The Next Subprime Mess

Get ready for another financial debacle. This time it is going to be those nasty SIVs. No, I don't mean SUVs, which I guess the "Green Movement" would consider to be nasty. SIVs stand for "Structured Investment Vehicles. Trust me, SIVs will become as well known as those SUVs we drive.

These investment vehicles are entities that banks use to issue commercial paper, which is a money market instrument. With the proceeds, banks purchase corporate receivables, auto loans, credit card debt, and, yes, mortgages. Why is this so alarming? Take Citigroup, for example. Citigroup owns about 25% of the market for SIVs, which is approximately $100 billion according to the "Wall Street Journal" in its September 5, 2007 edition. Yet, in its 2006 filing with the SEC, there is no mention of it. What? How can this be? Well, accounting rules don't require banks to separately record these type of off-balance sheet investment vehicle on their main financial statements. One would have thought that the accounting profession would have learned something from Enron, World Com, and Global Crossing. The demise of each of these companies was directly tied to off-balance sheet vehicles.

The Federal Reserve System has a major challenge ahead of itself in trying to bring stability and trust back to the financial markets. In my opinion, these challenges are a direct result of their own polices instituted during the past five years. The banks and financial markets did not create this subprime mess or pending SIV mess. The Fed did that all by themselves. The banks and financial markets were just reacting to what the Fed was doing. That is, when the Fed reinflated the banking system with reserves (money), banks made loans. Because interest rates were low, which was caused by the Fed reinflating the banking system, individuals were more than happy to refinance their homes and draw down their home equity. This resulted in real GDP growth. However, the consequence of all this liquidity has been the inflation of all financial assets. Like all bubbles, they do burst; and we have already seen the subprime bubble burst. The next one just could be those nasty SIVs.