more of what they did to get into the problem in the first place: create more debt. They know of no other response. When the big bankers met via conference calls, “Besides hearing from senior executives from each of the big banks, the group also sought ideas from others.” In other words, they are flailing for a solution to a problem that has no solution aside from taking measures to make it worse. I still think there is no better analogy to a system-wide credit binge than a person who keeps going only by gulping down amphetamines. He will collapse if he stops taking them, but if he keeps taking them he will ultimately die. Bankers always choose to ingest more speed. Their choice is to collapse now or die later. They always choose later. But they cannot avoid the inevitable result.
Speaking of the inevitable result, Bloomberg reports that a mortgage fund managed by Cheyne Capital Management Ltd. has just announced that it will fail to pay the interest immediately due on the commercial paper it issued to buy mortgages. Here’s the problem: If it tried to pay the interest, it would have to sell assets to raise the money. If it were to sell assets in an illiquid market, they would fall in value, making the collateral in the fund worth less. I’ll bet this company can’t wait for that call from the managers of the new super fund, that is, if it owns any top-rated mortgages.
Can you see how exquisite the conundrum is for the “investors” who lent money to this firm? If they ask for their rightful interest, their principal will fall. If they don’t ask for interest, they have no income. If they can’t sell the assets, in truth they have no principal.
The emperor has no clothes, but so far the stock market floats merrily unconcerned in a haze of unprecedented optimism. Someday that optimism will melt as fast as it did in the mortgage market.
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