SIV= Imagine Enron, Bank Wide.

By
Real Estate Broker/Owner with Northern Virginia Homes - FRANKLY REAL ESTATE Inc

 First, a disclaimer. I am not a banker. I am not a financial advisor. I'm just a Realtor. Please ignore anything that I say.

Update 12-1-07: I want to make the concept of SIVs more clear.

 

 

 

Imagine this:

  1. Bank has $1 Billion making 5%
  2. Bank figures they can start a fake company (which is not reported to shareholders, and off all books) and "Lend" the fake company/subsidiary the $1B in order to buy riskier portfolios and sell them for 8%, but with a "this is backed by an A grade company."
  3. Newly added 12-5-07 bank lever the business 14 to 1. 
  4. Pocket the 3%, and that makes them $30 Million a year (levered at $420M?)
  5. DO it with $10Billion and they make $300 Million (levered at $4.2 Billion?)
  6. Bank gets RICH.
  7. Do you get that? The buyers of the 8% notes get Grade A security (normally paying 5%) because it is "guaranteed" by a Grade A bank (somehow the name of the bank isn't shown publically).
  8. Bank never thought "what if these 8% securities go down and we have to back them up with cash"
  9. Then the 8% money becomes worth 2%. Bank has to bail them out...
  10. Everything crumbled like a house of cards.
  11. Then $10 Billion is wiped out.
  12. If it was levered 14 to 1. That is $140 Billion
  13. But it doesn't stop at $140 Billion since NOBODY KNOWS SINCE IT LEGALLY IS OFF THE BOOKS!

 Moody's estimate there are $400 Billion in SIVs, but it could be more since they are off the books. The Savings and Loan crisis was $150 Billion.

Have you ever heard of a SIV? You will soon. Just imagine Enron practices, and apply them to most major banks. (see WSJ article)

After a scary lunch with a bank friend of mine, I actually looked into buying Gold (see the the new GLD, basically gold, but in the form of an easy to buy "tracking stock" or EFT, kinda like the US dollar 35 years ago which was backed by gold).

So, now I'm doing research to better understand this stuff through other sources. I figured rather than keep all of this information to myself, I would share it, and maybe together we can get our virtual hands around it.

A SIV is a Structured Investment Vehicle (see Wiki definition).  Here comes the important Enron part: they are kept OFF BALANCE SHEET. Through some legal trickery, ala Enron, they can keep these subcompanies (funds) off of their balance sheets, so nobody really knows how much loss, or gains, or exposure these b anks have. And in the world of leverage, your dozens of Billions of dollars can vanish overnight.

Have you heard of the Super Fund SIV bailout proposal? Reading from a few blog and articles, it is essentially banks bailing each other out, and finding a way to profit from it. But essentially it is moving money from a smaller shirt pocket to a larger pant pocket.

Individuals might think that they are fine and the government can bail them out? FDIC insured right? Technically maybe, but if the US just prints more money to make up for it, there are international ramifications. We can't do things in a vacuum. The US is not the world. The dollar can collapse against foreign currencies, just like Mexico's currency collapsed in 1994.

Also let's stop blaming the press. We blamed them when everything was skyrocketing, accusing them of wanting to sell advertising to builders. Otherwise, if this collapse occurs, we will blame the press for not telling us about it. Also to say that the press causes fear, and fear causes collapse is absurb. Banks doing Enron-type off banks trickery is the cause, not the press that expose them. If anything the press makes things pop FASTER, and thus making for a LESS severe fall.

I know it sounds like doomsday stuff. I was born to Cuban parents that had everything taken away, so I hear these things and I know they can happen. The question is how likely is it? Under 1% 10%? Under .00001

Or as Lawrence Yun put it "Close to Zero" (regarding the chances of the DC market going down after 2005) 

This stuff could be REALLY bad.

- Written by Frank Borges LL0SA- Virginia Broker FranklyRealty.com

Related stuff to read:  http://activerain.com/blogsview/252212/Peter-Schiff-Was-Exactly

and CNN's The next credit scandal

CNBC 14 to 1 Leveraged

 

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Show All Comments
Rainer
78,048
Vicky Poe
Good Ole Rocky Top - Crossville, TN
Realtor/ Auctioneer
Isn't moving money from a smaller shirt pocket to a larger pant pocket "kiting"?  And that is illegal.
November 30, 2007 07:19 PM #2
Rainer
78,048
Vicky Poe
Good Ole Rocky Top - Crossville, TN
Realtor/ Auctioneer
I like your picture.  It is not the typical head shot.
November 30, 2007 07:20 PM #3
Rainmaker
138,632
Paige Rausch
Boback Commercial Group - Fort Myers, FL

 

Frank ....the key part of the whole post is this phrase: OFF-BALANCE SHEET ENTRIES. Do me a favor and read this, and let me know if it helps explain it.

Paige Rausch

paigerausch@earthlink.net 

Companies have used off-balance-sheet entities responsibly and irresponsibly for some time. These separate legal entities were permissible under generally accepted accounting principles (GAAP) and tax laws so that companies could finance business ventures by transferring the risk of these ventures from the parent to the off-balance-sheet subsidiary. This was also helpful to investors who did not want to invest in these other ventures.

Since the Enron scandal, however, companies that have any kind of off-balance-sheet items, whether justifiably or not, are being branded with a scarlet letter "E". This article will define some typical off-balance-sheet items and discuss whether they are "good" or "bad".

The term "off-balance-sheet" can refer to many things. Typically, it refers to separate legal entities (separate companies of which the parent holds less than 100% ownership) or contingent liabilities such as letters of credit or loans to separate legal entities that are guaranteed by the parent. GAAP allows these items to be excluded from the parent's financial statements but usually they must be described in footnotes. <!--[if !supportLineBreakNewLine]--> <!--[endif]-->

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The Good
Off-balance-sheet companies were created to help finance new ventures. Theoretically, these separate companies were used to transfer the risk of the new venture from the parent to the separate company. This way, the parent could finance the new venture without diluting existing shareholders or adding to the parent's debt burden. These separate legal entities could be privately held partnerships or publicly traded spin-offs.

Sometimes the separate companies were created to pursue a business project that was a part of the parent's main line of business. For example, oil-drilling companies established off-balance-sheet subsidiaries as a way to finance oil exploration projects. These subsidiaries were jointly funded by the parent and outside investors who were willing to take the exploration risk. The parent company could have sold shares or borrowed the money directly, but the accounting and tax laws were designed to allow the project funding come from investors who were interested in investing in specific explorations rather than investing in the parent company.

Other times these separate companies were created to house businesses that were decidedly different from the parent's line of work (in order to unlock "value"). For example, Williams Co's, created Williams Communications to pursue the communications business. Williams Companies spun off Williams Communications, but the bankers required the parent to guarantee the debt of Williams Communications. Because Williams Communications was a new company, this is not an unusual request.

This use of off-balance-sheet entities is good in that it transfers risk from the parent's shareholders to others that were willing to take the business risk. Investors in Williams Companies (an energy resource company) may not have wanted to invest in a communications company, so management created a separate entity to house that business. Likewise, oil companies used off-balance-sheet entities to remove the exploration risk from their business to share it with others that wanted a bigger piece of the potential return from exploration.

The Bad
While GAAP and tax laws allow off-balance-sheet entities for valid reasons noted above, bad things happen when economic reality differs significantly from the assumptions that were used to justify the off-balance-sheet entity. Problems also occur when egos get too big.

In Williams's case, the decision to spin off the communications business was reasonable at the time. The parent had the infrastructure on which to build a communications network, but it was an energy company. By spinning off the subsidiary, it was not forcing its investors to take on the risk of a communications company, and it was able to take advantage of the market's demand for communication stocks. At the same time, the need to guarantee the debt of a new subsidiary is a reasonable request that bankers make in this type of transaction.

What went "wrong" was that economic reality differed from the assumptions that were used to justify the spin off. Dotcom mania resulted in over-capacity, causing problems for all telecommunications companies. The loan guarantee, which is never expected to be triggered, is now an issue for the company because of the recession and the slump in the telecommunications sector.

Enron exemplifies how ego can be the basis for the misuse of off-balance-sheet items. Here, off-balance-sheet vehicles appear to have been used to pump up financial results rather than for legitimate business purposes. What started as a plan to legitimately use off-balance-sheet vehicles morphed into ways to manufacture earnings as trades went bad. While one could argue that this is also a case of economic reality differing from expectations, the way management reacted to the situation allows us to classify it as an ego thing.

This financial engineering is usually fueled by the need to reach certain operating targets established by Wall Street or compensation plans. Once management succumbs to this "Dark Side", more time is spent on trying to game the system than trying to manage the core business. It is then only a matter of time before the house of cards falls.

November 30, 2007 07:38 PM #4
Rainmaker
136,063
FRANK LL0SA Esq.- Northern Virginia Broker .:. FranklyRealty.com
Northern Virginia Homes - FRANKLY REAL ESTATE Inc - Arlington, VA

Vicky,

That is my entire point. I hope you read Paige's post. The entire problem is this:

1) The idea of starting another company off books is fine

2) But couple that with an asterick, where the new company is 100% secured/backed by the parent bank in case of default (which people just assumed would never happen)

3) When the new company goes under, and the bank backing it never expected to be called out on it... everything goes to sh*t.

November 30, 2007 11:32 PM #5
Rainmaker
136,063
FRANK LL0SA Esq.- Northern Virginia Broker .:. FranklyRealty.com
Northern Virginia Homes - FRANKLY REAL ESTATE Inc - Arlington, VA

Hey Karen,

I didn't coin the phrase that put Enron and Banks as being the same. This stuff is out there, you just have to look for it. 

November 30, 2007 11:37 PM #6
Rainmaker
129,089
Kevin McGrath
Long & Foster Real Estate Companies- Fredericksburg/Spotsylvania - Fredericksburg, VA
Long & Foster Real Estate Companies
Very interesting - I had not heard about this. Also - you post about blaming the press made me think. I am guilty of that, and maybe I need to come at that from a different angle. Good job of making something pretty confusing sound fairly clear.
December 01, 2007 06:40 AM #7
Rainmaker
136,063
FRANK LL0SA Esq.- Northern Virginia Broker .:. FranklyRealty.com
Northern Virginia Homes - FRANKLY REAL ESTATE Inc - Arlington, VA
I just updated my blog post for a ten steps to descruction break down to make it all a little easier.
December 01, 2007 09:00 PM #8
Rainmaker
340,180
Eric Reid
Renaissance Realty Group of Keller Williams Atlanta Partners - Lawrenceville, GA

Travel outside the US I have seen the value of our dollar fall to laughable levels and yet at home in the us we keep calling ourself a super power .. I don't think that relates to dollar superpower

December 02, 2007 08:19 AM #9
Rainmaker
630,864
Brian Block
RE/MAX Allegiance, Managing Broker/Branch Vice President - McLean, VA
Northern Virginia & D.C. Real Estate
Frank, an interesting piece and food for thought, for sure.  Of course there are fears that this type of activity could lead to an Enron type disaster, or a bailout akin to the S&L debacle of the 80s.  Speaking of S&L crisis, some of those lawsuits are still going on.  For 2 years, I worked at a law firm representing major banks and thrifts still suing the Feds over the handling of the S&L meltdown.  Thanks for the information on the SIVs -- I'll have to explore your links further.
December 02, 2007 11:46 AM #10
Rainmaker
136,063
FRANK LL0SA Esq.- Northern Virginia Broker .:. FranklyRealty.com
Northern Virginia Homes - FRANKLY REAL ESTATE Inc - Arlington, VA

Thanks Brian,

The problem is, it might not be able to simply be a US bail out. SIVs are leveraged in a way, and in such unknown amounts that they could be large enough to collapse the dollar. If the US bails out, all that means is printing money. Our dollar is being kept up artificially. If the dollar gets devalued by 30-70%, the bailout will be nothing compared to a dollar collapse. Sounds crazy, but how crazy is it that ENRON isn't bad enough, but possibly EVERY LARGE BANK has their own Enron.

Enron lost $60 Billion in value.

The S&L bailout was $150Billion.

Moody's estimates the exposure being as large as  $400 Billion

When you leverage to make money, it can be wiped out overnight.

December 02, 2007 12:07 PM #11
Rainmaker
136,063
FRANK LL0SA Esq.- Northern Virginia Broker .:. FranklyRealty.com
Northern Virginia Homes - FRANKLY REAL ESTATE Inc - Arlington, VA
I just added to the blog, that these vehicles are levered 14 to 1.
December 05, 2007 02:42 PM #12
Anonymous
Anonymous
Tom McCammon
What is particularly troubling about SIVs is that many large money market mutual funds (UBS, Schwab and Mogran Stanley among others you have heard of) have some sigificant SIV exposure.  Even at exposure levels of 1-3% of assets under mangement in the funds, MMMFs could "break the buck" if SIVs fail, or even they just suffer asset devaluation.  Just a few months ago BofA, Chase and Citi formed a superfund to repurchase some of these assets in an effort to prop up the asset values, but in the past week or so even that fund appears to be in trouble as potential investors have been hesitant to invest in it, if not avioding it altogether.  It hasn't been decided yet what, if anything, regulators are going to do with regards to this situation, but if assets continue to get downgraded by ratings agencies we would likely see more and more losses stemming from these vehicles, which would force the hand of regulators  to intervene.  That said, there is part of me that is getting the growing suspicion that some banks actually want these funds to fall in value so they can dump them on the way down to an artifical low and then pick them up at pennies on the dollar and ride the wave upward as the true value, net of hysteria pricing, manifests itself.  Then again, it could be a real problem.  Anyone have a crystal ball? 
December 11, 2007 10:08 AM #13
Rainmaker
136,063
FRANK LL0SA Esq.- Northern Virginia Broker .:. FranklyRealty.com
Northern Virginia Homes - FRANKLY REAL ESTATE Inc - Arlington, VA

did you all see the $50BILLION dollar bail out of SIVS??

http://online.wsj.com/article/SB119759010104328237.html?mod=hps_us_whats_news

December 13, 2007 10:18 PM #14
Rainer
77,666
Jeffrey Dolfinger
24/7 Realty Inc. - Poughkeepsie, NY
NRBA Member

This blog troubles me, its is correct but SIV's have the right to do swaps, essentially trading out bad assets for good ones even assets of other markets, i.e auto loans, credit cards etc. to keep the yield up above grade.  I spent alot of time running a private equity group and buying ABS especially RMBS is normal course for most major investment houses. 

The assets purchased are stratified into pools that have a yield.  Investors are sold a yield and the bank or fund makes the spread.  These investments are usually packaged as CMO (Collateralized Mortgage Obligations)or ABS (Asset Backed Securites, more than just mortgages)  and are placed into trusts.  The trusts have limited functions and authorites, swaps are usually one of the authorities. 

So why not swap?  Would you swap your good loans for bad one's then report those bad ones on your balance sheets therefore increasing your cash reserve requirements?  I think not.

The biggest investors for the banks were hedge funds.  The hedge funds used to buy the pools from traders at trading desks.  This was the secondary market.  The hedge funds have stopped buying and are no longer buying anything subprime.  Hence the collapse of the secondary market financing.  The banks have to keep cash to stay liquid under federal regs so more cash is taken away from lending.  Tighter lending requirements.

The same hedge funds that used to buy subprime, now buy what is termed scratch and dent or npm's (non performing mortgages) only now they do not buy them from the traders but go bank direct.  Why not traders?  Because the banks got greedy and opened their own in house trading desks in an attempt to cut wall street out.  The traders created the markets and kept things moving.  Without the traders the banks were now investing in their own partially funded SIV's consiting of CMO/ABS or CDO (Collatereralized Debt Obligations, 1st's, 2nd's 3rd's, other equipment) to fully fund the trust or SIV

The banks are now selling their bad paper to the same hedge funds that bought the subprime paper with guaranteed rates of return, a double whammy to the banks.  in my opinion the banks did this to themselves.

Will there be a bank bailout?  No but there may be acquisitions or mergers. 

December 13, 2007 11:37 PM #15
Rainmaker
136,063
FRANK LL0SA Esq.- Northern Virginia Broker .:. FranklyRealty.com
Northern Virginia Homes - FRANKLY REAL ESTATE Inc - Arlington, VA

Hey EJ,

I'm all for being corrected, but based on what you said, I didn't follow it.

1) Are you saying I am wrong somewhere?

2) Are you saying Off Balance Sheet Accounting is good and won't result in a collapse of the markets?

Tom? Your thoughts?

December 14, 2007 12:33 AM #16
Rainer
77,666
Jeffrey Dolfinger
24/7 Realty Inc. - Poughkeepsie, NY
NRBA Member

Not wrong just not complete.  Off balance sheet is okay if you understand the dynamics of the trusts and investments. 

December 14, 2007 12:39 AM #17
Rainmaker
136,063
FRANK LL0SA Esq.- Northern Virginia Broker .:. FranklyRealty.com
Northern Virginia Homes - FRANKLY REAL ESTATE Inc - Arlington, VA

Well it happened.

September 21, 2008 10:52 PM #18
Anonymous
Anonymous
Tom McCammon

"Will there be a bank bailout?  No but there may be acquisitions or mergers"

HAHA.  EJ drank the Kool Aid.   

October 11, 2008 06:48 AM #19
Anonymous
Anonymous
Anonymous

Tom:

Not one bank, if you even understand the strict definatition of bank, has been bailed out.  The banks have been taken over by the FDIC not bailed out!  Investment firms are getting bailed out, banks are merging like i said.  At least I understand the Kool Aid I drink!  Investment class 101, whats the difference between a bank, s&l, thirft, credit union, or bank holding company.  I guarantee you have no idea who regulates each without looking it up. 

October 11, 2008 10:24 AM #20
Anonymous
Anonymous
UrbanFlight

He who has no name:

You pedantic d-bag. In light of this mess and the fact that we are in fact bailing out wall street and printing imaginary money at break-neck pace to get it done, does it really matter what the "strict" definition of bank is?

 

 

November 17, 2008 01:58 PM #21
Anonymous
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Rainmaker
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FRANK LL0SA Esq.- Northern Virginia Broker .:. FranklyRealty.com

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