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Wednesday, December 05, 2007


SIV losses are coming

news today of fitch eradicating the junior instruments of one of citi's SIVs, sedna finance.

Citigroup Inc.'s Sedna Finance Corp. had $867 million of junior-ranking debt downgraded 12 levels to CCC by Fitch Ratings after declines in the structured investment vehicle's assets.

...Sedna's net asset value has fallen to 54 percent, eroding nearly all the protection the downgraded ``second priority senior'' notes gets from ranking above the lowest layer of debt, Fitch said in a statement today.

you can be sure that, with whole prime mortgage portfolios selling at unthinkable and even obscene discounts, the senior tranches of these same SIVs are worth nothing like they are being marked for the purposes of current accounting. with such marks coming fairly early in the game, you can zero out something like $100bn (for now) and more than $300bn (eventually) in underlying CDOs that stuff the SIVs and major bank balance sheets, which are virtually entirely backed by the most toxic mortgaged-backed securities -- indeed, the selling of which necessitated the widespread adoption of the CDO in the first place.

and all this when home prices haven't really started going down yet! what will this picture look like when home prices are down not 5% but 20% or 30% nationwide? when the number of mortgages with negative equity triples or quadruples from current levels?

the slowly-dawning truth of inevitable losses on the frozen asset-backed commercial paper issued by SIVs and conduits -- once thought to be as safe as treasury bills -- is sparking runs on government-managed funds in the states of florida, maine and montana among others states and municipalities. the depth of the problem is finding its way into the public consciousness for the first time -- from school district fund managers to politicians to the washington post (via housing wire), even in contravention to the bush administration's ever-more-unbelievably-unethical spinning.

It was Charles Mackay, the 19th-century Scottish journalist, who observed that men go mad in herds but only come to their senses one by one.

We are only at the beginning of the financial world coming to its senses after the bursting of the biggest credit bubble the world has seen. Everyone seems to acknowledge now that there will be lots of mortgage foreclosures and that house prices will fall nationally for the first time since the Great Depression. Some lenders and hedge funds have failed, while some banks have taken painful write-offs and fired executives. There's even a growing recognition that a recession is over the horizon.

But let me assure you, you ain't seen nothing, yet.

What's important to understand is that, contrary to what you heard from President Bush yesterday, this isn't just a mortgage or housing crisis.

...If all this sounds like a financial house of cards, that's because it is. And it is about to come crashing down, with serious consequences not only for banks and investors but for the economy as a whole.

That's not just my opinion. It's why banks are husbanding their cash and why the outstanding stock of bank loans and commercial paper is shrinking dramatically.

It is why Treasury officials are working overtime on schemes to stem the tide of mortgage foreclosures and provide a new vehicle to buy up CDO assets.

It's why state and federal budget officials are anticipating sharp decreases in tax revenue next year.

And it is why the Federal Reserve is now willing to toss aside concerns about inflation, the dollar and bailing out Wall Street, and move aggressively to cut interest rates and pump additional funds directly into the banking system.

This may not be 1929. But it's a good bet that it's way more serious than the junk bond crisis of 1987, the S&L crisis of 1990 or the bursting of the tech bubble in 2001.

it may not be 1929, surely. but on the other hand it may well be something very much like that -- or 1819, or 1873, or perhaps 1973 for that matter. and as the public grows ever more conscious of the validity of the comparison and what a massive debt unwinding awaits, the less measures like the proposed rate freeze or super-SIV will ultimately matter.

moreover, the super-SIV doesn't seem to be getting off the ground fast enough to prevent banks from having to take the whole kit onto their balance sheets, even as the most important tranches of RMBS are still receiving the forbearance of the ratings agencies. it increasingly appears that, if the super-SIV comes together, participation will not be widespread -- and i'm still baffled as to who would actually buy the underlying paper. (the treasury? and i'm only half-kidding.)

while the marks on these protfolios remain in a state of suspended animation and willful denial in spite of events like the e*trade portfolio sale, the forbearance can't last forever. fitch took a step closer in finally rerating sedna's junior tranches. someday soon, it will have to be the senior tranches, and in quantity. when it does, the administrating banks will be forced to take the stuff on balance sheet or simply allow the frozen construct to unwind into a firestorm and duped investors to take the losses in exchange for whatever liquidity they can get.

UPDATE: via calculated risk, it would appear the aversion of many banks to participation in the m-lec super-siv has reduced its probable size and participation. this is rapidly taking on the appearance of a failed proposal.

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