SIV-City
The Wall Street Journal says it is London. The Yves Smith of Naked Capitalism cries foul: the real SIV-City is Citi.
Yves Smith has a point. The Journal’s reporting makes it clear that Citi – an American bank – was the center of the SIV-world, even if most of Citi’s SIVs were managed out of London and registered in the Caymans.
I thought the Journal’s headline “Gordian Knot: How London Created a Snarl in Global Markets” exaggerated in another way: London-based SIVs seem to have created a far bigger snarl in the US market than in global markets. There is a reason why the US Treasury is trying to catalyze the creation of a super-SIV to create demand for the assets of existing SIVS – and why some global markets are doing a lot better than some parts of the US credit market.
All quibbling about headlines aside, the Carrick Mollenkamp, Deborah Solomon, Robin Sidel and Valerie Bauerlein story is well-worth reading.
It highlights something that I have long suspected: looking simply at the scale of cross-border capital flows may exaggerate the extent of financial globalization.
What do I mean?
A Citi-sponsored SIV (with a back-up credit in dollars, but one that only covers a portion of the SIV’s liabilities) is registered in the Cayman Islands and managed out of London.
It then sells dollar-denominated ABCP to US money market funds, and uses the proceeds to buy dollar-denominated asset-backed securities – securities ultimately backed by US payment streams.
The paragraph probably should be in the past tense; there isn't much demand for ABCP right now, or for that matter, the kind of assets SIVS used to buy. But let's set that aside, and get back to the example.
On the surface, financial globalization has gone up. American investors are investing abroad – the commercial paper issued by a Cayman’s company (or a London company). And foreigners – the Cayman registered fund managed out of London – buys a host of US assets.
But in some deeper sense, financial globalization hasn’t increased.
Americans are still saving in dollars. Their dollars are still being invested in the US economy.
But for a host of reasons – and I suspect “tax” arbitrage is at least as big a factor as London’s knowledge of how to set up a SIV– American savings that is lent to American households or firms is routed through London or the Caymans.
The capital outflow (US funds buying foreign ABCP), though, is balanced by a capital inflow (foreign purchases of US ABS). It cannot finance a US current account deficit.
And while measures of “home bias” based on the size of the US external balance sheet will show a fall, that fall is a bit deceptive.
This isn’t to say that Americans are not investing more abroad. They are – especially now that fast-growing foreign markets (like, you know, Europe) are out-performing the US markets.
But American investment abroad – at least American exposure to foreign markets – isn’t growing as fast as the US BoP data suggests. If you look at the details of the US data, the US lends a lot of money to London and the Caribbean, lending that is largely used to buy US assets.
The net result is a lot more activity on the external side of the United States balance sheet – in part because more and more “structures” are used to avoid US taxes – without a commensurate increase in real financial globalization.
To me, there is a difference between the kind of financial globalization represented by buying dollar-denominated commercial paper issued by a SIV backstopped by a US bank that is used to buy dollar-denominated asset-backed securities and the kind of financial globalization represented by rising US holdings of foreign equities balanced by rising foreign holdings of US equities.
There also is a difference between state-led financial globalization – one driven by sovereign wealth funds and central bank reserve growth – and private-sector led financial globalization. But that is another topic.
But the two issues do interesect. Some analysts now argue that official inflows are small relative to gross capital inflows – and their importance has consequently been overstated.
I disagree.
The US data almost certainly understates the real extent of official inflows – China is undercounted, as are Russia and the Gulf.
And the gross capital flows data includes an awful lot of dollar lending to offshore financial centers – lending that is used to buy US assets. Such tax and regulatory arbitrage pumps up the gross, but has no impact on the net.
And the net is what matters.
SEC should investigate Goldman Sachs balance sheet for “Creative Accounting”
http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/10/16/cnsachs116.xml
A Goldman Sachs filing with the US Securities and Exchange Commission has led to allegations that it may have inflated profits in the third quarter to a spectacular $8.23bn (£4.03bn) by booking paper gains on mortgage derivatives at too high a value.
Analysts cited by Fortune Magazine claim that almost a third of the bank’s revenue came from “short” positions on the lowest tier of mortgage derivatives and other forms of toxic debt.
These assets are extremely hard to price, and were not in fact realised. More than $2.62bn of declared profits were made entirely on house estimates at the underlying value.
Charles Peabody, an analyst at Portales Partners in New York, said there were concerns that Goldman had set optimistic values on instruments for which there was in reality little or no functioning market.
“Common sense tells me that a lot of these losses were real and a lot of their gains were paper, and that’s something we’d like to know more about,” he said.
Hi Brad,
Excellent piece!
So is there anyway we can clearly dissect the figures between the two?
Not easily — you sort of have to match the data on the currency composition of US external assets in the survey with data on its geographic composition in your mind, and to make some assumptions about the direction of bank flows …
some of the graphics from the BIS are helpful there as well.
But i think it is safe to assume that most private bank outflows from the US are in dollars and to other financial centers and generally are offset by dollar based inflows (s-term and l-term) from those financial centers. A decent share of the UK’s buying of US corp debt seems to have been financed by US lending, for example. but it is hard to know exactly how much.
so does that means, should the net returns being generated offshore be converted into other currencies, these numbers just dissappear?
and if so, its really a big issue for the US.
The Cayman example illustrates offshore booking of domestic financial intermediation.
Such activity grosses up the international investment position, without involving foreign players as investors or ‘investees’.
It overstates the degree to which the gross international investment position represents true financial integration.
It overstates the degree to which gross flows ‘dominate’ net flows.
And it overstates the degree to which private flows ‘dominate’ official flows.
Anonymous — very well said. I should have let you write the blog; you made the points i wanted to make but more sharply.
“Such activity grosses up the international investment position, without involving foreign players as investors or ‘investees’. ”
ergo, the US dollar has quite a bit further to fall in value.
Japan and China lead flight from the dollar
http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/10/16/bcnchina116.xml&CMP=ILC-mostviewedbox
Japan and China led a record withdrawl of foreign funds from the United States in August, heightening fears of a fresh slide in the dollar and a spike in US bond yields.
Data from the US Treasury showed outflows of $163bn (£80bn) from all forms of US investments. “These numbers are absolutely stunning,” said Marc Ostwald, an economist at Insinger de Beaufort.
Asian investors dumped $52bn worth of US Treasury bonds alone, led by Japan ($23bn), China ($14.2bn) and Taiwan ($5bn). It is the first time since 1998 that foreigners have, on balance, sold Treasuries.
The US requires $70bn a month in capital inflows to cover its current account deficit, but the key sources of finance are drying up one by one.
BNP Paribas said America has relied on “hot money” from abroad to cover 25pc to 30pc of the US short-term credit and commercial paper market over the last two years.
The Treasury data would have been even worse if it had not been for $60bn of inflows from hedge funds based in Britain and the Caymans, which needed to cover US positions at the height of the credit crunch.
Some lowest tier of mortgage derivatives and other forms of toxic debt are extremely easy to valuate. It’s worth zero.
The best part is Goldman Sach shorted securities they themselves created and marketed.
Goldman’s numbers are an absolute joke.
Goldman’s two fund managers generated abuot 30 points of negative alpha in each 2006 and 2007 (ytd). A firm simply does not reward that kind of trading behavior without other things going on.
In mid-August, Goldman was leveraged to the hilt. It was getting eaten alive.
Goldman stuck all its garbage alternately in the Level 3 (toxic crap) accounting category–Goldman has the highest Level 3 composition in the industry–and sloughed the remainder onto its two hedge funds.
Why the hell else could they be keeping those two guys on board, if not to shut them up?
Not to mention those Fed repos that Goldman allegedly took extra-extra-extra long to pay back.
Maybe it’s time to short the CAD, considering that they just put a Goldman boy in the top slot. You can’t bail yourself out if you are the central bank, after all.
The US was a second rate power before WW2, she is just going back to that previous, natural state, except in reverse:
2nd rate power->Great Depression->WW2->world power->Iraq War->coming depression->2nd rate power
Whatever we’re seeing in the economic/financial problems is just a prelude to that slide.
The US was a second rate power because before the Great Depression she practiced pure capitalism with no social bonding in place. She was run by monopoly interests and leaders who were average to incompetent. By catering to a small group of elite, the nation’s people and resources were serving that small group of coterie rather than being used to produce greater economic good. The continual demands of the elite to do away with regulations and law in order to maximize/justify their predatory activities also served to maintain her 2nd rate economic status. It was only WW2 and a spur of manufacturing activity for the war that brought her onto the world stage. Now she has done away with manufacturing and, once again, created monopolies/coterie, the natural state is to return to the past.
IL
The US deficit does not include many off-budget items like Iraq, Afganistan, Katrina, Highway Trust funds etc, they are supplemental.
Look at the y-o-y debt numbers, they never ever tie out to the deficit.
In fact it used to be easy to do at this link:
http://www.publicdebt.treas.gov/opd/opdhisto4.htm
…however it was taken down a few months ago. And guess what the new link stops… just before the Bush administration took office.
http://www.treasurydirect.gov/govt/reports/pd/histdebt/histdebt_histo4.htm
Now why would they stop at 1999? They used to have the old data up there.
…from the people who brought you a strong dollar policy.
DC: Analysts cited by Fortune Magazine claim that almost a third of the bank’s revenue came from “short” positions on the lowest tier of mortgage derivatives and other forms of toxic debt.
Yup. In other words they took the other banks to the cleaners. Cool…….
You can’t have it both ways. Either the mortgage derivatives are worthless or are valuable. If you think that the mortgage derivatives are worthless, then you must think that the GS made a ton of money, since what GS did was to put a huge bet that the subprime market would blow up.
If you think that GS is cooking their books, then you must logically believe that the sub-prime crisis isn’t quite as bad as people present it and those mortgage-backed securities are actually valuable.
I’m not sure the US is going back to second rate power status anytime soon, there isn’t anyone even close at the moment to contend for equal position as first rate. But then there is a disconnect between GDP and power. After WWII, the US had some 40% of world GDP by some figures, but was still a newby in the power game. Economically it was a great power long before it had a great military. Meanwhile, European mini-powers strutted their stuff on the global stage throughout the first part of the last century.
My guess is that the same will be true for future-powers China and Europe. They have a certain amount of economic power now, but military power will lag, perhaps for a generation, because there is a certain sense in focusing on practical things — and leaving ruling the world to others, who have arguably lost their minds!!
I also need to point out that having two groups of people with strong interest in making the value of an asset go in opposite directions is how markets get a value. You have a CDO. It’s in Goldman-Sach’s interest to make that CDO worth as little as possible since the less that CDO is worth, the more money it makes. On the other hand, it is in Bear-Stearn’s interest to make that CDO worth as much as possible since the more that CDO is work, the more money it makes.
So you put these two companies in a room and have them beat each other up until they come up with a number.
Rereading…. I’m just appalled by the Daily Telegraph article since it quotes people that obviously have no idea what a “short position” is.
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It’s amazing,
Once upon a time there was a commenter who used to write economics by haikus.
Now, we have a new one with mystic love poems, in a post about SIVs.
Global attraction for you, Brad!