So why are the banks so keen to rescue them? It’s not about the SIVs per se but fear of collateral damage, the knock-on effects of the assets of SIVs being sold at fire-sale prices because too many assets come on the market at once. Most people have focused on the impact if players like investment banks have to mark similar assets to market. They may have some similar unsold inventory, but the bigger impact is likely to be that they will mark down the price of collateral against which they have made margin loans, which will lead to margin calls and probably forced selling.

The other collateral damage scenario is the one from Accrued Interest: that the focus of worry may instead by money market funds. Forced sales from some SIVs would put the value of other SIVS in even greater doubt, and if a money market fund had too much exposure to similar paper, it might “break the buck.”

Banks are involved in SIVs to make money; namely they buy asset backed paper (CDO’s) on a long horizon and issue commercial paper on a short horizon, then pocket the difference. The CDO’s pay a higher rate and until recently had a stable NAV.

The Fed’s job is to make sure the banking system is stable. By lowering rates, they make sure the $400B in SIV bets banks made aren’t out of the money. Because if short term rates goes higher than the long term rates locked in on those CDO investments, the whole thing is a money loser.

The credit markets froze because nobody wanted to lend short term money to a bank that might give it to a SIV that was about to blow up.

The M-LEC super SIV might be a plan to lock as much capital in as possible for as long as possible at the Fed’s currently low rates, because they might not stay low forever. At the same time, they’ll buy up all the distressed CDO’s they can. The lower the NAV, the higher the yield on that toxic waste.

Two lessons: banks always make money; and the Fed isn’t going to let $400B go out of the money.