Master Rider Blog

SIVs Versus SUVs

October 19th, 2007 NW Teong

While SUVs help to push up the crude oil to its record price recently, SIVs help to spread the pain due to the sub-prime loans crisis in US. Indeed, SIVs are the core concern of the sub-prime loans crisis. What are SIVs and what are SUVs? SIVs are Structured Investment Vehicles and SUVs are none other than Sport Utility Vehicles. While we are all familiar with how much SUVs help to consume the petrol, most of us are not so familiar with these SIVs.

SIVs are basically entities that raise funds by issuing short-term, low-yielding notes called commercial papers and invest in longer-term, higher-yielding instruments such as credit card debt and mortgage-backed securities. SIVs can be hurt in two ways, one is that the funding dry up and two the assets that SIVs hold suffer huge losses. The funding dry up actually happened at the peak of sub-prime loan crisis in the middle of August 2007 where there were no takers of the commercial papers that these SIVs issued. In short, investors were spooked by the sub-prime loans problem that they refuse to look at other debt papers except the Treasurys which are considered risk-free. As most SIVs are affiliated to banks, banks were forced to provide the funding or liquidate the vehicles altogether. This creates severe liquidity problem as banks scramble to raise funds for these vehicles. At the same time, the assets that these SIVs hold suffered huge losses as investors are dumping the debt papers, be it asset backed or not. In short, banks face liquidity problem as well as suffered huge losses. The worst thing to happen will be that these banks are forced to sell the assets in order to repay debts. If all the banks with exposure to SIVs started to this, it will cause a negative chain effect. So much so that the whole debt market will collapse, this means the breakdown in the whole financial system which will have dire impact on the real economy. In order to cushion this, Citibank has initiated to create a Super fund which in essence is to provide funding as well as to prevent panic selling among the players.

Both SIVs and SUVs are smart creations of human beings but they are still not perfect. It is challenging to come up with a financial vehicle so as to give you a decent return and yet shield you from any market turmoil all the time. Of course, it is equally challenging to create a SUV (with the same power and performance) that consumes little petrol or gasoline. While we cannot overcome this issue (powerful and consume little fuel) overnight, I am very sure we will have better products over time with the advancement of technology and financial innovation.

Someone asked me right after lunch today, “Hey Mr. Teong, why don’t you talk about markets today as the regional markets are under great pressure?” I replied this gentleman that I have said what I wanted to say about markets days ago.  Didn’t I talk about The Big Trend on 9 Oct, Liquidity Play Intact on 10 Oct, Heightened Volatility on 12 Oct (mind you, I talked about this last week), A Tale of Two Markets on 16 Oct and Eve of Black Monday Anniversary on 18 Oct 2007? In short, my view is that the markets would be very volatile in Oct but I feel that any correction would be short term as the liquidity play will resume after each correction barring unforeseen circumstances. My take is that there might be “small” (small if you compared to the fall on 19 Oct 1987) correction in global markets today (all eyes would be glue to US markets tonight), i.e. there will not be any huge correction that will cause panic among investors. By the way, US Fed still have plenty of ammunitions to be deployed should the need arises. Cheers!

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Entry Filed under: Environment, Macro, Stocks, Singapore