Tuesday, August 21, 2007

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securitized, then sold to speculators and investors who are the ultimate lenders, i.e. those hapless depositors have been replaced by hapless investors/speculators.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.


  1. Oh Yes ! the next 1 - 3 months is the final real test ! As you said if the ABCP don't find lenders at a fair interest rate either they bring their banks with them in the collapse (activation of the due credit line) or the Fed accept to buy these assets and we have monetisation...

  2. You write "immediately sell large portions of their CDO's, CLO's and other assets".

    Whom do you expect to buy those things? Are the buyers not on strike?

    Of course, if the price is right, anything sells. But the sellers will make some serious losses, I assume.

  3. In an emergency you sell what you CAN sell at whatever price you can get (i.e. the best parts of your portfolio). If that doesn't work... throw the entity into the mercy of the government, like at least two German banks have done, thus far.

    The Fed's turn is next...I think.

  4. How much of this paper was peddled to a certain fast growing Asian country with a HUGH stash of dollar reserves?


  5. If you are referring to China, I think little. Lots of the c*ap was sold to european banks and pension funds, who "justified" it to their boards by invoking the need for elevated returns due to the looming pensions crisis, bank profit slowdown, etc.

    Baloney... those things carried IMMENSE commissions (or spreads), that were sprinkled about very liberally, sort of like fertilizer.

  6. to hellasious :
    may be to european banks for the reasons you give...but if i am correct the market of theses CP is in US$. So the individuals or pension funds who should have been the most interested in the yield capture should have been thinking in US$; otherwise for europeans the currency risk should have been seen as to big compared the yield surplus, no ? or may be that has been seen as an alternative among the available and held US$ investments

  7. Hellasious,

    I learn much from this blog and really dig it, but must question one thing.

    You say, "The buyers are amongst the most sophisticated...so they must have made their determination based mostly on facts..."

    Granted, but you make it sound as if these facts concern the value of the underlying collateral, and not the paper itself.

    I think you are suggesting that investors perceive the *collateral* for the bonds as either having lost value or likely to lose value in the future.

    Mmm, I don't know about that.

    It's true the paper has lost value, but the collateral is something else.

    I am speaking here about non-subprime stuff -- commercial mortgages in CMBS and credit-card debt and car-loan debt in ABS.

    We haven't seen a crisis of confidence in the underlying collateral in these sectors, have we?

    There are no significant defaults going on in these areas. (unlike the subprime area)

    However, the non-subprime paper is losing value even without any defaults going on, and everybody in these markets will tell you that it's "technical" and not related to fundamentals.

    So buyers have stopped buying non-subprime paper simply because they see spreads widening.

    For example, they bought this paper two weeks ago at 60 over swaps and now the paper they bought is worth 80 over swaps, so they've already lost money.

    And there's no telling when the widening will stop. They don't want to throw good money after bad.

    So they're on the sidelines till they see spreads stabilize.

    But that's not the same thing as moving to the sidelines because you're afraid of what's going on with the underlying collateral.

    I spoke with a hedge fund investor a week or so ago and she said they'd love to buy CMBS at the current spreads -- which then were about 60 or 65 bp over swaps -- because they thought it was ridiculously cheap for the good-quality collateral they'd be getting.

    But they couldn't do it, because there's too much volatility, and that "riculously cheap" paper at 65 bp could get even cheaper tomorrow, and they can't afford to take a big hit because they're a leveraged buyer.

    So, if you think I'm wrong by all means say so. I just think when it comes to the collateral, the only stuff that people have lost confidence in is the subprime collateral. (Even though paper backed by all sorts of things is getting walloped.)

    best, GG

  8. Dear GG,

    In a bear market cheap keeps getting cheaper, then cheapest, then...you get my drift.

    I think serious investors (not leveraged speculators) are making the determination that the credit expansion party is over and are simply stepping away. The reason they are making that determination, in my opinion, is that they perceive the credit market as a whole, not as segmented into credit card, auto loan, prime mortgage, LBO, etc. And there is no question that the whole system is over-indebted and as if that's not enough, you have highly leveraged speculators(like your hedge fund example) who take on additional debt just to make a spread and multiply it x times. They forget that the first thing they should worry about when buying bonds is safety of principal and THEN rate or return or YTM.

    The sub-prime loans were the first to go because they were the weakest. The rest will follow, probably in order of credit quality.

    I really don't think this is a temporary panic within a fundamentally sound market. There ARE banks failing, there ARE hedge funds shutting down, there ARE LBO deals getting canceled...and, of course, mortgage foreclosures are now 93% higher than last year (RealtyTrac data out today).

    This is real and it is happening on the ground, not inside some fund manager's head.


  9. It's a lot more than just subprime...The players are trying to drive volatility out of the markets once again to placate the situation. However, if volatility becomes heavy in many different assets, then confidence is going to be shaken to the core...From equities to commodities to higher rated corporate and municipal paper...And the reason this is happening is due to the unheard of debt levels that have been assumed over the last several decades and especially in the last 6 years.

  10. Hellasious,

    You say, "The buyers are amongst the most sophisticated...so they must have made their determination based mostly on facts..."

    I think this is double speaking. If these institute buyers were real smart, they should NOT have bought these toxic waste.

    After all, US housing have been in trouble for over 1 year and subprime problems had exploded 1st round in Feb/March 2007 already.

    So, I think these institution managers are way-way overpaid and do nothing. Pretty fat brains and, I guess, make decisions more so on emotions than Real Intelligence.

  11. What do you think of Mr. Andros' analysis?

  12. I forgot Andros' link.

    Here 'tis:


  13. Great blog.

    Can you please add some more details to your profile it would be interesting to find out more about you.

    Nothing too specific of course if you want to stay annonymous.

  14. So, are we blind to the impact on States and their municipalities?

    As the tax rolls shrink, the impact on their largess is a multiplier looking for an input.

    gg assumes current facts are ceteris paribus. Ain't the real world.

    The bleeding edge, where the host focuses his attention, is the reality, and is a useful reference when one wishes to read the future via the pattern of the tea leaves as they are in the cup at this moment in time.

    Add my thx to the host for this blog.

  15. If any of you are in touch with any institutions banks, pension funds, endowments, that are looking to sell any AAA CLO's please let me know. I am looking for AAA CLO paper. You can email me at cmoinvestor@gmail.com thanks