The Sub Prime Crisis: Trouble at banks

(Ref: The Economist, dt. 18 August)

Many banks and financial institutions have been affected by the sub prime crisis. These include HSBC, Lloyds, HBOS (England), Coventree (Canada), Citi (USA), IKB, West LB, Sachsen LB (Germany). Some of these banks have used off balance sheet investment vehicles popularly called “conduits”. These vehicles are typically funded in the asset backed commercial paper market. The loans are cheap but of short maturity and are rolled over every few months. The conduits use the money to buy Collateralised Debt Obligations (CDOs), which are much higher yielding securities. But as market conditions have worsened, the source of funds has dried up and the problem has spread to banks who typically provide the conduits back up credit. The global asset based commercial paper market is estimated at $1.2 trillion, up from $650 billion three years ago. These are not trivial numbers and the rapid growth confirms that greed can drive markets crazy.

Banks have also gone beyond conduits and set up the more leveraged structured investment vehicles (SIV). Indeed, SIVs represent one of the fastest growing areas of structured finance. Some 23% of SIV assets seem to be in residential mortgage securities. Covenant-lite versions of SIVs (i.e., SIVs with less restrictions) are also floating around. These involve borrowings of up to 40-70 times the equity collateral. The SIV lites seem to have gone heavily into sub prime assets.

In an environment of mistrust, as these kinds of information come to the notice of the public, banks are being viewed increasingly with suspicion.