One of the benefits of these boards is the facility for the less well informed to listen and learn from a bunch of pros talking to each other. But it’s sometimes easier to detect that contributors know what they are talking about than to understand what they are saying. Fortunately, some of these guys occasionally throw in an explanatory piece for the unseen audience.

BertEEE did it with post 2582, which elicited appropriate appreciation. The crucial bit IMO was this tantalising para quoted by m06een00:

SIV's/ABS/structures complicated this. Using one of these a bank could set it up - put in say $500m as capital, then the SIV would leverage up by say 20 times (to say $10bn) then use that $10bn to buy loans back off the bank. So the bank lends to Mr X, sells the loan on to SIV Z (clearing it off their balance sheet and taking a margin for making the loan in the first place), then as they've had the money back off SIV Z they can lend it again! and again! and again! Even better. The $500m they have as capital in the SIV is an asset, so they can class this in their asset pool and lend even more money off it! [Now thats clever and the evolution of this is basically whats been the driver in the decade+ long credit expansion we've seen]

Do we have here in a few lines the root cause of the greatest global financial crisis since 1929? I suspect we do - but there are still a few chinks that need filling in for us plebs.

SIV's/ABS/structures complicated this. Using one of these a bank could set it up - put in say $500m as capital, then the SIV would leverage up by say 20 times (to say $10bn) then use that $10bn to buy loans back off the bank.

So a ‘SIV and other things’ is a company (thanks John Corey), set up in this case by a bank which injects $500 of capital. And the SIV can borrow up to say 20 times its capital to $10bn because it’s not a bank and subject to capital ratio rules.

At this point, is the SIV still owned by the bank that formed it (surely not????) or has it been sold/transferred to another party (Hedge Fund99)?

Assuming the latter, HF99 then uses its borrowed $10bn to buy loans (MBS1) from the same bank (in this instance). It is assumed that the yield on MBS1 is better than the interest charged by the bank for lending HF99 its $10bn and that it will stay that way!

In an either/or situation, these two transactions would make no sense for the bank. It would be better to retain the higher yielding loans and not lend at a lower rate to HF99. But if the bank can take a rake off from each transaction and then make more loans (MBS2) because MBS1 is now off its balance sheet, it does make sense because the process can continue ad infinitum.

Even better. The $500m they have as capital in the SIV is an asset, so they can class this in their asset pool and lend even more money off it!

Makes me think in this case the SIV is still owned by the bank, i.e. just an off balance sheet subsidiary, 'borrowing' money off the parent to 'buy' more loans from the parent, which the parent can provide repetitively because basic banking rules have been evaded. I bet the bank would make sure such loans were insured against default . . . . . . hmmmmm.

[Now thats clever and the evolution of this is basically what’s been the driver in the decade+ long credit expansion we've seen]

It puzzles me that what seems like a reckless ponzi scheme has survived for so long without regulation. Central banks must have been fully aware and even the odd politician.

DoY