U.S Credit Rating Downgrade - A Humpty Dumpty Moment

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

As everyone knows by now, S&P downgraded the U.S. sovereign debt rating from AAA to AA+ on Friday. While the extent of the downgrade is minor, the implications are major. As the recent debt ceiling negotiations revealed, the U.S. cannot run its day-to-day operations without borrowing money. It lives on credit (as do most countries in the world today) and anything that impacts its ability to borrow money has serious consequences.

It takes a lot for a credit rating agency to lower the credit rating of a top corporation or country. This is usually only done long after the actual credit worthiness has experienced a significant decline.  The last major Friday afternoon credit downgrade from the credit rating agencies was when they lowered Bear Stearns rating on March 14, 2008. The company didn't open its doors again the following Monday.  The rating agencies were also tardy with lowering the credit ratings of accounting fraud poster child Enron, although they all did finally lower its rating to junk status four days before it declared bankruptcy. Perhaps the best analogy to the current U.S. situation though is the AAA ratings given to a number of securitized bonds that held subprime mortgages. These turned out not to be worthy of a top credit rating after all.

The farcical nature of how the credit agencies determine the rating of U.S. government debt was made clear during the debt ceiling negotiations. Numerous articles in the press reported that failure to come to an agreement, which would allow the U.S. to continue to spend money it didn't have because it could borrow more, would be viewed as fiscally irresponsible! A more rational response would have been, it's quite obvious that the U.S. can't function without borrowing an increasing amount of money and it is therefore insolvent. Under such circumstances its credit rating should be at the junk level - a BB or less - not an AA+. Eventually, this might happen, but as was the case with Enron, this would mean the U.S. would likely be going under a few days later.

The difference between the AA+ credit rating and the BB or lower one is caused by the fantasy factor. The AA+ rating is based on the glorious financial past of the U.S. and ignores the current downward trajectory it is on. Before the debt ceiling problems temporarily curtailed spending for a while, the U.S. was on course for as much as a $1.65 trillion budget deficit. This represents 11% of the current GDP number of $15 trillion (there are many reasons to think GDP is substantially overstated). It is true, that the U.S. is not borrowing money to pay for most of this deficit however - it's printing it. Quantitative Easing 2, a form of money printing, conducted by the Fed covered 70% of the deficit in the first half of the year. A country doing this certainly does not deserve an AAA credit rating, nor does it deserve an AA+ credit rating unless you can make a case that a company engaged in the business of counterfeiting money also deserves a close to top credit rating.

The Obama administration complained that S&P overestimated future U.S. deficits by $2 trillion. What this means is that S&P refused to accept the pie-in-the sky budgets numbers that the government generates. If you look at these, you will see that they assume GDP growth of over 5% a year, each and every year, until 2016. One year of GDP growth over 5% would be good and continual annual GDP growth of over 5% for the U.S. economy just isn't possible. The budget scenario also assumes very low inflation, which would certainly not be the case if the high growth it assumes takes place.  A combined deficit of $20 trillion in the next decade instead of the administration's $7.7 trillion would be more plausible. S&P assuming $2 more is still ridiculously low.

The immediate impact of the U.S. credit downgrade will be to cap the credit rating of companies at AA+. The government of the country has to have the highest credit rating in that country because in theory it has no default risk. Economists say that governments can use their ability to tax to pay off their debts. Although as finances deteriorate it is much more likely governments will print money to pay off their debts. No fiscally solvent government ever engages in excess money printing however. The U.S. Fed had increased its balance sheet (a measure of money printing) by $2 trillion since 2007. It doesn't appear that the credit agencies are taking this into account.

The longer-term implications for the lowered credit rating are far more serious.  More downgrades are likely. Interest rates will go up. Money will leave the United States. The U.S. dollar will lose its reserve currency status and this will lower its value substantially. Higher interest rates and a falling currency will both be inflationary. 

The financial world operates very much on image and reputation. Once that's shattered, it can take years to repair it, if it can be done at all.  When Bear Stearns was downgraded in March 2008, the damage to its ability to operate in the financial markets was terminal. The company imploded like an overinflated balloon that had a pin stuck in it. Fortunately, this is not likely to happen to the U.S. - at least not yet.

Disclosure: None

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21
Author: Inflation Investing - A Guide for the 2010s

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Moody's Sovereign Debt Assurances Should Concern Investors

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


According to ratings agency Moody's, credit ratings of the world's four largest Aaa-rated sovereign nations - the U.S., UK, Germany and France - are currently "well positioned despite their stretched finances". The agency does however admit that risks have grown. Based on Moody's past actions, this should give investors little comfort.

In the current Greek debt crisis, Moody's was behind S&P and Fitch in downgrading Greek government debt. As reported in the Wall Street Journal, it took Moody's until December 23rd to make a downgrade of just one notch from A1 to A2. After the elections on October 4th, the Greek government admitted it had lied about its budget deficit and its ratio to GDP would be 12.7%, several times higher than previously reported. Even though the original numbers from the Greek government should have seemed unbelievably rosy, this apparently didn't make the rating's agencies suspicious. Are they likely to be more suspicious of the numbers generated by the politically powerful major countries that get their top ratings?

Prior to the Greek crisis, there was Iceland. According to the Central Bank of Iceland's website, Moody's downgraded Iceland's long-term debt obligations in domestic and foreign currency to A1 (still well within the investment grade range) on October 8, 2008. This was the same day that the Iceland's krona peg to the euro collapsed. Iceland had already nationalized major banks Glitnir and Landsbanki the month before. The Iceland prime minister had stated on October 6th that there had been a real danger of national bankruptcy. That scenario would have justified a rating of C from Moody's, many notches below the October 8th rating.

Investors should also not forget the role of the rating's agencies in giving securitized sub-prime loans top triple A ratings (Aaa in the case of Moody's). Moody's had to downgrade more than 5000 mortgage securities in 2007. The ratings agencies in general blamed mortgage holders that turned out to be 'deadbeats' and not their own practices. They would like us to believe that it was unreasonable for them to have assumed that people with spotty employment, a history of not paying their bills, and who bought houses they couldn't afford would default on their mortgages. If the rating agencies can ignore those problems, investors should ask themselves what problems they are ignoring with U.S., UK, German and French government financing?

How did the rating's agencies do with problem companies? Moody's downgraded Bear Stearns to Baa1 from A2 on March 14th, 2008. The Baa1 rating is an investment grade rating for Moody's (there are five speculative rating's below that level). That downgrade took place on the last day that Bear Stearns' stock traded. Moody's was still maintaining it was an investment quality company. The rating agencies did a little better with Enron, downgrading it to below investment grade four days before it declared bankruptcy. The stock had already lost almost all of its value before the downgrades, so the move was too little too late.

In its current analysis of sovereign finances, Moody's maintains that the major countries will be able to maintain fiscal stability because interest payments are reasonable compared to government revenues. However, government debts are increasing rapidly because of weak economies. If the global economy continues to stay weak, interest payments will go higher , tax receipts lower and debt will continue to pile up. Recovery, on the other hand, will raise interest rates substantially and this could overwhelm tax receipts and create a major debt spiral. The rating agencies are unlikely to consider that the major countries are caught in a lose/lose situation though since they seem to reserve their most speculative ratings for basic logic and common sense.

Disclosure: None

NEXT: The CFTC and Manipulation of the Silver Market

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Enron Accounting and GDP; FDIC's Money Shortage

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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Second quarter GDP revisions were out this morning and they were unchanged from the down 1.0% in the first reporting. The government claims that while some components of the GDP numbers declined, increases in other components offset the losses. Components revised upward included government spending (what a surprise). State and local government spending was supposedly up 3.6% (federal spending up 11%) even though over 30 state governments are now considered to be in serious financial trouble. In a separate report, the FDIC is once again about to run out of money because of the increasing rate of bank failures that are taking place even though Fed Chair Bernanke has told us repeatedly that the financial system has been fixed.

While the state and local government spending numbers are suspicious to say the least, far more suspicious is the corporate profits component of the GDP report. Before-tax corporate profits supposedly increased $67.6 billion or by 5.7% quarterly. This was the biggest increase in four years and even larger than the 5.3% gain in the first quarter. You may be wondering how can corporate profits increase by large amounts during the worst recession since the 1930s? Quite simply, they can't. Even worse, proof of the inaccuracy of these numbers is supported by the net cash flow figures in the GDP report. These fell by $26.9 billion. Companies that are actually making money generate cash. Those who are lying about making money don't. This is what happened with Enron. It claimed to have substantial profits, but its cash flow indicated that it didn't. While this smoking gun was right there is the published figures, Wall Street and the mainstream financial media talked up the stock almost to the day that the company declared bankruptcy.

Other components from the report indicate an economy that is in extremely bad shape. Amazingly, even though corporations are making those huge profits, business investment fell 10.9% after plunging at a record depression level 39.2% annual rate in the first quarter. Another impossible statistic in the report is disposable income for consumers. The GDP report claims this went up 3.8% despite the severe recession. However, according to the report the savings rate rose 5.0%, which means that this increased fantasy income wasn't flowing into the economy. Exports, which the Fed and economists have pointed to as one of the cornerstones of the 'resurgent' economy, fell 5%. Imports fell 15.1%. Collapsing trade is a sign of a sick economy. Even though we have heard repeatedly from the media and the Fed that the U.S. real estate market has bottomed, investments in housing fell for the 14th consecutive quarter, dropping at a 22.8% annual rate -that's some recovery all right.

Also contradicting the government's 'economy is getting better' PR blitz, is the continuing failures of U.S. banks. This problem hasn't been solved, it has merely been swept under the rug. The FDIC's deposit fund will be running out of money sometime later this year. It would have run out of money last year if it had to pay off for either the Washington Mutual or Wachovia failures. Both were handled outside the system with the U.S. Treasury making guarantees for the acquiring banks. So far 81 banks have failed this year and the number of banks on the FDIC's troubled list is now 416 (up from 305 at the end of the first quarter). This is the largest number since the Savings and Loan Crisis. Banks insured by the FDIC swung to a total quarterly loss of $3.7 billion in Q2. It looks like we can expect a lot more bank failures in the future.

NEXT: Commodities, the Dollar and More Government Fantasy

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21


This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

The Bull Heard Around the World

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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Almost every market throughout the world rallied on April 1st. In the morning (New York time) things didn't look promising. While most Asian markets had closed up nicely, all European bourses were down well into their trading day. Stocks in New York then gapped down sharply. Within a relatively short time, both New York and Europe reversed and then closed with good numbers. Today has been even more bullish. In Asia, the Hang Seng rose over 1000 points, closing up over 7%. The Nikkei went up over 4%. The Dax in Germany closed up more than 6%.

The European rally was helped by the ECB cutting interest rates by 25 basis points to 1.25%. They are also considering buying up toxic assets which the Fed in the U.S. has been doing for sometime now. At the G20 meeting in London, France and Germany pursued stronger financial regulation aimed at tax havens, hedge funds and rating agencies. European leaders said they had no need for stimulus plans because their more generous welfare systems kick in automatically with benefits for more people as the economy deteriorates. Obama kept emphasizing that 'we are all in this together'.

Meanwhile in the U.S., the financial accounting standards board FASB gave companies more leeway when valuing assets and reporting losses, providing a potential boost to battered banks' balance sheets. The mark to market system, will now be replaced with a mark to fantasy system. FASB made its move because of pressure from Capitol Hill. Our elected representatives are demanding rules that help companies mislead investors. In case you had any doubt whose side they are on, it should be pretty obvious with this action. If this was actually something that worked, Enron would managed to have avoided imploding and still be in business because it lied about its financial numbers. The banks may be able to carry on however since they have an apparently unlimited supply of freshly minted federal money available for continually bailing them out. Of course, like every other free lunch program the Feds have come up with, the costs for this one will be heavy indeed.

Money has flowed into stocks globally in the last two days and this indicates the big money is supporting the current rally - at least for awhile. The media has been filled with reports in the last week about how the rally was going to end any moment and investors had better get out. When it comes to deciding whether or not to listen to some know nothing windbag media pundit or the market, always chose the market. There is still a lot of danger in the financial system however with a lot more blow ups awaiting us. Enjoy the party while it lasts, but don't stay too long. The U.S. Employment Report tomorrow may trim the sails of this rally temporarily.

NEXT: U.S. Unemployment Rises to 15.6%

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Excess Liquidity to Solve Excess Liquidity Problem

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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Almost everyone expects the U.S. Fed to lower interest rates by 50 basis points to 50 basis points today. Soon we will find out what will happen when there are no more rate cuts left as I asked rhetorically long ago in one of the New York Investing meetup's You Tube videos. We do know what has happened in the past because of excess liquidity with one bubble inflated after another because of fed policy. Each bubble leaves a trail of victims, many of whom should have known better. The list for the Madoff scandal keeps growing and the similarity to suspended belief that made Enron possible should be noted. While there were a few lone voices saying the emperor had no clothes, the top Wall Street players supported both and questioning from the media just didn't exist.

Hedge funds were one of the many beneficiaries of U.S. government easy money in the 1990s and 2000s. In 1990, there were only 610 of them in the U.S, by the end of 2006, there 9462. Assets under management went from $38.9 billion in 1990 to $1.9 trillion in June of 2008, when according to Bloomberg they peaked. As of November 24th (long before the Madoff scandal) U.S hedge funds returns were down 22% on the year - some protection from the Bear Market! A number of hedge funds themselves invested with Madoff and their clients were generally charged 20% of profits and a one and half percent maintenance fee to get them in on the biggest Ponzi scheme in American history. Just another of example of Wall Street being filled with people who know other people, but know little about investing.

While hedge funds still remain beyond the reach of the average investor (and in many cases this is fortunate), the other big beneficiary of the credit bubble, mutual funds, are also suffering. In the six months between May and October, U.S. mutual funds had a decline of $2.5 trillion in assets. Much, but not all of this, was the result of the declining stock market. Money seems to be flowing into money market funds which hit a record $3.7 trillion last week and have hit records highs for the last 11 consecutive weeks. There also seems to be some shift of funds toward ETFs. Despite the declining market, ETF assets have grown by $104 billion in the first nine months of 2008. Perhaps the American public is slowly realizing that the mutual fund industry is obsolete and does little except take a slice of their investing money in exchange for lower than average market returns?

The New York Investing meetup continually points out that there is no free lunch and much of our investing predictions are based on this simple premise which is why they are so accurate. Don't think we don't get a lot of flack because of this because we do. Most people want to believe in the too good to be true premise (and the Madoff scandal makes it clear that the rich and well-connected are just as susceptible to this as everyone else) and the U.S. government through its interest rate policy, the Treasury through its bailouts and the mass media that refuses to question, all keep the illusion going. Most people of course also don't make money with their investments either. Instead they wind up eating the free lunch and invariably go hungry later on.

NEXT:

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Bailout Cost: $8.5 Trillion so far ... and Counting

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Video Related to this Blog:

One analysis has calculated that so far the bailout efforts of the U.S. government are up to $8.5 trillion. This is almost as much as the U.S. National Debt was when the bailout efforts began. So basically in a year the U.S. government has managed to double a debt level than took well over 200 years to accumulate. Don't expect to see all of these bailout costs included in the official National Debt figures however since the U.S. government engages in more off-balance sheet accounting than Enron ever dreamed of.

While these figures would seem alarming to even a casual observer, many mainstream economists don't find them troubling. Recent Nobel winner Paul Krugman claims the U.S. National Debt could be twice GDP (which would be around $28 trillion if you believe the official overstated GDP figures). How this could be a sustainable debt load for the U.S is hard to fathom, especially since we have a huge stream of social security and medicaid payments coming due in the next couple of decades because of retiring Baby Boomers (there is no money in either of these trust funds by the way, all the funds are used to support current government spending the moment they are received). Economists are also not worrying because over 50% of the bailout costs so far have been structured in the form of a loan. Much of those loans are backed by the truly worthless assets though - apparently the hope that sub-prime borrowers (this time companies) will by some magic pay back their loans still lives on and on in the fantasy land of modern economic belief. While up to now over 95% of bailout costs have been in the form of corporate welfare, expect this to change starting next year with a shift toward more support for individuals.

Although the inflation implications of U.S. government bailout profligacy should be ratcheting government bond yields to record levels, this has not happened yet. A flight to safety among desperate investors had kept U.S. bond yields unusually low (corporate bond yields are at a record spread to treasuries however). The drop in yields combined with the plunge in U.S. stocks has actually caused S&P 500 yields to be greater than 10-year U.S. Treasuries for the first time since 1958. Before that date this relationship was the norm. Don't assume that norm is returning however as some pundits are claiming. Stock yields are being kept artificially high by the bailout programs, which have allowed some companies to fund their dividends with U.S. taxpayer money. Stock dividends are going to come down and U.S. bond yields will eventually go up when they adjust to the inflationary realities of government spending.

Meanwhile, the bailout programs are not nearly at an end yet. As we have said in the New York Investing meetup since the credit crisis began, there is no such thing as one bailout for an insolvent financial firm. No firm has been better than Citigroup in proving this point. After five private bailouts earlier in the year, Citi got $25 billion from TARP and only weeks later had to have a much bigger government cash infusion to stay afloat. The auto makers are in Washington hat in hand at the moment with a low entry level bailout request - expect those costs to keep going up next year as well. And of course, their are more bailouts waiting in the wings.

NEXT: Economic Predictions for 2009

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

When Silence Isn't Golden

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Video Related to this Blog:

Global terrorism reared it ugly head again with the horrific attacks in Mumbai in the last two days and the foiling of a plot to blow up Long Island railroad trains in New York City. One reason Mumbai seems to have been targeted is that it is the financial capital of India. If they had their way, the forces behind the terrorist threat would establish a totalitarian theocracy that would bring us back both socially and economically to the Middle Ages. It is not surprising that they would want to destroy the symbols of opulence created by capitalism. Unfortunately, the government-financial complex of the world's industrial economies has done more in this regard in the last few years than the terrorists could ever do.

The forces of ignorance though have not been extirpated in the U.S. by any means and I have a personal experience that took place at the same time to confirm this. An economics blog that is part of a well-known 'educational' site quoted an entire paragraph commentary of mine (my name was not mentioned) dealing with how people need to know the truth about the credit crisis and the state of the economy. This economics 'expert' for this site replied to my claims with the assertion that people who make such negative statements and predictions (doesn't matter whether or not they are true apparently) are helping to cause the economic problems the U.S. is experiencing! If markets and democracies can function without people having access to the truth, I am unaware of it. And of course, if you extend this logic, the less bad things the public knows about a company, the better off the investors will be (Enron actually made claims similar to this by the way).

Despite my best efforts at trying to spread reality throughout the land, the recently released U.S. consumer confidence number increased slightly from last months record low. Apparently it was falling energy prices that caused the slight uptick. Consumer views of current conditions however worsened even further in the November report. The October durable goods report didn't help create a rosy picture either. There was a 6.2% plunge following a 3.3% drop in September. On the consumer side, September was the month when purchases of asset backed paper for credit cards literally came to a halt - meaning no ability on the part of the big banks to fund any additional credit card debt to keep the American economy going (hence the sudden change in emphasis for TARP that was announced recently). Year over year delinquencies in credit card payments rose 17% and charge offs 45%.

Investor confidence in the state of the economy seems to have fallen to new lows if you consider that corporate bonds in the U.S and Europe have the highest yield ever relative to government debt. And while Citigroup is busy imploding, it just issued a report on its predictions for the gold market in the next two years. Citi is predicting gold could rise to $2000 an ounce (something New York Investing predicted many months ago). Their reasoning is that all the liquidity being pumped into the financial system is going to be highly inflationary (something New York Investing first said in September 2007). Rumors that China might increase its gold holdings from 600 to 4000 tons in order to help reduce its large dollar holdings (something else New York Investing mentioned as a possibility many months ago) seems to have contributed to Citi's bullish call on gold. All in all a clear pattern seems to be emerging - if only New York Investing would just shut up and stop making predictions, none of these things would happen and everything would just be fine - not!

NEXT: Synchronized Contractions Give Birth to Global Recession

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

What Banks and Enron Had in Common

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

The Subprime Crisis began to take a serious toll on bank and broker earnings by the third quarter of 2007. Merrill Lynch led the pack with a $8.4 billion dollar write down. Citibank reduced its earnings by $5.9 billion, UBS by $3.4 billion, and JP Morgan by $3.1 billion. Deutsche Banks had $3.1 billion in write downs, but still amazingly managed to post a rise in earnings (one wonders who did their accounting). There was of course a lot of chatter from the talking heads in the media about whether or not these write downs were the final word in the impact of the Subprime Crisis on financial company earnings. Even the most casual knowledge of stock market history would have provided the answer - 'no they were not!' Whenever earnings in a group of stocks start to fall apart, the first write downs are never the last and usually aren't even the biggest for that matter. This was the pattern when the tech bubble burst only a few years earlier and yet many media commentators couldn't seem to remember even that far back.
Even without a knowledge of history, there was more than enough evidence to indicate that financial company write offs might get much bigger and go on for a long time. SIVs - structured investment vehicles - had already hit the news many weeks before November of 2007. These off-balance sheet items (think Enron) were so obscure that most people on Wall Street had never heard of them. Suddenly, there were an extra $400 billion of possibly bad debt that was not on the balance sheet of the banks, but would be winding up there eventually. Citibank alone had $100 billion in credit exposure to SIVs. This new wrinkle in the Subprime Crisis was viewed as so serious by the U.S. Treasury Secretary that he attempted to organize a bailout (how he had the authority to do so is unclear) by getting a number of large banks and brokers to create a pool that could buy up SIV assets and thereby support their prices. While much ballyhooed by the press, this effort went nowhere and was eventually abandoned by December.

While the Treasury Department's plans for SIVs fell through, the Federal Reserve created an alternative that could help out the big banks. It allowed them to borrow against their (highly questionable) assets, but this necessitated bringing the assets onto the books. In December, Citibank indeed brought $49 billion in SIV assets onto it balance sheet. It is presumed that the other $51 billion the Citi had originally in SIVs had disappeared because of reductions in value. Indeed, it was reported in December that the total value of SIVs was then only $298 billion (it was quite possible that even this was a significant overstatement of their actual worth). If Citi had lost approximate $50 billion in its SIV investments, it was not fully (if at all) reflected in write offs in its first quarter 2008 earnings report.

Although SIVs were considered a serious threat to the stability of the banking system, little did the public know in the fall of 2007, that they were not the sum total of all off-balance sheet items that the banks were holding. After all, why would a company have off-balance sheet items unless it wanted to hide what it was really doing? Since there purpose is secrecy, how does anyone know how many off-balance sheet items a company has, what assets they contain, and how much those assets are really worth? While it would be reasonable to assume that if there was one type of off-balance sheet item on a companies books, there could easily be others, there was little if any speculation on this matter by the financial media. Only in February of 2008 was it reported that SIVs were actually only one type of off-balance sheet items held by the banks - and the possible losses were much greater than had been previously imagined. The accountants who did Enron's book must have been envious.

Next: Mortgage Insurer Meltdown.

Daryl Montgomery
Organizer, New York Investing meetup

For more information about us, please see our web site: http://investing.meetup.com/21.