Nah, Chriss Street’s not distracted.

There has been a great deal of discussion about the issue of the County investing about 14% of its portfolio, $837 million, in high-risk Structured Investment Vehicles, (SIV) the largest such investment of any local government entity in California.

So what are SIV’s?

From Wikipedia: A structured investment vehicle (SIV) is a fund which borrows money by issuing short-term securities at low interest and then lends that money by buying long-term securities at higher interest, making a profit for investors from the difference. SIVs are a type of structured credit product; they are usually from $1bn to $30bn in size and invest in a range of asset-backed securities, as well as some financial corporate bonds. A SIV has an open-ended (or evergreen) structure; it plans to stay in business indefinitely by buying new assets as the old ones mature, and the SIV manager is allowed to exchange investments without providing investors transparency / the ability to look through to the structure.

The risk that arises from the transaction is twofold. First, the solvency of the SIV may be at risk if the value of the long term security that the SIV’s has bought falls below the short term securities that the SIV has sold. Second, there is a liquidity risk, as the SIV borrows short term and invests long term i.e. outpayments become due before the inpayments are due. Unless the borrower can refinance short-term at favorable rates, he may be forced to sell the asset into a depressed market. 

Andrew Bary over at Barron’s Online describes them this way…

SIVs are held off the books — sound like Enron? You’re right. It was off-balance-sheet liabilities that played a major role in Enron’s collapse. Banks keep SIVs off the books to reduce the amount of assets they must keep on hand according to federal regulations.

A friendly warning, this post is a little bit long. There’s a lot to cover, but I think it will be worth the time

The Orange County Register’s Ron Campbell reported on Saturday regarding the SIV crisis.

Orange County Treasurer-Tax Collector Chriss Street said Friday he’s sticking by his $837 million bet on structured investment vehicles.

Street pointed to Citigroup’s $58 billion bailout of its own securities – including five in which he invested $215 million – as proof the controversial investment will work out.

Two weeks ago, Moody’s Investors Service said it might downgrade hundreds of the securities, including 11 in which the county invested $460 million. Another six county-owned securities worth $377 million were not threatened.

Among California local governments, Orange County is by far the largest owner of these securities. They comprise 14 percent of the county’s $6 billion pool.

A Register survey found that only one other county among the 15 largest counties had owned the securities. That county, San Diego, got out last month. At their peak, the securities comprised 1.25 percent of San Diego’s pool.

Street said his office has more knowledge and expertise than other county treasurers do.

Asked if his office has more expertise than the state treasurer’s office – which manages $62 billion in public funds but does not invest in these securities – Street said he was just comparing himself with other county treasurers.

Street held a workshop about SIV’s on Friday afternoon, where he tried to convince the assembled media that the County’s SIV investments are “sturdy, strong, and safe.” Street based the foundation of his safe and sturdy argument on two factors, the still positive credit ratings of the County SIV holdings, and the decisions of the two banks managing the bulk of the County’s SIV investments to place these investments on their books, in an effort to shore up their stability and avert a mass sell off.

Then Street’s analysis took what I find to be a wild diversion from logic. He claimed that the fact that those banks have placed these instruments on their balance sheets is a testament to his “teams’ calm, conservative, and rational approach…as evidenced by our handling of the current SIV situation.”

Huh? These banks did not place these investments on their books out of the goodness of their hearts, and there was no guarantee that they would take such action. Their actions were solely based upon their own corporate self interest of preserving their reputations and preventing a run on selling these investments. And as far as the Moody’s and other ratings are concerned, if the banks had not acted, the SIV’s in question would have, without any doubt, been negatively downgraded.

Street further claimed in his workshop that it was an unprecedented sign of openness, I believe he called it “transparency,” that he disclosed the November 30th credit watch notice from Moody’s to the Board within two business days. This claim appears valid on the surface until you dig deeper into the facts of the SIV market problems and when people started to notice that there were some major problems on the horizon for SIV’s.

There was this press release from Rabobank regarding their Tango Financial SIV from June 12, 2007. Orange County has $165 million invested in this SIV.

“Rabobank believes there is no immediate prospect of the funding situation for SIVs improving in 2008. To prevent a potential fire sale of high quality assets, the bank has announced that it is prepared to take the remaining assets of Tango onto its balance sheet in early 2008.”

That could have been a warning.”

There was also this report from Reuters on August 22, 2007.

Money-market funds, which are big buyers of commercial paper, are spooked by possible contagion from subprime mortgages, or risky home loans granted to low-credit home buyers, and are shunning commercial paper backed by assets.

As a result, SIVs can’t raise any new funds and could soon be forced to dump more than $120 billion in investments — including higher-rated securities backed by mortgages and collateralized debt obligations, or bonds backed by other types of debt — on jittery investors who are already fleeing risk.

While alarming, I suppose it was just too early to sound alarm bells in the Treasurer’s office.

There was this in mid-October.

Finally some possible good news: There may be a solution to the credit crisis caused by shaky subprime mortgages. Citigroup is leading the charge to piece together a pool of funds with other big banks that would financially back as much as $100 billion in shaky mortgage securities and other investments, according to the Wall Street Journal. Talks to work out this solution started three weeks ago at the U.S. Treasury Department, which is playing a crucial role in making this happen. Success in putting this fix together may be announced as early as Monday. Two other key players in these talks are Bank of America Corp. and J.P. Morgan Chase & Co., which don’t have SIVs but would earn fees in helping to arrange the fix.

In August, banks holding SIVs had difficulty rolling over their short-term debt, which seized up credit markets until the Fed stepped in and encouraged banks to borrow money by reducing the rate at which they could borrow it.

SIVs are held off the books — sound like Enron? You’re right. It was off-balance-sheet liabilities that played a major role in Enron’s collapse. Banks keep SIVs off the books to reduce the amount of assets they must keep on hand according to federal regulations.

Of course there was this from Barron’s Online on October 24th, which I found over at that might have given Street a clue.  

WHEN A POST-MORTEM eventually is done on the now-infamous structured investment vehicles, one likely conclusion is that key participants in the debacle, including Citigroup and buyers of SIV-issued debt, took on a lot of risk and received very modest returns.

There’s plenty of blame to go around in the SIV crisis, which became front-page news last week when three banks — Citigroup, Bank of America and JP Morgan — agreed to create a fund to buy $80 billion or more in SIV assets in order to provide funds for the SIVs to redeem maturing debt. In hindsight, SIVs were another dubious leveraged creation from Wall Street.

Citigroup, the leading issuer in the $400 billion SIV market, should have realized that it was earning very little, while risking its reputation and exposing itself to potential financial losses. Citigroup may have netted just $150 million annually from its SIVs, a rounding error for a bank with $30 billion of pretax profits last year.

The major rating agencies have another black eye because they’ve had to downgrade the formerly prime credit ratings on the debt of some SIVs.

So let’s review…

  • On August 23, 2007, former OC Treasurer and current Second District Supervisor John Moorlach called upon his former protégé, and hand picked successor as Treasurer, Chriss Street to resign. Moorlach put it this way: “…the public investigations and the civil suits, give rise to an appearance that would cause most fair-minded persons to question Mr. Street’s judgment. But, while Mr. Street is certainly entitled to his day in court on the allegations, it is unfair to the public and the taxpayers and citizens of the County of Orange to have their elected Treasurer-Tax Collector divide his time between the duties of his office and personal legal battles.”
  • On November 29th I pointed out the Street has had a great deal of difficulty making it to, or sitting through, the meetings of the Orange County Employee Retirement System Board of Directors.    
  • The problems with SIV’s was starting to be noticed as early as June 2007 and became widely known in mid-October when the US Treasury Secretary negotiated an $80 billion security fund with major banks to shore up the SIV market and prevent a panic in that market.
  • SIVs are held off the books. It was off-balance-sheet liabilities like these that played a major role in Enron’s collapse. And we’ve are invested 14% of our money in them.
  • The County Treasury Investment Committee discussed SIV’s in September and Street provided the Board with the record of that meeting in his September Management Report. (I’m still looking for the report on the Treasurer’s website, but it isn’t included in his report online. Found it) My guess is that everyone was assured that everything was fine; noting to worry about. A quick review shows Street indicating the stability of the very SIVs that were placed on watch.
  • True transparency would have required our Treasurer to inform the Board of the problems with SIV’s and offer his assurances long before Moody’s made their decision. But given the timing, it looks as though Mr. Street may have been distracted by something starting in early August and continuing up through the end of September. You can find all the distractions here.

Street got lucky this time, and the major banks stepped in to cover the potential for losses when they really didn’t have to. That luck is not an example of the investing skills of Street or his staff as he tried to spin us yesterday. It is just luck, plain and simple.

Street reminded us on Friday that Moody’s and Fitch have rated the County of Orange as AAA credit risk. That’s great.  The problem is that this rating is in good part based upon the confidence of these rating agencies in the skills, ability, and performance of our Treasurer. Negative perceptions of that competence, justified or not, can jeopardize those ratings.

The problem that Street faces is not so much the risk that these investments may bring down the entire County investment pool; rather it is the lack of confidence in his ability to perform the task of managing the County’s investments while also dealing with multiple investigations and litigation that it creates.

In a poll of registered Orange County conducted by the Orange County Employees Association in mid-September found that voters are not happy with Street maintaining his investment, puchasing, and contracting responsibilities. 58% support removing Street’s authority in those areas. 

“In 1994 they told us not to worry and it was only a paper problem. I’m more worried in 2007 than I was in 1994,” OCEA General Manager Nick Berardino said. “When they say not to worry, it’s time to start worrying because the last time they said that, the entire pool collapsed.”

Berardino goes on to say; “By neglecting to take action, the Board of Supervisors is out of step with the voters.”

My favorite inconsistency of Street’s comments on Friday was this. When asked by the Register’s Ron Campbell whether he would invest in SIV’s again, his answer was no.

That leaves me with a burning question, if these SIV investments are as sound as he is telling us they are; why not?

Like SIV’s, I believe Chriss Street is a risky investment for the taxpayers of Orange County. Keeping him in direct control of our investment pool is simply too great a risk.  The Board needs to strip Street of his investment powers until the storms surrounding him have blown over.

On the matter of Chriss Street Supervisor Moorlach was right… it is unfair to the public and the taxpayers and citizens of the County of Orange to have their elected Treasurer-Tax Collector divide his time between the duties of his office and personal legal battles.