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Another Alphabet Soup Ready To Run Off The Rails

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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."

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]