Those are very good points, but I was making a very specific argument: that this summer (starting in August) buyers started repudiating commercial paper, and the concern they gave was possible subprime exposure. No mention at the time of concern about Alt-A or option ARM.

Remember, the proximate cause had been the failure of a fund related to German bank IKB due to subprime exposure, and then the halting of redemptions from three funds run by Paribas because they had roughly 30% subprime exposure and according to them, could not fairly value the assets to allow for redemptions in a way that would be fair to the investors who wanted their money back and the remaining investors.

So the news that caused the panic was about subprimes, not about the other sorts of mortgage exposures, And that’s what investor comments to the press stressed. Recall also that US money market fund investors were redeeming out fear of subprime exposure, adding to pressure in the market.

As for Fitch, while it’s hard to know what they know, SIVs are easier to evaluate than CDOs and even regular structured mortgage deals, which is where their ratings have become suspect.

This paper by Fitch goes into mind-numbing detail about the legal and financial structure of SIVs, and the characteristics of the SIVs that Fitch rates. It is worth noting that SIVs are not as complex financially as CDOs or even traditional asset backed bonds. You have a pool of assets and three elements in the capital structure: commercial paper, medium term notes, and equity (some have a small subordinated layer between the MTN and equity.

However, another reason the rating agency grades are now viewed with suspicion is that they downgrade late. They tend to do that anyhow, even with corporate securities, and the tendency is worse with asset-backed securities. So that is a fair reason to worry about SIV ratings.

A paper by Joseph Mason and Joshua Rosner goes in gory detail through what is wrong with CDO ratings. Most of the problems they cited to not apply to CDOs (which isn’t to say that there may not be problems with SIV ratings too, but that as much as everyone likes to blame the rating agencies these days, the flaws in the process with CDOs doesn’t establish that their SIV ratings are screwed up, although given their track record, it is certainly a reasonable suspicion).

These figures are given in an FT Alphaville post.

Caution: the source is a commenter on Nouriel Roubini’s blog. But if the numbers are verified, then the only institution with a Level 3 to equity ratio less than 100% is… Merrill Lynch.

Yes but when they count subprime paper, are they including “non-subprime” Alt-A and Option ARMs? It seems many do not. (See the IMF graph of ARM resets/recasts that has been making the rounds in the past weeks.) As if the magic of a high FICO score (the only way I can see a piece of toxic crap like an Option ARM being considered “non subprime”) will allow people to cope with doubling or tripling payments that or increasing payments far beyond their “stated income”.

Also, does Fitch even know what is in the stuff they rate? The rating companies seem amazingly clueless.

-Structured credit products—Structured credit products include synthetic CDOs and other complex derivatives. Synthetic CDOs are not collateralized by a physical portfolio of assets like bonds or loans. Instead, synthetic CDOs gain credit exposure to a portfolio of fixed income assets through the use of credit default swaps. Only structured credit products where key inputs, such as correlation, are not observable are classified as Level 3.

or-Asset-backed commercial paper (ABCP)—ABCP is short-term debt issued by an SPE. The SPE issuer uses proceeds from the issuance to purchase asset-backed securities. Repayment of ABCP is dependent on collections from these investments or the issuance of new ABCP. This inventory is classified as Level 3 due to illiquidity in the ABCP market during the 2007 third quarter.

They have additionally placed 15.1bn of ‘loans held-for-sale’ in Level 3.

Incidentally I am willing to bet that for all the big wall street banks, level 3 assets are now well above 100% of total stockholder equity (or for that matter tier 1 capital).

AI

http://ftalphaville.ft.com/blog/2007/11/06/8630/commercial-paper-freeze-forced-citi-to-add-25bn-subprime-cdo-exposure/