Wednesday, September 5, 2007

SIV's sieve

Simian immunodeficiency virus (SIV) is the strain of the virus that causes AIDS. SIV(structured-investment vehicle) is the "virus" affecting the credit market. Here's what you need to know.

SIV's are off-balance sheet items. They have problems because of their opaque nature and this "structured" finance, is off-balance sheet; the vehicle being established in the Cayman Islands for tax purposes, with US debt sold by a Delaware subsidiary. SIV's raise money by selling commercial paper, and investing in higher yielding or riskier assets, earning the spread, and paying the manager a big fee. You have 30 SIV's controlling $400 billion, and Moody's downgraded $14 billion of the bonds today. Why? Because the value of the collateral has dropped to 85 cents on the dollar, and those exposed to mortgages have dropped to 72 cents on the dollar.

Now when you hear how the commercial paper market has "seized up", understand that these vehicles use commercial paper for funding. What do they do now? They tap the banks with stand by letter of credits. Now the banks, already stuffed with mortgage and LBO loans, now have SIV exposure. Who started the spread of this virus? Enter the NY investment banks.

These investment banks, put some of these products together and sold it to the banks in Europe, so the investment banks clients, the hedge funds, could buy the inventory of the garbage these banks were peddling, by borrowing money at a cheap rate courteous of those European banks, who thought they were buying AAA paper with a higher yield. The hedge fund, who now had a cheap source of money, turned around and bought even higher yielding product from the investment bank who would pocket nice sized commissions, by selling his inventory of overpriced bonds to the hedge fund manager, who levered up these transactions, so he could make more overpriced fees. As long as the value of the asset, backing the SIV increased, it worked. Now that house prices have turned down, those SIV's with mortgage exposure are getting marked down across the board.

Now you know why it's called an SIV. It's a financial virus of exposure; and with fear pervading the bond desks, no one wants to partner in this daisy chain. They've gotten fiscal religion, and have turned off the financial porn channel to watching Hanna Montana on Disney.