Enzio's Clock

Background

1. SIVs, ABCPs and all that: digging deeper

Asian markets got slammed today: finally markets are moving out of denial and into panic. Even "secure" China's A-Shares tumbled by a daily 6%,with H-Shares skidding by 5%, India by 4% and Korea as well as Hong Kong by 3%.

So the market is beginning to accept that there is more at stake than a mere asset-management problem. Exacerbating this is an horrendous liability management issue: banks don't want to fund shonky assets anymore!

The Financial Times (FT) of Monday, 14th August, ran a fabulous, albeit convoluted story, on page 2 that is worth reviewing for you. The reason is that sub-prime asset management problems have morphed into funding liability management issues. Let me try to make sense of what the writers were seeking to express:

1. Repeat mistake. The basic problem facing markets is age - old: borrowing at a low rate and investing in higher-yielding assets.
2. Instruments. Structured investment vehicles (SIVs) are high yield assets that invest -inter alia - in colaterallised debt obligations (CDOs) and sub-prime mortgage-backed bonds (SPMBBs). They are funded by liabilities such as by asset-backed commercial paper (ABCP). Commercial paper is a money market instrument issued by large banks and corporations in order to secure short-term funding. "Asset backed" means that this commercial paper is supported by the stable cash flows generated by the issuer's business.
3. Events. The tail - the SIV's assets - have wagged the dog - the ABCP liabilities. In the last couple of weeks, people started getting nervous about the quality of the SIVs' assets, namely their CDOs and the SPMBBs. Thus, the SIVs have found it increasingly difficult to issue ABCPs as the lenders don't trust what their funding is going into, namely CDOs and these SPMBBs. So, SIVs cannot issue any more ABCPs: there are no takers. An asset management problem has morphed into a liability management problem.
   
4. Lenders of last resort. In their financing deals with banks, SIVs agreed that if they could not get funding via ABCPs, then the banks would stand by and guarantee funding. This is where European banks - most notably the Germans - have come unstuck.
5. Two ends of the stick. In review, the assets of SIVs are just as caught up in current market turmoil as are their liabilities!

2. Timeline

Crucially, yesterday two things happened in America and elsewhere:

• investors had to tell hedge funds if they want to redeem within the next one to three months, and
• millions of dollars of ABCPs matured and had to be renewed.

Keep an eye out for news on both fronts. Nothing on CNBC's Squawk this morning, but the mess will unfold.

This is why we are not keen to lurch back into the market: nobody has a clue about the extent of the damage - yet.

Using Popper's "pattern prediction" approach, based on history, my guess is that this mess will last until early November.

How to Make Money Off This Idea

1. Always contact your financial adviser to get a second opinion AND to select the safest instruments.
2. If you have the gift of understanding how to make money off shorting markets (which I don't), then go for ETF puts and for puts based on options.
3. I have chosen the less sexy route, and very happily am sitting on cash - until my wife's birthday this November.