The Fundamental Analyst: Credit Crunch 2.0

If you thought that the credit crunch was over and things were getting better the mooted SIV rescue program, which amounts to little more than a game of musical chairs should be enough to set you straight.

Dick Bove of Punk Zeigel brought up some good points in an interview on marketwatch.com. Most notably that for the US Treasury to get involved this must be a serious problem. Click on the clip below to see the interview.

A lot of comments on the proposed bailout of SIV's seem to portray it as more of a PR stunt. This from Christian Stracke from CreditSights:

"For me, this is more of a P.R. blitz," he said. The banks are "saying, it’s not just that we are doing this on an ad hoc, individual basis. Rather, we have a plan and consortium in cooperation with Treasury, which gives it a veneer of respectability." "The banks were going to need to inject more liquidity into the SIVs anyway, so the public co-operation just makes the bail-outs of SIVs seem more orderly.''

and this from Alex Roever, a debt strategist at JPMorgan:

"Eighty billion is great, but it's not that big a number,'' said Roever. "It still leaves you with $240 billion. That's a lot of dough. There may be enough money to pay the senior debt holders, but it's not enough to pay off everyone else.''

Also of interest is the that the so-called Master Liquidity Enhancement Conduit (MLEC) will not buy anything but AAA & AA rated securities. How does this help SIV's by leaving the most toxic assets on their balance sheets? Nouriel Roubini summarised the dilemma well in a post on his RGE Monitor blog:

The proposed solution thus looks like a game of musical chairs that may not work. Indeed, if we assume that many of the assets held by the SIVs are of low quality, the attempt to avoid losses that would be incurred by selling these assets in secondary markets would not be possible. It is true that impaired assets of poor quality may also suffer of illiquidity and thus their current market price would be even lower than the low fundamental price given their low credit quality. But putting such assets into a super-conduit would not resolve either the liquidity problem or the solvency/credit problem of these assets. Banks will have to accept that they bought lousy assets whose true value is now well below par – even leaving aside any current discount due to illiquidity – and that these losses cannot be fudged or eliminated by creating a super-SIV.

Also, it is not clear what will be the quality of the assets of the new super-conduit. If, as allegedly argued, the new super-conduit would avoid the toxic waste of subprime MBS and CDOs, the better acquired assets would have to be purchased at current market value: and, since those market value today of even better assets are below par because of credit risk and liquidity premium, if Citi and other banks were to dispose of the SIVs assets into the super-conduit at current market values, they would still suffer the same losses as in the case of selling now in the secondary markets the same illiquid assets; thus, their objective of avoiding such losses would not be achieved. Also, if only better assets were to be sold to the super-conduit, the SIVs would be left with only the bad assets (the toxic subprime MBS, CDOs, etc.) and thus the roll-off of the commercial paper backing those assets would accelerate rather than be reduced. It is like stripping a bank that has a run from its best assets and keeping only the bad assets on its balance sheet; the run would accelerate. So, this scheme of shedding only the best assets of the SIVs cannot work. And if the assets to be shed were the lousy ones, of course no one would want to fund such super-conduit as this conduit would be made out of only toxic waste radioactive assets.

Click on the link above for the full article I thoroughly recommend it. Nouriel makes an excellent argument about how any claim by the Fed that they have not engaged in moral hazard is quite ludicrous.

The stockmarket recently celebrated the revelation of around $20 billion in write downs from the major banks. However given the exposure of their conduits (Citigroup has $100 billion alone) and the initial low-ball estimate of the sub-prime mess of $100 billion there is a long way to go.

Speaking of toxic waste, S&P announced yesterday that they had downgraded another $4.6 billion of junk:

S&P cuts $4.6 bln of subprime mortgage backed assets
Standard & Poor's on Monday cut its ratings on $4.6 billion worth of residential mortgage-backed securities exposed to subprime mortgages, citing expectations of further defaults and losses in the securities.
The downgrades include 402 pieces of 138 transactions. All are backed by first-lien subprime mortgage loans issued in the first three quarters of 2005.
The majority of the ratings cuts were in the "BBB" category, which is the lowest tier of investment grade.
"These rating actions incorporate our most recent economic assumptions, and reflect our expectation of further defaults and losses on the underlying mortgage loans and the consequent reduction of credit support from current and projected losses," S&P said in a statement.

"Furthermore, the affected transactions include provisions that allow the release of credit support on certain step-down dates," S&P said. "The release of credit support after the step-down dates will leave these transactions even more vulnerable to losses going forward."

So how are those BBB ABS indexes looking? Take a look below, it's not pretty.