Money Sage (archive)

Several weeks ago The Great Unwashed (including yours truly) were permitted a brief gaze into the inner sanctum of Treasury policymaking. The media conveyed to us the revelation that the Treasury was acting as the prime mover in a "plan" to prevent a SIV debacle. These bank-affiliated Structured Investment Vehicles (SIVs) were, as we are all now aware, essentially gigantic gambling casinos. They all made the same bet and, surprise, surprise, were confronted with a one-way market when the bet turned sour.

Unfortunately, the continuing health of our economy requires a robust banking system. Successful banks require skillful and prudent management. Turns out that top banking executives receiving 8 and 9 figure compensation packages were neither skilled nor prudent. These gentlemen placed the liquidity, and, ultimately, the very solvency of the insititions with whose care they were entrusted, in grave jeopardy. And that is where they remain today.

There are some smart people at the Treasury. They realized that the banks could not save themselves. Essentially, the banks gambled with a key portion of their capital and lost. There was no way to get rid of the bad loans, and the Treasury, we must infer, concluded that their losses were too great for them to eat. Since the banks could not save themselves, and since they must be saved, the Treasury determined to craft a rescue plan without providing any of the wherewithal. Certainly, we have no quarrel with the analysis. The problem, however, is that Treasury policymakers were satisfied to develop a "solution" which depended upon huge dollops of wishful thinking, and which counted upon a continuation of ineffably stupid behavior on the part of investors already smarting over gargantuan losses in mortgage-backed securities and in the securities issued by the speculators in mortgage-backeds.

We predicted at the very outset that the SUPER-SIV would not fly, that it would be DOA (Dead on Arrival). This is precisely what occurred. It is not that we are necessarily wise; we do, however, like to think our judgments are informed by a measure of prudence and realistic analysis.

With the SUPER-SIV concoction proven unsalable, the banks have been forced to take desperate action. Both UBS and Citigroup have taken the assets of their SIVs onto their balance sheets. This is a very euphemistic way of saying the following: frightened and angered lenders to the SIVs refused to renew their loans (ie, roll over the SIVs commercial paper). Since the SIVs would have been unable to pay their creditors, they would have been compelled to declare bankrupty, leading quite possibly to a fire-sale of their mortgage-backeds with dire consequences for the net capital, solvency, and survival of many of the principal banks of the United States and Europe. To avert this catastrophe, the banks are paying off the SIVs creditors themselves. In the case of Citigroup, media accounts suggest that this will cost Citi some $50-$60 billion. The "offset" to this is a portfolio of largely unsalable mortgage-backeds whose actual market value is crumbling by the hour, and is now probably only a modest portion of its par value.

Well, it sounds bad, but not that bad. We mean, moral hazard has now come home to roost, no? Citigroup and other wildly imprudent banks must now eat their immense losses. The media advise us that the consequences will be a dividend cut and a need to raise more capital.

It is upon closer examination that the starkness of the situation is brought home. The basic problem is that the banks who are now paying off the SIVs' creditors DO NOT HAVE THE MONEY TO MAKE THE PAYOFF AND STLL REMAIN IN BUSINESS. This reality is shrouded by euphemistic drivel about the need to cut dividends and "raise capital." It is kind of like saying that Joe Sixpack needs to find a relative to loan him a lot of money, but failing to note that if he is unable to get the loan he will not be able to continue providing food, shelter, clothing, heat, and gasoline for his family.

Therefore, the question with regard to the banks naturally arises: who will step into the breach? In an earlier post we had noted, on the occasion when Bank of America purchased a huge quantity of specially issued preferred stock of Countrywide, that "now that Bank of America has rescued Countrywide, who will rescue Bank of America?" The first part of the equation was a tad too optimistic, we fear. Looking at the price of Countrywide stock, and the $1 billion loss Bank of America has already sustained, it is rather debatable whether Countrywide has in fact been rescued.

Now that the SIVs have demonstrated that they are actually SIEVES, through which the core capital of the banking system has washed away, the question is more pressing: who will save the banks?

Well folks, the good news is that there are plenty of well-heeled potential "saviors" waiting in the wings. Problem is, they are a bit short on philanthropy. One "savior" -- the Abu Dhabi Investment Authority -- employed about 1% of its $800 billion of capital to purchase a special issue of Citigroup preferred stock paying a "junk" yield. Having duly noted this, we must also note that it is only a drop in ye olde bucket. We have no doubt that Citi will be saved, along with any other major bank facing a critical shortfall of capital. We are skeptical, however, whether private capital and foreign capital, even loaned at usurious rates, will prove sufficient. Uncle Sam, we think, will likely have to step into the breach, rendering either direct assistance or via guaranteeing Citigroup's borrowings.

In fact, it is our judgment that the BAILOUT is already underway. Thus far it is a very inadequate patchwork, but more substance will be added as necessity presses. To paraphrase Gertrude Stein: "A bailout is a bailout is a bailout" vehement denials to the contrary notwithsanding.

As for the FED, we believe that this remarkably inept institution will find market and political pressures for it to behave prudently ultimately irresistible.