Nesting

An SIV is a financial matryoshka doll.

What, you ask, is an SIV? There are long-winded answers to that question, but I think Dr. Hypercube has the right short answer. An SIV is a financial matryoshka.

Gzhel_russiandolls.jpg

The outermost shell is the SIV, which looks like a fixed-income mutual fund. Inside the SIV there are CDOs (collateralized debt obligations), which are slices of mortgage pools, each slice carrying a different, but hard-to-determine, level of risk. Inside the CDOs there are mortgages, many of which are never going to pay off, because inside the mortgages are houses, some of which couldn’t be sold for what is currently owed on them.

Each layer increases the opacity of the system, worsening the lemons problem that leads to unsalable assets and thus a liquidity crunch, and makes it impossible to know whether the liquidity crunch is just a short-term glitch or whether instead it covers a solvency problem for some of the financial institutions involved.

And that’s why Citigroup has to pay several points above prime on its short-term debt.

Update Krugman says it’s a solvency problem, not just a liquidity problem. But I’m not sure how he thinks he knows that.

Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact: Markarkleiman-at-gmail.com