On December 4, 2007, Wall Street Journal reporter Shefali Anand reported that some money market funds may be invested in risky debt securities issued by structured investment vehicles, or SIVs, that were recently downgraded or put on review for possible downgrade by Moody’s Investors Service. These money market funds include Charles Schwab Advisor Cash Reserves, as well as similar funds from Morgan Stanley, Barclays PLC, UBS AG, Deutsche Bank AG, and others, according to the article. While these funds hold only 1% to 2% of their investments in such debt, even a small amount poses a risk that has analysts paying attention. If a SIV debt obligation held by a money fund lost all its value, that could cause the money fund to “break the buck” ? i.e., violate a requirement to maintain a $1 per share value.
The review and downgrade of SIV debt was reported by Carrick Mollenkamp in the December 1st edition of the Wall Street Journal. Moody’s downgraded $14 billion in SIV debt and placed under review another $105 billion, according to the article. Moody’s said this action reflected “the continued deterioration in market value of SIV portfolios combined with the sector’s inability to refinance maturing liabilities,” reported Mollenkamp.
The liabilities in question are commercial paper. Commercial paper is a short-term debt obligation sold by banks and other businesses to investors. The proceeds are commonly used to meet short-term operating needs. Commercial paper is generally bought by money funds and has been regarded as very safe. SIV commercial paper is another matter, though.
SIVs are entities that issue commercial paper to buy longer-term, higher-yielding instruments, such as collateralized debt obligations (“CDOs”) that own contract rights in mortgage securities. SIVs also use the proceeds from sales of commercial paper to pay the principal and interest owed on previously issued commercial paper that has matured. These mortgage securities consist of bundles of mortgages, including risky sub-prime mortgages. “The credit crunch that began this summer sapped demand for both commercial paper and risky asset-based securities?a double-whammy for SIVs,” according to the Wall Street Journal.
As sub-prime loans have gone into default, the value of the CDOs that hold interests in them, and the credit-worthiness of the SIVs that hold the CDOs, have plummeted. Money funds have stopped buying the SIVs’ commercial paper. As a result, the SIVs face the inability to finance new investments and refinance existing debt obligations without selling their holdings at “fire-sale” prices.
SIVs were invented in the late 1980s by bankers at Citigroup. SIVs are not typically carried on the sponsor’s balance sheet. Because of the “fire-sale” dilemma, however, pressure is building for banks such as Citigroup to take the SIVs onto their balance sheets and “support the billions of dollars in debt that SIVs face having to pay in coming months,” according to the Mollenkamp article.
Citigroup and other banks are trying to set up a “super fund” of cash to provide liquidity to their SIVs. But CDOs dropped 22% in market value between October 19 and November 23. This worsening performance and Moody’s downgrades have led some to question whether a super fund will be enough. HSBC Holdings PLC has already said that it will shut down its SIVs and take $45 billion in asset-backed securities onto its own balance sheet. As reported in the Mollenkamp article: “It’s time for the bank sponsored ones to step up, provide support,” said Douglas Long, executive vice president at London-based structured-finance software firm Principia Partners. “Or they need to accelerate restructuring.”
A Citigroup spokesman said that its SIVs continue to rely on asset sales for funding, according to the Mollenkamp article. Citigroup is the largest sponsor of SIVs.
All of this has investors looking for cover. On December 4, Deborah Lynn Blumberg of the Wall Street Journal reported that treasury bond prices increased as investors, concerned over SIV downgrades and looking for safety, bid them up.