More Off-Balance Sheet Risks: Conduits

(Alt title: Move over FASB 157 — FIN46-R is in town).

While investors of banks and brokers breathe a sigh of relief over the Citi-group rescue, another problem is on the horizon: Conduit financing.

From The Next Credit Scandal by Fortune’s Peter Eavis.

"The failure by banks to properly inform shareholders of their potential losses is perhaps the biggest scandal so far of the credit crunch that began this summer…The lack of disclosure not only has unsettled investors, but also has raised the prospect that large losses are lurking in other parts of the banks’ businesses.

One likely new trouble spot: Conduits, the opaque structures banks set up to provide debt funding to borrowers. Often, the debt issued by the conduits is collateralized with assets, like mortgages.

Conduits typically aren’t consolidated on a bank’s balance sheet. But banks are often on the hook to fund them if investors stop buying the debt they’ve issued. When that happens, a lot of risk can get moved onto the balance sheet.

Now, conduits could trigger a similar process at many big banks. Since demand for certain types of conduit debt has shrunk dramatically and bad loan numbers on subprime debt are soaring, banks could well end up absorbing large amounts of conduit debt."

Run-don’t-walk to read the full piece . . .


The Next Credit Scandal
Peter Eavis
Fortune, NOVEMBER 26 2007: 10:15 AM

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What's been said:

Discussions found on the web:
  1. Marcus Aurelius commented on Nov 27

    How much more junk can they hide in the closet? When they finally open the door, you’d better stand back.

  2. peter from oz commented on Nov 27

    following up my previous comment on the “rescue” the clock is ticking to 31/12 and big ticket vulture investors will take no risk high priced positions in medium term quality assets using dollars they are reaping from an inflated oil price (and/or to buy some time for the big end of wall street perhaps a desperate administration is calling in some some strategic mid east chits)
    meanwhile back at the ranch the ostriches celebrate this show of “confidence in the market” because they are so comfortable with their head in the sand this close to christmas
    rgds pcm

  3. Francois Theberge commented on Nov 27

    In all the clusterf*ck that is the so-called “subprime” mess, one little data point that really get under my skin is the fact that investors bought these CDO’s, RMBS, and all the alphabet soup of securitized stuff, trusting the rating posted by agencies like Moody’s, Fitch and companies. Said ratings were provided by the sellers who paid for it.

    What would you think of a home buyer that would trust on faith, an inspection report paid for by the seller??

    And now, we, the taxpayers, will most likely be called upon (whether we like it or not) to bail out (some if not all) buyers and sellers alike?

    F*ck me plenty!

  4. Francois Theberge commented on Nov 27

    Gotta love that one:

    “The FAILURE by banks to properly inform shareholders of their potential losses is perhaps the biggest scandal so far of the credit crunch that began this summer.”

    Are you kidding me?

    I see no failure in here. Since banks were not obliged by law to do it, they didn’t. Why run the risk of discomfort, blame, pain and suffering when it is oh so much easier to hide the bad stuff?

    If one wants to talk to me about failure, why not turn the attention to Washington DC? They’re the ones in charge of mandating and regulating financial institutions.

    At the risk of sounding like a broken record, I’ll say it again: Our politicians will start working for us the day we, the people, pay them. (public financing of electoral campaigns)

    When Dave Davies interviewed Senator Kennedy on Fresh Air, he asked him: “What is the thing that has changed the most in the 43 years you have been in the Senate?” Answer: “The influence of money”

    (starting at 20:55min)

    Said influence has been enough to brainwash DC on the virtues of “industry can self-police their behavior”

    Got several bridges to sell you: bulk discounts are accepted.

  5. rp commented on Nov 27

    Interestingly enough, it appears that at least one back (HSBC) just moved $45 billion of SIV’s back on to their balance sheet, acknowledging that they bear ultimate responsibility for the attempt to shift the risk off the balance sheet. I wonder who will be next?

  6. Estragon commented on Nov 27

    Unless you’ve been living under a rock on Mars for the last 10 years, you probably already know that banks have been earning more fee income and less interest margin income. That’s what investors wanted, and bank managements responded to varying degrees. In other words, that banks structure lending off their balance sheets and generate fee income isn’t new news.

    Eavis is trying to morph this widely known fact into a scoop, and to paint it as some sort of deep dark conspiracy.

    The fact is that NOBODY knows the extent to which these structures will end up on banks’ balance sheets, and NOBODY knows what, if any, hold-to-term losses will ultimately be. If banks started abitrarily adjusting reserves for every contingent liability out there, they’d be legitimately accused of cookie-jar accounting and possibly options fraud. Eavis would likely be at the front of the lynch mob, and rightly so.

    There are lots of other issues in the credit mess, and I’m a bit disappointed that Eavis is going into hysterics over red herrings. I guess it’s an easier sell in MSM than say, the potential for cascading failure of counterparty risk modelling.

  7. peter from oz commented on Nov 27

    agree its not a scoop
    conduits as common as muck for years along with cdos and sivs etc etc
    but until the great unwashed become educated thru the mass media/popular magazines such as fortune or dare I say it business week the big end of wall street can maintain the rort e.g lehman did the most damage to the little man and the “sophisticated” corporations here in oz with their “eminence” and “yield greed” being the only marketing tools
    no point depending on cnbc because the illiterate can’t educate
    as discussed with barry don’t knock a free wsj at least uncle rupert broadens the scope for some investor literacy with access to some quality reporting
    rgds pcm

  8. peter from oz commented on Nov 27

    cascading failure of counterparty risk modelling is the coup de grace
    unfortunately my clients and friends think a coup de grace is a christmas cocktail and my highly indoctrinated well educated overpaid juniors reject cascading etc angrily as it devastatingly extinguishes the lustre of their education and their raison d’etre
    don’t expect any publicity or warning any time soon
    hmmm just like a tsunami i’m told
    rgds pcm

  9. Snarky commented on Nov 28

    The counterparty risk can be in the billons.

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