Bank Runs - 21st Century Style

Forget the images of anxious depositors toting well-worn passbooks, thronging outside Local Savings and Loan to withdraw their hard-earned savings. Today's bank runs happen "upstairs" and in a very different way - but they are runs, nevertheless. Keep in mind what I had stressed in previous posts, namely that banking is no longer what it used to be: loans are packaged and securitized, then sold to speculators and investors who are the ultimate lenders, i.e. those hapless depositors have been replaced by hapless investors/speculators.

Here is what is happening, right now: a bank/broker/fund had the bright idea of setting up a special investment vehicle (SIV) to own CDO's, CLO's, etc., securities that had been created by putting together a bunch of mortgages, commercial loans, or hybrids thereoff. To further enhance the yield (and fees) they leveraged those holdings by borrowing short term money from the money market via commercial paper, for which they pledged those CDO, CLO, etc. assets as collateral, creating what is known as asset-backed commercial paper (ABCP). Many of those SIV's took the form of special purpose hedge funds and were sold to pension funds, individual investors - and other banks. An incredible $1.1 trillion, or 50% of all commercial paper now in circulation, is ABCP and about half of it ($550 billion) is coming due within the next 90 days.

The problem is that ABCP buyers have now gone on a strike, refusing to roll over purchases of anything that is tinged with "asset backed" - even if the mortgages and loans backing it are still performing well. Despite ABCP yields rising to 6.03%, short term investors are shunning them and turning to the safety of T-bills instead, driving 3m bill yields down to 3.20%! This leaves all those SIV's with two choices: temporarily find alternative sources of funding, or immediately sell large portions of their CDO's, CLO's and other assets. Alternative funding, if available, will likely come from vulture funds: it will be small in size, very short-term and very expensive, i.e. nothing more than a band-aid. The SIV's can't afford negative carry for long, i.e. they can't pay more for funding than the return on their portfolio. So, unless the underlying market for their assets and their ABCP's quickly normalizes, the SIV's will have to sell and do so very soon.

Naturally, the question is, why are ABCP buyers refusing to roll over their purchases? Is it just a case of temporary panic which will soon blow over, or are their concerns well founded? The buyers are amongst the largest and most sophisticated institutional investors (money funds, insurance companies, other banks), so they must have made their determination based mostly on facts rather than sentiment. And the facts are that most of this ABCP is just another form of margin debt, used to leverage the purchases of structured finance assets by the SIV's. Once the bull market for those assets is over (as it is clearly the case now), it is only natural that margin lenders will immediately pull their lines. This is not panic - it is a rational business decision.

So, this is what part of a modern "run" looks like in the 21st Century: not a demand for deposited cash, but a refusal to roll over ABCP's as they expire. But the net effect is the same as a "regular" bank run, except there is no George Bailey to rally the people.

P.S. Is it a coincidence that so much sub-prime and structured finance trouble seems to be concentrated at smallish European banks, particularly semi-state controlled ones? No coincidence, oh no, not at all. I could write a whole post on this subject but...I won't. Suffice it to say that many such out of the way banks bought huge amts. of US structured finance products (relative to their size), not out of deeply held convictions about their investment merits. There were other, much more..ah, how should I put this in an elegant way... mundane reasons. Like yachts, vacation homes, brown envelopes, offshore accounts...

Oh .. and government controlled pension funds, too. Just wait.