I DID NOT HAVE SEX WITH THAT SIV

Unless you are very young, you remember the now infamous declaration by President Bill Clinton “I did not have sex with that woman.” Then there was the stained dress, and everyone said “but you did!” His reply was that “sex”, where he was from, meant intercourse and he did not have sex with that woman. The public was outraged! Liar! Liar! Impeach!

Today we find ourselves arguing over another definition, although framing the argument seems to be difficult because there is so much that is not known (even though we are talking about entities that can profoundly impact our economy). The definition in question is “value.” How much are the assets in those SIV things worth. This is a critical issue because if they are worth say 50, then the owner SIV would have to sell them. If they are worth 95, then they do not need to sell them or, if they do, they can sell them to this “super-siv” or M-LEC thing you’ve been hearing about ($80 billion bank fund) without any really bad repercussions for the banks. Rather than get into the details about what happens if the value is on the low side, lets just say it could cause the banks and, unfortunately, our economy some significant pain because it could trigger a massive de-leveraging. (Of course there will be some who are impacted little by this, and you can find a really good piece about that written by Ben Stein here: http://www.nytimes.com/2007/10/21/business/21every.html?ex=1350619200&en=bfe48f041e1a9aaf&ei=5124&partner=permalink&exprod=permalink). Such an event could easily lead to a pretty bad recession.

So what do we do about this? We morph the definition of value. Now, the people in charge of determining the value of these assets in question are not just people off the street. These are exceptionally smart people who have developed these SIV things using all kinds of mathematical models based on quantitative methods and such. I believe they know exactly what the assets are worth if they tried to sell them today, and accepting that value could trigger a very destructive de-leveraging. But they argue that value can be defined differently. What if we define value as what these assets may be worth if we wait for a really long time by selling them to a big daddy SIV (at, oh, lets say a value of 98), bring down interest rates (which causes the value of interest-bearing securities to rise – here is our inflation problem too), and hope that these assets pay out over time more than they are worth today? Hey, I like that definition! 98 it is! Who wants a recession anyway? “I did not hide the value of that SIV!” (Liar! Liar!)

PS:
In the words of William Poole, president of the Federal Reserve Bank of St. Louis:

“I think the big uncertainty right now has to do with the subprime paper: the extent to which there are owners that are potentially really stressed and are going to be forced to sell, how strong are their positions, to what extent can they gain financing from other sources so that they don’t have to dump assets,” Mr. Poole said. “They may be convinced that this paper is worth 60 cents on the dollar and they don’t want to be forced to sell it at 30 cents on the dollar. I really don’t know very much about that, and I suspect that a lot of the people even who run these funds, whose businesses run these funds, don’t know exactly where they stand on that and are out there trying to figure out what to do.”
From The Wall Street Journal Online Edition here: http://blogs.wsj.com/economics/2007/10/22/poole-sees-improvement-but-says-contagion-threat-remains/#comment-5676 .

Sounds like a lot of confusion for the President of one of our Federal Reserve Banks, especially when you consider that this all gets back to the sufficiency of bank capital in our financial system. Those "people even who run these funds," aren't those the major financial institutions regulated by the FED?

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