Aug 30 2007
“Eforcement Events” at Strectched Funds Lead to “Firesales”
Bad news this a.m. as analysts at Royal Bank of Scotland estimate that forced asset sales from two struggling SIVs and four troubled SIV-lites mean assets with a face value of up to $43bn worth are at risk of flooding on to the markets, according the the Financial Times. Such ongoing fresh news is one reason why the markets are continuing with volatility.
SIV and SIV-lites are structured investment vehicles are essentially an investment company structure often (though not always) used by banks that falls under the CDO category, which generates investment returns by playing yield curve arbitrage, primarily with high grade (AAA, AA) debt on the mid and longer term, while financing themselves with low cost short term senior debt, usually via the asset backed commercial paper (ABCP) market. Typically they are leveraged at 10 to 15 times. Many have invested heavily in the Mortgaged Backed Security (MBS) market, which is at the epicenter of the recent lock up, with many MBSs having an extremely tight market given the carnage from the U.S. housing bubble and mortgage default crisis is still unfolding.
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With the lock up in the short term money market, this primary source of funding is no longer forthcoming, adding substantial pressure to SIVs. Add to that the pressure of ratings downgrades due to their reliance on falling MBSs, and suddenly their backup liquidity from banks lines of credit vanish… and your int the mess we now have, where few dare to invest into SIVs when so little is known about what they hold.
The most recent vehicle to hit trouble was Cheyne Finance, an SIV with assets with a face value of roughly £6bn run by Cheyne Capital Management, a London-based hedge fund. The firm said this week its SIV had hit an “enforcement event”, which is rating agency jargon for having to sell assets in order to pay back debt. [FT 8-29-2007]
The problem SIVs face is that they are governed by tight rules that demand adjustments to the portfolios in the event of fresh risk or negative valuation issues. And so, when one begins to have issues with MBSs, they are jettisoned into the market to generate liquidity — a problem that then reverberates throughout the SIV marketplace, and causes other risk balancing fallout among other hedge fund related strategies. All of this then trickles into the general equities and credit markets as credit tightens and otherwise unrelated securities are sold to balance risk requirements and meet margin calls thanks to overzealous use of leverage.
So much for the risk dispersion miracle of modern finance, which everyone from Greenspan and Bernanke on down through to Wall Street risk apologist told us washed away our need to worry about old fashioned prudence regarding debt loads and money supply manipulation. In only a few weeks, we learn economic gravity still applies. Unfortunately there are so many other issues related to the credit bubble and beyond that will pound that lesson home time and again.
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