Nightmare scenario for SIVs(ZT)

(excerpted from latest edition of forcastglobaleconomy) Sincethe financial panic of late summer SIVs have been shut out of thecommercial paper markets. In coming months SIVs need to roll over about100 billion dollar maturing commercial papers. With no means toraise new money to redeem the maturing commercial papers SIVs will beforced to sell their holdings of risky mortgage backed securities. Suchfire sales will depress already depressed prices of those riskysecurities further. At the end many SIVs will not be able to raiseenough money to redeem their maturing commercial papers and will gointo bankruptcy, and many money market funds holding their commercialpapers will suffer substantial losses. Money market fundsare touted as the super safe way to save with a decent return to theirdepositors. As the news of the losses suffered by money market fundsspreads, depositors will withdraw their deposits and transfer them intosuper-super safe funds specialized only in short-term US treasuries. Thetainted money market funds will be forced to liquidate all commercialpapers at hand, even those not tainted by mortgage backed securities,in order to satisfy the massive withdraws by their depositors. Thebusinesses not related to any mortgages will also be denied borrowingin the commercial paper markets as those markets stop functioning,whereas the yields of short-term US treasuries will plunge, wideningthe interest spread to an amazing level. On the other hand thecollapse of the prices of those tainted securities due to the firesales of SIVs will also hit large financial entities even though theyare not legally obliged to shoulder the losses of SIVs that theyfounded. Before Oct. 15, large US financial entities havealready announced the write-downs of risky securities carried on theirbalance sheets. The aggregated amount of write-downs add up to about 20billion dollars. With the assumption that they have written down 5% to10% of the value of the risky securities in their possession, weestimate that those large financial entities are holding about a fewhundred billion dollars worth of tainted securities. Thecollapse of the prices of those securities due to the fire sales ofSIVs will force those financial entities to make much largerwrite-downs. When banks write down the value of their securities, theymust apply their own capital to cover the losses; as the consequenceless capital will be available for lending to businesses and consumers. Thus many adverse forces will converge to form a perfectstorm to hit the financial system and will bring the US economy into arecession. US Treasury Department is probably scared by such acatastrophic scenario and is promoting the idea of the Super-SIV toprevent such a financial disaster. The idea of the Super-SIVis for large banks and Wall Street firms to contribute money, say 100billion dollars in total, to set up an independent financial entitycalled the “Super-SIV”. The Super-SIV will also borrow a substantialsum from financial markets by issuing short-term commercial papers, andwill use the funds at hand to buy up the troubled securities from SIVsto prevent the fire sales. As mentioned before that SIVs needto raise about 100 billion dollars in the next few months. The firstbatch of purchase will be easy since the Super-SIV can just use its owncapital to buy the securities from SIVs. However, the attempt for theSuper-SIV to borrow from financial markets by issuing short-termcommercial papers will probably fail. Those commercial papers from theSuper-SIV will be backed by exactly the same tainted securities as heldby SIVs now. If buyers reject those commercial papers fromSIVs now, they will reject similar commercial papers from theSuper-SIV, too. If the Super-SIV only buys securities backed by higherquality mortgages to enhance its credit quality and leave risky portionof the securities in the hands of SIVs, SIVs will still fail and achain reaction of fire storms will still sweep through the financialmarket as discussed previously. Even if the Super-SIV is formed asplanned, we should expect that it will only be able to postpone the dayof reckoning by several months.