I-Bank profits: Leaking like a SIV?

All of a sudden, the world doesn't appear quite so rosy, does it? The recent floating-on-air performance of risk trades, which as recently as yesterday morning had Macro Man's blog portfolio knocking on the door of 3% month-to-date profits, has swiftly descended to Earth. The heady days of last week seem like a long, long time ago....

The decline in US equities yesterday was telling. Whereas markets had previously been willing to shrug off bad news (e.g. Merrill and UBS), yesterday's earnings announcement from the Prince of Darkness appeared to dent morale from the get go. And what we're left with is an S&P 500 teetering nervously on a highly visible and obvious trendline. A close below would, in all likelihood, generate further position liquidation. Although Asian equity trade was mixed, price action in S&P futures this morning does not bode well.
Of course, there was more news than just Citigroup earnings (which, as far as Macro Man could make out, were actually a tad higher than the consensus expectation.) The announcement that Citi, B of A, and JP Morgan were jointly creating a "super SIV" also generated quite a buzz.

Now, Macro Man does not purport to be an expert on structured crdit and the inner workings of SIV-type vehicles. But as far as he can make out, the premise of this vehicle's creation, which was orchestrated by the US Treasury, is as follows: SIVs are currently unable to issue sufficient quantities of short-term debt to avoid the sale of illiquid assets, with the concomitant unpleasant voyage of price discovery that follows. As a result, banks are forced to take these unwanted assets onto their balance sheets, which is impairing their capital ratios and potentially their willingness or ability to lend. As a result, it is better to create a new SIV...which will then attempt to issue short-term debt to finance its illiquid asset base.

Errr....if there were sufficient demand for asset-backed CP, wouldn't that obviate the need for this super-vehicle in the first place? And if banks are forced to extend credit to this super-SIV if it's unable to issue short-term debt, won't that compromise their ability to lend to other borrowers?

A cynic might observe that this vehicle is a handy way to stripping turdholdings off these banks' balance sheets, and replacing them with even more-difficult-to-value loans to the super-SIV. Moreover, it also appears to concentrate a very substantial amount of asset-backed risk into a single entity. All the easier, perhaps, to conduct the inevitable government bailout?

Meanwhile, a Fortune magazine story is now doing the rounds, highlighting the degree to which Goldman's stellar 3rd quarter earnings were the result of so-called Level 3 "mark-to-myth" valuations. Macro Man recalls that GS was relatively opaque when it came to disclosing the impact of Level 3 earnings when they announced profits last month; evidently more colour was provided in a recent filing. Macro Man hasn't read the filing, and even if he did, he isn't sufficiently conversant in these issues to make an informed judgement as to their severity. In a sense, though, he doesn't need to; when markets turn, participants tend to shoot first and ask questions later.

It's perhaps worth putting the last few weeks in perspective. NZD/JPY is a useful barometer for global risk appetite, as it is the highest-yielding cross in the G10 FX complex and captures Japanese risk appetite in a way that many standard measures do not. The chart below is really remarkable, as it shows that the NZD/JPY cross delivered two rallies of 20% plus-not including carry-in a little more than seven months. Quite amazing, really. That second rally, of 23%, took less than two months, and is now putting in quite a clear top. What odds on a further position liquidation? One would think it must be reasonably high.

Finally, Big Ben's speech yesterday had someone for everyone. Depending on the prior viewpoint of the analyst, one could read that it was dovish, hawkish, or something in between. All you really need to know is that the Fed could cut, hike, or remain on hold as circumstances warrant.

In this environment, a long volatility position is looking good. Macro Man will sell out his long USD/JPY option hedge at 116.95 on a spot basis and €30 million of his EUR/USD long at 1.4170 spot basis. Time to batten down the hatches, folks: all of a sudden it's looking like the no-brainer risk trade has come to an end.

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Macro Man
December 5, 2007 at 9:23 PM ×


Congrats bro Macro Man you got PERTAMAX...! hehehehe...