Finally the half baked idea of further fudging the SIV mess by parking some of the toxic waste into a Super-SIV is officially dead: good riddance to a plan that – as discussed here months ago - was conceptually flawed in the first place.  Also good riddance to the entire SIVs schemes or scams - $350 billion of them - that are now comatose and dying an undignified and well deserved death.

Of the three ways to deal with this SIV scandal (scandal as these special purpose vehicles were in the first place one step short of criminal Enron-style of SPVs) the Super-SIV was the worst as it would have attempted to hide the losses deriving from these vehicles holding tons of toxic ABS junk on their books.

Of course the two other alternatives were painful for the financial institutions sponsoring these SIVs: sell the assets in a fire sale in illiquid markets at whatever market prices one could get for them and accept massive losses for the investors in these vehicles; or bring back all the assets on the balance sheet of the banks that had sponsored them. Finally, the banks decided to go for the latter solution: bring back the junk from off-balance sheet to on-balance sheet. The reason is simple: given massive credit enhancement provided by the banks to the SIVs dumping the losses on the investors was not feasible, even leaving aside the reputational costs and potential litigation that would derive from that attempting to shove the losses on the investors in these SIV. Credit enhancement implied that the banks were responsible for such losses. 

Also given the significant liquidity lines that the banks committed to the SIVs (in

many cases 100% lines) keeping the SIVs off-balance sheet was not an option as the massive and persistent roll-off of the ACBP backing those toxic asset would have forced anyhow banks to provide the liquidity support and thus seize precious banks’ liquidity to back these loser vehicles.

So at the end the banks did the rational and unavoidable thing given that no investors was foolish enough to fork money in this Super-SIV turkey that could not fly in spite of the full support of Treasury; and given that letting the roll-off of the ABCP destroy the SIVs and force a fire sale of the assets would have triggered even bigger losses than the alternative of parking back the assets on the balance sheet of the banks.

And with the maturing and likely roll-off - starting in January - of many of the medium term notes - on top of the shorter term asset backed CP that is already falling off the cliff of a massive roll-off  - the unraveling and meltdown of the SIVs was certain to build momentum. So bringing back on balance sheet assets backed by paper - short term or maturing medium term - that was inexorably being rolled off was the only feasible solution to prevent a scary fire sale of the toxic assets and a more immediate recognition of the massive losses that these schemes have already engendered.

However parking these assets on the balance sheet of the banks will only provide a temporary reprieve to the need to mark them to markets; a fire sale would have led to immediate losses; but the need to value these assets according to FASB 157 will force the banks to provide a more realistic and market based assessment of their value once on balance sheet. You can certainly expect - by keeping the assets on balance sheet rather than selling them - some accounting fudge - i.e. attempts to not fully recognize that many of these illiquid assets are now worth much less than par; indee, the alternative of a fire sales would have determined the true current market value of these assets. But given the extreme current illiquidity of the secondary market for these assets a fire sale today would have implied even larger losses than those warranted by the fact that these assets will never have the value that was assumed in the first place. So hopefully application of FASB 157 will limit the amount of accounting fudge that will be certainly be tried once the assets are parked back on the balance sheet of the banks.

This is finally the pathetic conclusion to the entire SIVs scam, as these were scams in the first place. The banks went to extreme length to create off balance sheet vehicles to exploit regulatory arbitrage (avoiding capital charges, prudent liquidity ratios, reporting requirements, compliance requirements) and to provide tax avoidance (in some case one step away from tax evasion) to investors. They pretended that these vehicles were fully independent of the banks to be able to keep them off-balance sheet and avoid all the supervision and regulation of on-balance sheet assets. But by providing both significant liquidity lines in case of a roll-off of the liabilities and massive credit enhancements they created a real monster that was effectively on-balance sheet while pretending to be off-balance sheet; these were de facto, if not de jure, vehicles that were part and parcel of the bank that sponsored them; and given the liquidity lines and credit enhancements even from a de jure point of view litigation would have forced the banks to recognize their responsibility for them.  

Worse, for the sponsoring banks the SIV was a scam to get off their balance sheet hundreds of billions of dollars of toxic RMBSs, CDOs, CDOs of CDOs  that they had created in the first place. A good chunk of that toxic waste was directly sold to clueless investors in the capital markets – in the US and abroad – that were both greedy and gullible enough to trust the investment grade rating that the rating agencies had blessed on this radioactive junk. But even after shoving down the throat of investors a good chunk of the hundreds of billions of dollars of complex, illiquid and toxic assets the banks were still left with tons of these assets  that would have remained on their balance sheet unless there was a way to offload it off balance sheet. So the great scheme or scam of SIV was created to pretend that these assets were off-balance sheet and sold to investors rather than being effectively on the balance sheet of the banks.  So the SIVs were part and parcel of a securitization food chain that produced Franken toxic food to be disposed of and shoved off the banks’ tables.

Thus, these SIVs should have been banned in the first place by regulators; or be subject to the same regulations and supervision (capital requirements, liquidity ratios, reporting, disclosure and compliance requirements) as the assets on the balance sheet of banks. Instead a bunch of clueless and incompetent regulators blinded by a free markets fundamentalist ideology - that ignores that financial markets without appropriate rules and regulations behave according to the law of the jungle - allowed these monsters to be created in the first place; these are the same folks that allowed the Enron’s SPVs – a close cousins of the SIVs – to be created and fester a cancer that destroyed Enron. It is a scandal that after the Enron affair these SIVs were allowed to mushroom without any supervision and regulation. 

And the Fed’s pretense that it had nothing to do with this Super-SIV scheme is disingenuous: liquidity support by the Fed was indeed indirectly put at work in order to rescue these SIVs in the first place by giving to Bank of America, Citigroup and other institutions a waiver of Regulation W to be allowed to channel more of the liquidity support received from the Fed to their affiliates.

So now the roll-off of the ABCP paper backing these toxic SIV assets is in full steam and all the major financial institutions that created these monsters are taking those assets back on their balance sheet where they – de facto and de jure – belonged in the first place. Of course this re-intermediation will now make the US and global liquidity and credit crunch worse as precious liquidity is used to back the roll-off of the ABCP and precious and depleted capital is now frozen to back these risky assets that are now back on the balance sheet where they belonged in the first place.

Will U.S. regulators learn their lesson and ban these off balance sheet scams or force them to have the same regulatory framework of on balance sheet assets and liabilities? Don’t be sure of it. After allowing for years the most reckless practices in mortgage lending to fester without any control only this week the Fed has come up this week with new regulations that look like band aid and will do little to avoid the same kind of deceptive and predatory lending practices that went on for years; and even these mild regulations mean nothing unless regulators change their attitudes compared to the last six years and decide to put some resources to enforce them. 

Expect similar kind of fudge with respect to the SIVs: instead of treating them like on-balance sheet items there will be the same flawed Basel 2 approach of using internal risk models, credit rating agencies ratings and some band aid capital charges for commitments of liquidity lines to provide flawed “principles-based” rather than more effective “rules-based”  regulation and supervision of a financial system that has now gone into the beserk law of the jungle when it comes to reckless and unregulated financial innovation.