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Monday, November 12, 2007


new life for the super-siv?

the nyt is reporting so, against previous suspicions.

but the key question: does it matter? on this, there is a lot of skepticism -- which is of course not new.

It doesn't sound bad with assets "fetching between 97 cents and 98 cents on the dollar", however, because of leverage, this puts the SIVs right on the threshold of a possible enforcement event.

As noted in my earlier SIV post, Fitch rated SIVs average 14 times leverage. So, if an SIV had $1 Billion in capital, and an additional $14 Billion in leverage (mostly from selling commercial paper and medium-term notes), the SIV would hold $15 Billion in assets. If the typical asset was "fetching between 97 cents and 98 cents on the dollar", that would be a loss of $300M to $450M, or a loss of 30% to 45% of capital (from the $1 Billion) giving a NAV of 55% (97 cents on the dollar) to 70% (98 cents on the dollar).

According to Fitch, if the NAV for an SIV falls below 50%, then the fund might face an enforcement event, and it might have to be liquidated. Once the assets of one fund were liquidated - say at 96 cents on the dollar - that would mean the NAVs for other SIVs would probably fall below 50% - and they might also have to be liquidated, further depressing prices.

the greatest part of the difficulty therein is that the most important tranches of rmbs have not yet been downgraded. they're getting exceptional deference from the ratings agencies, and so therefore are the cdo's and investment banks that own them.

Further writedowns or downgrades of derivatives could lead to a deterioration in Tier 1 capital, especially if one takes into consideration that despite the many downgrades of 2006 CDOs for instance, none of the AAA rated paper has been downgraded yet. While 92% of 2006 vintage RMBS backed by 1st lien subprime mortgages have been downgraded by Moody’s already, only 13% of the total value has been, and none of the AA and AAA grades have been downgraded yet.

this is why writedowns to date are so small ($25bn) in comparison to the true likely depth of the problem ($400-500bn). when these are finally called to downgrade, perhaps the largest wave of bank problems will materialize -- that is, the forced writedowns of level 3 assets that threaten the solvency of some of wall street's stalwarts. meredith whitney thinks it will come to a head in 4q2007 -- that is, imminently. already some of the riskiest siv's have defaulted. but many more are probably coming regardless of m-lec, as unwinds similar to the kind beginning in cdo's snowball.

beyond that, there is a serious unanswered question which is becoming particularly relevant as the reformulated super-siv will apparently not be restricted to purchasing the best-quality siv assets (an unsurprising change, as doing so negates the purpose of the bailout). and that question is this: who in the hell is going to buy into this thing? if no one wants to buy the old siv, why on earth would they buy the new siv?

this is a critical point which gets to the heart of wall street's wishcasting over this affair. many in the investment banking community clearly think the market is mispricing these assets, and that if they can wait it out they will be able to liquidate at much better prices. indeed, the purpose of the super-siv is essentially just to slow down the liquidation spiral -- treasury secretary paulson will tell you so directly.

the problem with that plan, as i see it, is that the market is not mispricing these securities -- which is to say that desperate wall street leadership, not the marketplace, is wrong. waiting is likely only to further impair the value of siv securities as house prices continue to drop, mortgage default rates continue to increase, and credit problems likely spread to other siv receivables such as auto loans and credit cards as recession takes hold.

and, to judge from the freeze in abcp, most market participants suspect as much. so where will the capital come from? a government agency?

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