Wednesday, November 28, 2007

Watch out for the oncoming SIV not the SUV

Last week I brought to your attention the potential problems with Special Investment Vehicles (SIV). These investments are not currently on the balance sheets of the banks or investment banks. The result of this off balance sheet financing is that nobody knows for sure how much is out there. I thought it might be important to get some information to you so as more and more information comes out about SIV you are knowledgeable. I have collected information from several sources about SIV to give you diverse background.

Offshore Companies

SIVs are typically offshore companies created by banks and other firms to sell short-term debt to buy mortgage securities and finance company bonds with higher yields. They profit on the spread between the two.

Banks such as New York-based Citigroup, which manages $83 billion in SIVs, collect fees for running SIVs while keeping their contents off the bank's books. SIVs finance themselves by selling asset-backed commercial paper, or short-term loans backed by collateral such as mortgages.

When the subprime debt market blew up in August, investors stopped buying SIV commercial paper. As a result, in September and October, SIVs didn't have the cash to pay debt holders of more than $8 billion of their paper.

The banks had also peddled SIV paper to their clients, including state officials who oversee pools of taxpayer funds like Florida's. The $27 billion Florida pool, the largest in the U.S., has invested $2 billion in SIVs and other subprime-tainted debt, state records show. About $725 million of these holdings have already defaulted.

Yesterday, Governor Charles Crist held a public meeting disclosing that 4 percent of the state's short-term investments, including those in the state pool, had been downgraded by credit rating companies.

`Would be Devastated'

State pool losses may hit taxpayers in places like Jefferson County in the form of reduced services or higher taxes.

Jefferson County's Wilson says he still trusts the Florida pool managers and will keep the school's money in the fund. ``I really hope this isn't any worse than we know today,'' he said after the Nov. 14 meeting. ``If something happened to that investment, our county would be devastated.''

State officials have no business putting taxpayer money into debt investments that have baffled even the most seasoned Wall Street executives, says Joseph Mason, finance professor at Drexel University in Philadelphia and a former economist at the U.S. Treasury Department.

Municipalities shouldn't be playing like they're expert investors, squeezing the last penny out of SIVs,'' Mason says. ``They're making a giant jump into a new product area which has unknown, unforeseen risks.''

Cheyne Default

Thousands of school, fire, water and other local districts across the U.S. keep their cash in state- and county-run pools. These public accounts, modeled after private money market funds, are supposed to invest in safe, liquid, short-term debt such as U.S. Treasuries and certificates of deposit.

All told, there were about 100 such pools, containing more than $200 billion at the end of 2006, according to Westborough, Massachusetts-based iMoneyNet, a research firm that tracks these funds.

Public fund managers say they've bought SIV debt because it had the safest credit ratings and offered higher yields than other short-term fixed-income investments.

SIVs, many of which are assembled by London-based bankers, had a low profile until some of them collapsed. The $7 billion Cheyne Finance SIV, incorporated in Delaware, defaulted on Oct. 17.

`High-Risk Investments'

Among the places caught up in the SIV and subprime snarls are Connecticut, Florida, Maine, Montana and King County, Washington. Public funds hold $1 billion of defaulted asset- backed commercial paper, including $273.5 million from SIVs. Montana entrusted $465 million, or 19 percent of its $2.5 billion investment pool, to SIVs.

Someone once said that"if it sounds to good to be true then it must be." As people shopped for yield they didn't ask the question, "What are they doing with my money to get a higher return?" When thing went bad we always hear the same statement, "Nobody told me the risk I was taking."

Dan Perkins

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