SIV-City

The Wall Street Journal says it is London.  The Yves Smith of Naked Capitalism cries foul: the real SIV-City is Citi.  

Yves Smith has a point.   The Journal’s reporting makes it clear that Citi – an American bank – was the center of the SIV-world, even if most of Citi’s SIVs were managed out of London and registered in the Caymans.

I thought the Journal’s headline “Gordian Knot: How London Created a Snarl in Global Markets” exaggerated in another way: London-based SIVs seem to have created a far bigger snarl in the US market than in global markets.   There is a reason why the US Treasury is trying to catalyze the creation of a super-SIV to create demand for the assets of existing SIVS – and why some global markets are doing a lot better than some parts of the US credit market. 

All quibbling about headlines aside, the Carrick Mollenkamp, Deborah Solomon, Robin Sidel and Valerie Bauerlein story is well-worth reading.  

It highlights something that I have long suspected: looking simply at the scale of cross-border capital flows may exaggerate the extent of financial globalization. 

What do I mean?

A Citi-sponsored SIV (with a back-up credit in dollars, but one that only covers a portion of the SIV’s liabilities) is registered in the Cayman Islands and managed out of London. 

It then sells dollar-denominated ABCP to US money market funds, and uses the proceeds to buy dollar-denominated asset-backed securities – securities ultimately backed by US payment streams.    

The paragraph probably should be in the past tense; there isn't much demand for ABCP right now, or for that matter, the kind of assets SIVS used to buy.  But let's set that aside, and get back to the example.

On the surface, financial globalization has gone up.    American investors are investing abroad – the commercial paper issued by a Cayman’s company (or a London company).   And foreigners – the Cayman registered fund managed out of London – buys a host of US assets. 

But in some deeper sense, financial globalization hasn’t increased.

Americans are still saving in dollars.   Their dollars are still being invested in the US economy.    

But for a host of reasons – and I suspect “tax” arbitrage is at least as big a factor as London’s knowledge of how to set up a SIV– American savings that is lent to American households or firms is routed through London or the Caymans.  

The capital outflow (US funds buying foreign ABCP), though, is balanced by a capital inflow (foreign purchases of US ABS).   It cannot finance a US current account deficit.   

And while measures of “home bias” based on the size of the US external balance sheet will show a fall, that fall is a bit deceptive.  

This isn’t to say that Americans are not investing more abroad.  They are – especially now that fast-growing foreign markets (like, you know, Europe) are out-performing the US markets.     

But American investment abroad – at least American exposure to foreign markets – isn’t growing as fast as the US BoP data suggests.  If you look at the details of the US data, the US lends a lot of money to London and the Caribbean, lending that is largely used to buy US assets.    

The net result is a lot more activity on the external side of the United States balance sheet – in part because more and more “structures” are used to avoid US taxes – without a commensurate increase in real financial globalization.

To me, there is a difference between the kind of financial globalization represented by buying dollar-denominated commercial paper issued by a SIV backstopped by a US bank that is used to buy dollar-denominated asset-backed securities and the kind of financial globalization represented by rising US holdings of foreign equities balanced by rising foreign holdings of US equities.    

There also is a difference between state-led financial globalization – one driven by sovereign wealth funds and central bank reserve growth – and private-sector led financial globalization.   But that is another topic.

But the two issues do interesect.  Some analysts now argue that official inflows are small relative to gross capital inflows – and their importance has consequently been overstated.  

I disagree. 

The US data almost certainly understates the real extent of official inflows – China is undercounted, as are Russia and the Gulf.  

And the gross capital flows data includes an awful lot of dollar lending to offshore financial centers – lending that is used to buy US assets.  Such tax and regulatory arbitrage pumps up the gross, but has no impact on the net.    

And the net is what matters.