If it's a day that ends in the letter y, it's probably time to learn about problems in another dark corner of the credit markets. On the lesson plan for today are financial creatures known as variable interest rate entities. These were known as special purpose vehicles, or SPVs, until Enron tarnished that designation for off balance-sheet assets and liabilities. Rather than quitting the SPV business altogether, Wall Street simply adopted a less familiar name and kept right on keeping on.
Now bond research firm CreditSights tells us that VIEs may contribute as much as $88 billion in losses for financial firms. Goldman Sachs, which has done so well in avoiding the worst of the self-harming habits of Wall Street, has warned that it may incur as much as $11.1 billion of losses from VIEs. That's just a few hundred million short of Goldman's earnings for all of last year.
So what went wrong with the VIEs? Stop us if you've already heard this one. They are loaded up with assets such as subprime mortgages, and financed with commercial paper. As their assets get downgraded, investors shy away. The banks have agreed to back the VIEs with line of credit, meaning they wind up buying the commercial paper and notes from the VIEs when no one else will. The troubles of the bond insurers, of course, play a role. If Ambac gets downgraded or split, the assets of the the VIEs will likely have to be written-down. So, yes, once again the off-balance sheet liabilities find their way back onto the balance sheets of the banks.
"The disclosure on VIEs is hopeless,'' S&P's Tanya Azarchs tells Bloomberg. "You have no idea of the structure or how that structure works. Until you know that you don't know anything. It's like every day you come into the office and another alphabet soup has run off the rails."
Update: A reader asks a fair question: what's the difference between a SIV and a VIE? Well, we used to actually do some work structuring these things back in the days before DealBreaker. The way we remember it is that SIVs are actually a subcategory of VIEs. What we think is being discussed here is another type of VIE, the asset back commercial paper conduit or ABC paper conduit. Although officially off balance sheet, the ABCP conduits are usually backed by credit lines from the banks (whereas SIVs weren't usually officially backed by the banks). When they can't roll over their short-term commercial paper financing, they can turn to the banks to refi. This means they are less risky for outside investors but more risky for the bank parents. Got it?
Goldman, Lehman May Not Have Dodged Credit Crisis [Bloomberg]
Posted by guest , Feb 27, 2008 10:15AM
Would anyone care to illuminate the material differences between VIEs & SIVs?
Posted by guest , Feb 27, 2008 10:21AM
Did you even read the article?
Posted by 36th Chamber , Feb 27, 2008 10:27AM
VIEs are backed by a letter of credit from the bank.
Also, notch a mark up for Carney trying to use the E*Trade sale as some form of mark to market with this from the end of the article:
"The securities in the VIEs may be worth as little as 27 cents on the dollar once they're put back on balance sheets, according to David Hendler, an analyst at New York-based CreditSights. Hendler based his estimate on the recent sale of $800 million of bonds by E*Trade Financial Corp."
Posted by John Carney , Feb 27, 2008 10:33AM
@ Chamber,
I hadn't noticed that. Thanks for pointing it out. Excellent stuff. Glad to see that point is still kicking around.
Posted by guest , Feb 27, 2008 10:51AM
thanks for the clarification, Carney
Posted by guest , Feb 27, 2008 11:06AM
Kicking around with everyone except those who know what they are talking about?
Posted by John Carney , Feb 27, 2008 11:24AM
@11:06: And who, exactly, are "those who know what they are talking about?" Haven't we just seen that those who know don't really know very much at all? I mean, Merrill can't even get its cash flows right.
Posted by guest , Feb 27, 2008 11:31AM
VIE is a term created in the accounting literature (FIN 46). Basically any entity that isn't what you'd consider a regular company could be a VIE.
SPVs, SIVs, CDOs, are VIEs (trusts are used for these things and are almost always VIEs). Plus a whole lot of other stuff, like JVs could also be VIEs.
Posted by guest , Feb 27, 2008 11:50AM
I read the entire CreditSights article. The $88 billion relates to rating agency estimates of monoline exposure at banks/brokers.
Posted by guest , Feb 27, 2008 11:50AM
Guest at 11.31 is basically right. VIE is an accounting phrase. Any type of "SPV" - a very generic phrase, which includes SIVs, ABCP conduits, CDO/CLO vehicles etc, would be a VIE for accounting purposes. Post Enron FIN 46 was released by the accounting wonks, and the street spent a bunch of time figuring how to deconsolidate VIEs (the usual consolidation analysis applies to the antithysis of VIEs, Voting Interest Entities, which are effectively operating entities/"real" companies).
Posted by guest , Feb 27, 2008 12:09PM
"The disclosure on VIEs is hopeless,'' S&P's Tanya Azarchs tells Bloomberg. "You have no idea of the structure or how that structure works. Until you know that you don't know anything. It's like every day you come into the office and another alphabet soup has run off the rails."
Ummm....Tanya dear, as was pointed out by longorshortcapital.com, it is your job and the job of your firm to know how these things work if you're going to slap a rating on the sponsoring firms.
Posted by guest , Feb 27, 2008 1:00PM
Who thinks the banks are gonna just come out and tell us how they been makin money outta nothin? It's off the balance sheet for a reason. They have thievishly fixed the numbers on the way up. Newtons first law though says it must come down, so whos gonna fix the #s comin down. Spitzer and Danallo are trying as hard as they can, but it aint gonna work. What do I know though? I'm a 26 year old nurse. All I know is that somthing smells funny. Money sure is a funny thing when you consider how it has influenced civilizations. I love charts and change. My favorite chart: The world population curve. 1900ad=1B Today=7B. Chart that on some graph paper you monkeys and you'll see why Wall St. is making as much as they can as fast as they can. They don't have to break the rules to do it either cuz they make the rules.
Posted by guest , Feb 27, 2008 1:23PM
Guest 1:00:
What are you wearing?
Posted by guest , Feb 27, 2008 1:32PM
I don't know, but i bet she's fucking Matt Damon
Posted by guest , Feb 27, 2008 2:31PM
Could be a male nurse. In that case you might not want to know what he's wearing...
Posted by John Carney , Feb 27, 2008 4:21PM
@1:23: That comment made my day.