Recession Triggers Firing – When Money Disapears

| November 26, 2007

Dollar Fire.jpg

Recessions are interesting things, the most interesting part of which is just how the world financial powers have been able to avoid any significant ones for quite some time. The minor one just after September 11th, 2001 was avoided by the central banks opening up the flood gates and swamping the economies with easy money. It may come to be proven later that this action laid the foundation for the mess we are entering now.

Today we are going to talk about Conduits and SIVs – Structured Investment Vehicles. If you are a normal person you don’t know about these things and probably could (and should) care less. But SIVs and Conduits are going to be shown at the end of the day to have been one of the prime movers in what could be a very nasty financial down turn.

SIVs are complex “deals” where a financial institution creates a “Structured Investment Vehicle” (SIV) that gathers up large amounts of investment money. In recent years many of these were formed to purchase bonds that were backed up by mortgages. They were held off the balance sheets, so gains and losses never appeared on the company profit reports. This means companies like Citi and Merrill are able to have these huge funds and never have to report the shareholders the liability they involve.

Let me shine a light on a nasty corner of this strange, opaque instrument: Moody’s says some SIV NAVs have fallen below 50%

What this strangely worded article means – many of these SIVs, that are not being reported to shareholders or the federal government, are now worth less than 100% of the money that was put in them.

Moody’s yesterday said that the average NAV across the SIV sector has fallen from 101% at the beginning of July to 71% at the beginning of November, and the shut-down of the CP market has led to realised losses in some cases.

What that means – $100 invested in these SIVs was worth $101 in July. Today that same $100 is worth $71, in some funds it is now worth less than $50. Now you may think it’s just fat cats losing some of their walking around money, and I am sure there is some of that going on. But we will come to find out as this unfolds that money from your insurance company, your pension plan, the bank that you have your checking account with and even your state government put huge sums of money into these looking to make some “easy money”. This is not a US problem, banks and investment firms across the world were in on these deals.

What is happening is money is evaporating out of the economy. When that happens there is less to invest in new projects, or maintaining old. This is the beginning of deflation in the money supply, and it’s one of the things that scares the US Federal Reserve, the Bank of England and the EU Central Bank the most. At present they are trying everything they can to slow its velocity. In spite of their best efforts, it is at present accelerating.

Why does deflation matter? Put it in personal terms. Let’s say you bring home about $2000 every 2 weeks as pay from your job. You find out this morning that you have to take a pay cut, and now only bring home $1500 every 2 weeks. For most people this would be cause for serious round of “what can we do without to make ends meet”? As a result your family would pull back even harder, worrying that you may have to endure another cutback sometime in the future. Your friends and relatives start to worry the same might happen to them, so they start cutting back and stockpiling ready cash – taking it out of the economy. As money either real or expected is removed from the economy, it hurts everyone eventually.

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Category: Economics, Main, Recession Watch

About the Author ()

Bruce Henderson is a former Marine who focuses custom data mining and visualization technologies on the economy and other disasters.

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