This week was not pretty for stocks. It all started off with the announcement of a special 80-100 billion dollar fund orchestrated by the US Treasury to bail out something called an SIV. Then Caterpillar gave negative guidance this morning, especially on its US business and the selling began in earnest. October 19 is still not a friendly day to the stock market 20 years later. But it was a great week for bonds. One-month treasury bills dropped 60 basis points in one day in a real flight to short-term quality, and the entire yield curve moved down substantially.
But it all circles back around to the subprime mortgage mess. It is clearly having an effect on the economy (witness the Caterpillar guidance, which used the "R" word - that's recession - in association with some of its prime customers, like housing). The subprime mortgage problems, which we were assured only a few months ago would be contained, have now spread to what Paul McCulley calls the Shadow Banking System. In this week's letter, we talk about something called a Structured Investment Vehicle or SIV. There is a real crisis brewing that has serious implications for Fed policy, credit spreads, and your ability to get a loan. There is a lot of ground to cover, so let's jump right in.
This week we learned that Structured Investment Vehicles or SIVs should more properly be termed SIGs or Structured Investment Garbage. Several SIVs worth over $20 billion are closing shop, and investors will lose money. More SIVs are selling assets to meet loan demands. SIVs had issued at the peak about $400 billion worth of asset-backed commercial paper. The total of asset-backed commercial paper was $1.2 trillion. Since July, that has plummeted, nose-dived, crashed to $888 billion, and is on its way to a small fraction of that. In effect, we are taking a trillion dollars of financing for a wide variety of things we need, like credit cards, autos, homes, and corporate loans out of the credit market. That is going to have an impact.
Taking Out the SIV Garbage
But I don't want to get ahead of myself. Let's start at the beginning. What is an SIV and where do they come from? Who owns them? Why do they exist?
We can blame the Brits. In 1988, two London bankers left Citigroup to start this industry. Today they run the largest SIV, called Gordian Knot, worth $57 billion. Essentially, a SIV allows a bank to take assets off its…