The How & Why: Conduits, CDO, ABS & MBS
Two of the best explanatory missives on the current ABCP liquidity issue, that you absolutely MUST READ from Brad Setzer
A few months ago a lot of subprime debt could be packaged into a security that was worth more than the sum of its parts (with a bit of help from the credit rating agencies. And this process was widely lauded.
The IMF argued that the United States unique skill at creating innovative fixed income “product” was pulling in the capital needed to finance the US current account deficit.
The Fed argued that financial innovation allowed the banks to sell risks that they previously might have held on their balance sheet -- though it is also worth noting that the banks themselves were big buyers of MBS as well. Risks were divided and then sold to those best able to manage them.
There were, of course, notes of caution from the Fed. Some warned that many new instruments had not been tested by a real downturn – and hinted that credit spreads might not be commensurate with the risks.
And MUST READ RIIP
The (ex-)masters of the universe were using the commercial paper market – formerly a way for quaint old fashioned “companies” to get short term funding – as financing for leveraged carry trades.
Now some of these conduits (also known as SIVs, structured investment vehicles) may be related to the bank’s operations (e.g., a bank makes mortgage loans and then sells them to the off-balance sheet conduit) but I suspect that a lot of these vehicles – like that for KKR – were just another way to play the ponies – er, execute investment strategies.
A few months ago a lot of subprime debt could be packaged into a security that was worth more than the sum of its parts (with a bit of help from the credit rating agencies. And this process was widely lauded.
The IMF argued that the United States unique skill at creating innovative fixed income “product” was pulling in the capital needed to finance the US current account deficit.
The Fed argued that financial innovation allowed the banks to sell risks that they previously might have held on their balance sheet -- though it is also worth noting that the banks themselves were big buyers of MBS as well. Risks were divided and then sold to those best able to manage them.
There were, of course, notes of caution from the Fed. Some warned that many new instruments had not been tested by a real downturn – and hinted that credit spreads might not be commensurate with the risks.
And MUST READ RIIP
The (ex-)masters of the universe were using the commercial paper market – formerly a way for quaint old fashioned “companies” to get short term funding – as financing for leveraged carry trades.
Now some of these conduits (also known as SIVs, structured investment vehicles) may be related to the bank’s operations (e.g., a bank makes mortgage loans and then sells them to the off-balance sheet conduit) but I suspect that a lot of these vehicles – like that for KKR – were just another way to play the ponies – er, execute investment strategies.
Comments