Liquidity risk: Jump to it
How do you price liquidity risk?
If there is one thing that buyers and sellers in structured finance can still agree on it is that mark-to-market accounting has utterly failed. The fact that investment banks have clubbed together to create a fund to mop up forced sales from ABCP conduit and SIV vehicles indicates the extent of the destruction it has caused. Much as the banks involved do not want this action to be compared with the bail-out of LTCM, the objectives are the same: to prop up the value of assets and avoid a fire sale.
This move is prompted not only by the banks’ desire to avert a total wind-down in the SIV sector but also by the fact that they know the assets are worth much more than their marks suggest. SIVs bought at the very top of the capital structure and (with a couple of exceptions – both of which have paid the price for it) had limited exposure to US sub-prime. But, according to Moody’s, SIV capital Nav fell from 102% in June to 85% at the beginning of September.
To say that SIVs were not modelled to deal with the type of market disruption that has occurred is an understatement; they were structured to withstand a maximum of five days’ disruption in the CP market.