Slaying the Structured Investment Vehicle Monster with the double-edged sword of transparency

Update:  Oil Money Infusion Buoys Citigroup -- According to a bulletin from Bloomberg, Citigroup has struck a deal with Abu Dhabi's state investment group to pump $7.5 BILLION dollars into the firm to insure capital adequacy in these hard times. In return for the capital infusion, the state-owned agency will receive securities yielding 11% and which are convertible into stock. Almost double the yield that is currently being offered to ordinatry investors. Do we detect the fine hand of Saudi Arabia's billionaire Prince Alwaleed bin Talal who already owns a significant stake in the corporation?  Perhaps this is part two of trying to save a New York signature bank.

Once again, we see the continuing interest in bailing out Structured Investment Vehicles with their "off balance sheet"  treatment. All challenged by HSBC which could bring the household crashing down with its plans for SIV transparency.

According to the Associated Press...

"Calls for more transparency at Citigroup Inc. grew louder Monday when HSBC Holdings PLC said it would put two funds with mortgage exposure on its balance sheet and spend $35 billion to bail them out."

Arms Length ... is that a word play on Adjustable Rate Mortgage Securities?

"Citigroup said it has no plans to mimic HSBC's move. So far, Citi has committed $10 billion in liquidity to the seven structured investment vehicles it manages on an "arm's length" basis, and has kept them off its balance sheet -- meaning Citi has not been counting the SIVs' debt as its own."

Transparency -- the mythical goal of financial organizations who do not want their bad deals scrutinized or their profitable deals cloned by others...

"That strategy may end up backfiring, though, some industry watchers say, because shareholders, fed up with remaining in the dark about how much risk the largest U.S. bank holds, are selling off."

A classic explanation of leverage...

"SIVs, which JPMorgan Chase & Co. CEO Jamie Dimon recently predicted will 'go the way of the dinosaur,' have hit snags this year. The vehicles sell short-term debt, such as unsecured commercial paper, to investors such as hedge funds, then use the proceeds to buy longer-term assets, like mortgage-backed securities, that yield richer returns. "

The crux of the matter: liquidity problems for SIVs...

"SIVs normally generate money through fees and the difference between short-term and long-term rates. But demand for short-term assets has vanished in the midst of the U.S. housing market implosion, creating liquidity problems for the vehicles."

And why is it, again, that these SIVs need to be kept afloat at the investors and taxpayer's expense?

Playing transparency games with its investors...

"If Citi changes its mind and put its SIVs on its balance sheet, it may be forced to take even bigger write-downs than the $8 billion to $11 billion it projected for the fourth quarter. The seven SIVs have, in total, about $83 billion in assets. "

The following is an absurd statement. "Risks looking as if it is deliberately obscuring its holdings."  Which is exactly the reason for SPEs (Special Purpose Entities) and SIVs (Structure Investment Vehicles). The Financial Accounting Standards Board recently expanded and modified Rule 125 into  FASB Rule 140 for the sole purpose of allowing certain SPEs and SIVs to be kept off their owner's balance sheets. Who are we kidding? If the investors knew the magnitude of the true risk assumed by these banks with their leveraged shenanigans, they would have never been allowed to proceed in the first place. This is ENRON-style, off-the-balance-sheet, accounting in spades.   


It's a matter of dealing with monkeys -- the trio of monkeys that are named "see no evil, hear no evil, speak no evil" or the other monkey saying, "Monkey see, Monkey Do."

"But if Citi doesn't put its SIVs on its balance sheets and other banks do, it risks looking as if it is deliberately obscuring its holdings. "

Is the Fed participating in a bailout?

The question that must be asked: Is the Federal Reserve bailing out the depository institutions (banks) by lowering the discount window rate and providing needed liquidity into the marketplace? Thus allowing, under specially modified rules, the proceeds of these loans to be passed to other related entities.

Sanity check?

Who, in their right mind, would participate in a superfund just to keep the owners of SIVs from having to liquidate their holdings at fire-sale prices when it makes good financial sense to wait for the crash and then buy the derivatives and underlying assets at pennies-on-the-dollar?

"HSBC's move also complicates Citi's plans for a 'super fund' to buy up hard-to-sell securities -- an arrangement that does not appear to be attracting as many participants as Wall Street hoped. So far, only Wachovia Corp. has officially agreed to participate in the plan, after Citi, JPMorgan Chase & Co. and Bank of America Corp. announced the project seven weeks ago."

Here is a man who really does know Jack...

"With someone like HSBC throwing in the towel, going for transparency ... it makes Citi and the other parties look conspiratorial at this point if they don't 'fess up and do that," said Jack Ciesielski, publisher of the industry newsletter The Analyst's Accounting Observer."

Perhaps what this world needs is more bookkeepers -- the people who add and subtract numbers; and less accountants who spend their days trying to paint a false picture of a corporation's finances. The letter that they so proudly sign with the accounting firm's name and which promises that the numbers accurately represent the numbers is hooey. If they did tell the truth, the whole truth and the truth that is hinted at in the footnotes, it is certain that they would be out of a cushy accounting gig. Every major fraud seems to have their world-class auditors and world-class lawyers. How about adding some world-class truth-tellers?

So far, auditors have not told Citi it must put its SIVs on its balance sheets.

Forget the auditors, where are the regulators such as the Securities and Exchange Commission, FDIC, the Comptroller of the Currency and the other regulatory bodies?

"'Variable interest entities' like SIVs are allowed to be off-the-books as long as the bank does not hold more than 50 percent or more of the risk or reward involved in the entity, said Russ Golden, director of technical application and implementation activities at the Financial Accounting Standards Board."

Perhaps Russ Golden can enlighten us as to why the risk cannot be quantified using mark-to-market techniques and reported on the balance sheet for the world to see -- and be used to make "prudent" investment decisions?

Creating products out of the thinnest of air -- slicing and dicing risk... all to earn a commission on the multiple sale of the underlying assets

"Still, banks remain under close scrutiny for their fixed-income holdings, particularly the products known as collateralized debt obligations, or CDOs. CDOs are chopped-up and rebundled chunks of assets, including mortgage-backed assets, and have plunged in value in recent months."

Can you trust the auditors?

"The four major auditing firms -- PricewaterhouseCoopers, Deloitte, Ernst & Young and KPMG -- as well as BDO International and Grant Thorton have drawn up standards to appropriately value bank holdings. The paper, still in draft form, will be published in December, said PwC partner Pauline Wallace."

Who believes that the auditors have the best interests of the investment community in mind when it conflicts with their client's wishes? Perhaps the "draft" standard should be ratified by FASB after being vetted by the regulatory agencies.

Of course, by then all of the SIVs and SPEs will pass into investment history and other investment structures will be created by those financial engineers known colloquially as the "Wizards of Wall Street."

What can YOU do?

Perhaps the best advice that can be given to the investment community is courtesy of the Better Business Bureau: Investigate BEFORE You Invest.

Followed by:  if  it is too difficult to explain to the ordinary investor or too difficult to understand by the ordinary investors, perhaps it should be passed over. 

And it is always wise to remember: the Wall Street Wizards produce nothing of tangible value as they slice, dice and package their wares. To those who claim that Wall Street funds the engines of our capitalistic society, one must ask: at what artificially manipulated price?

-- steve

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Reference Links:

HSBC Fund Bailout Raises Citi Questions: Financial News - Yahoo! Finance

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