All the Devils Are Here [189]
In addition to owning mortgage-backed securities, SIVs had 30 percent of their assets in financial corporate debt, according to a report done by the congressional Joint Economic Committee. In other words, banks were setting up off-balance-sheet vehicles that they could then use to buy not just slices of CDOs but possibly also their own debt—all without incurring any capital charges. It was a free fee machine and a self-funding mechanism—until it wasn’t. In the wake of Cheyne’s collapse, the SIV market cratered; Citi eventually absorbed $58 billion in troubled, but supposedly off-balance-sheet, SIV debt onto its own balance sheet at the worst moment imaginable. In addition, Citi, Bank of America, and other banks that had written liquidity puts ended up taking those assets back onto their own balance sheets. “Thus the sponsoring banks implicitly acknowledged that these... SIVs should never have been considered as separate entities from either an accounting or a regulatory perspective,” wrote the Joint Economic Committee in its report to Congress. Thus did another source of funding disappear from the market.
As the world would soon discover in spectacular fashion, the rating agencies weren’t wrong just about RMBS, CDOs, and asset-backed commercial paper.17 They were also wrong about the entire global financial system. In July 2007, Moody’s issued a special comment entitled “Another False Alarm in Terms of Banking Systemic Risk but a Reality Check.” “There is no easy way to predict whether a financial shock is systemic by nature,” Moody’s wrote. “The best way remains to look at the main financial institutions, i.e., the pillars of the system. In our view, their ability to withstand shocks is very high, perhaps higher than ever.” Although Moody’s conceded that “model risk has inexorably mushroomed,” it said that most global financial institutions had a “rather high degree of risk awareness.”
A few weeks later, in an “update,” Moody’s said that “there are currently no negative rating implications... as a result of [the banks’] involvement in the subprime sector.” The truly shocking thing is that Moody’s was willing to make this pronouncement even while acknowledging, in the very same paper, that there was no way the agency, or anyone else, could really know anything about the risks these institutions were holding. (“Public disclosures and position transparency make it virtually impossible for investors to accurately quantify each firm’s credit, market and liquidity exposure.”)
That was precisely the problem. The issue wasn’t actual cash losses. It was uncertainty. No one knew where the subprime problem would pop up next, no one could figure out what any of this stuff was worth, no one believed what anyone else said about what it was worth, and no one believed that anyone who was supposed to know something actually did. That included the nation’s top regulators. “I’d like to know what those damn things are worth,” Federal Reserve chairman Ben Bernanke said during an appearance at the Economic Club of New York in October 2007.
Bernanke’s comment infuriated an outspoken, deeply skeptical Georgia mutual fund manager named Michael Orkin. Not long after the Fed chairman’s speech, Orkin wrote in his monthly letter to investors, “Since the first shot was fired across the credit bow in February 2007, investors have been force-fed a constant diet of half-truths and whole lies regarding the nature and status of the mammoth mortgage-based derivative machine and the housing market bubble it inflated... The fact that the credit crisis has now turned into a confidence crisis should serve as a wake-up call to Wall Street, the Treasury and the Fed.”
In late November 2007, a senior vice president in structured finance at