Saturday, October 20, 2007

Learn the Lingo - SIV what?

Alright so the recent crisis is all about SIVs, ABCP and the like. Let's talk about this for a bit.

SIV - Structured Investment Vehicle. So most people don't really understand how these work (I didn't really know how they worked until I did some research a couple months ago when this fiasco started to come up). SIVs are similar to conduits or SPVs used for other structured products like MBS and CDOs. They are a legal entity that holds a bunch of securities. SIVs in particular are like mini-banks. They borrow short term and lend long term and make money off the spread--just like a bank. Usually SIVs stick to ABS and high grade bonds, mostly ABS.

ABS - Asset Backed Securities. These are securities created by pooling things like car loans, credit cards, student loans, airplane loans, etc. Generally they are tranched up to various credit ratings. Most of it is pretty high-grade since they are backed by an actual asset that could be sold off if necessary.

CP - Commercial Paper. Commercial paper refers to the world of super-short term borrowing.
Companies often issue commercial paper as a cheap way to borrow very short term. This financing is often used a bridge financing to keep their cash-flow timing balanced (say you receive money en-masse in the winter, but tend to have to borrow extra during the summer because your working cashflow isn't as good in teh summer).

ABCP - Asset Backed Commercial Paper. ABCP usually refers to the commercial paper issued by an SIV. They are considered asset backed because the SIV acts as a intermediary taking cashflows from the ABS and turning it into shorter term lending via the CP market. If anything should happen, the SIV could theoretically liquidate the ABS and pay off its debts.

Money Markets - The CP market is often considered the money market. You know those money market savings accounts at banks? Yea, they invest in CP. There are also treasury money market accounts which invest in treasury bills as opposed to CP. CP tends to yield more. Generally bills and CP are considered minimal risk, but as our current crisis shows CP is not risk free.

So hopefully this helps clear up why our financial world is in chaos. First off, if SIVs really started to go illiquid, billions of dollars of money market holders would feel the pain. That's consumers with money market accounts earning negative savings. That could be an issue. Next if the ABCP market dries up, so goes the ABS market as well. Since SIVs provide the liquidity needed in the market to pull these ABS off bank/dealer balance sheets and into the general public, this market drying up would stop ABS issuance to a large extent. That could be an issue to all sorts of consumers who need to take out credit in the form of car loans, student loans, credit cards, etc. Now you see why this SIV thing can have such an impact on our consumer.

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