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Sunday, March 23, 2008

BANKS - Acrobatic BalanceSheet Management - Thesis

author thomas ramseyer
Pump it up, yeah... pump it up!

1) Grant credit - balance sheet is growing, full risk exposed, affecting liquidity rules

2) Found SPV (Special Purpose Vehicle) - purpose thereof is to relieve balance sheet from credits and the sort, making liquidity available to other tasks (capital contribution amounting to some 5 % of the SPV's total balance)

3) Give short term credit to SPV in the first place (amounting to some 95 % of the SPV's total balance)

4) Transfer debits, bonds, constructs to SPV (exchange total short term assets for variety of constructs, debts and bonds)

5) Create Bonds amounting to some 95 % of SPV's total assets to refinance short term credit granted by creator to SPV

6) Hardsell bonds to individuals, pensionfunds, funds supported by rating agencies - risk transfer of 95 % of SPV's total assets; only 5 % remaining with the originator or a related holder of the equity.

7) Run SPV as a shareholding (investment) - only net worth to be shown (some 5 % of SPV's total assets) thus taking the interest rate spread on 95 % as a profit (high leverage)

Scenario a) worst case
see 6) created bonds to refinance SPVs' short term credit were not yet absorbed by the market when real estate prices were cut down because of lack of buyers.

While deterioration of real estate market was speeded up by executed house-owners, investment banks still invented more SPVs on stock - full risk-exposure as if the programme was stopped at 5) <>

Scenario b) moderate case
see 7) Risk transfer of 95 % to final investors; risk-exposure for 5 % of the SPVs' total assets only

I think it to be likely, that banks' riskmanagers were not aware of the fact that those investments - residing within two different asset classes - considered shareholding on one hand and granted liquidity to agency-rated A or higher class vehicles on the other hand bore the risk of all the assets originally transferred to the SPVs.

Furthermore Investment Banks may have partly bought protection via credit default swaps (CDS) from the central risk management desk within the organisation. It is common knowledge that there risk may be measured by diversification as well as based on rating agencies' opinions. In short: someone shifting a hot stone from his left to his right pocket may still feel the pain.

This is supported by the fact of the major banks' staggering revelation of the desaster hidden up their sleeves. I.e. first discover and reveal loss on SPVs residing as shareholding, then become aware of the fact that short, medium or long term investments may be affected too and reveal write-offs thereon.

Remedy of risk management systems to be applied in the next round:

Full consolidation i.e. for risk management purpose state all individual holdings as if the mother company was the holder of the full construct. Advantage: the real debt-equity ratio shows up thus pointing out the equity's vulnarability. Risktransfer activity within the affiliated group is balanced thus showing the real risk exposure.

With the actual recession - which even might lead into stagflation - taking place in the US, estimated demand for another USD 400 bio write-offs (from 200 to 600) might come true. Central banks' USD 200 bios' liquidity injection does not help; no one can be trusted any longer.

Thus major banks may use short term money to just refinance US treasury bills and bonds. They even may be able to invest the money abroad. (USD weakness!, force liquidity out of US- into foreign money systems)

copyright Thomas Ramseyer