This has mostly happened through the growing diffusion of “conduits” and structured investment vehicles, widely know as SIVs[3]. These are entities, off the banks’ balance sheet, that invest long-term, largely in high-yield asset-backed securities, and raise short-term finance by issuing correspondingly collateralized commercial paper (so-called asset-backed commercial paper). The banks provide such entities with financial guarantees that only appear below-the-line in their balance sheet, playing the role of last-resort liquidity providers if and when difficulties of refinancing arise. The precise extent of such commitments in the aggregate and for individual banks is unknown. According to market estimates reported by the BIS outstanding asset-backed commercial paper reached a sum of $1.5 trillion last March, of which some $300 billion was based on mortgage-backed assets. According to another estimate, European banks have more than $500 billion invested in asset-backed-commercial-paper conduits with German banks holding a quarter of this sum.

As the prices and market liquidity of the collateral collapsed, refinancing by rolling over the outstanding commercial paper has become almost impossible. This is why the committed banks and financial institutions have been required to provide emergency liquidity. In this way, some of the credit risk that was transferred to the market by the banking system has re-emerged on the banks’ books, straining capital requirements to an extent depending on the size of the commitment relative to the assets of the bank. Two small German financial institutions (IKB and SachsenLB) found themselves exposed to their vehicles to such an extent, that they had to be bailed out with emergency rescues. The position of bigger banks, with more solid capital positions, has obviously not reached anything near a critical stage, but the suspicion of hidden difficulties infects the market. The problem is compounded by the fact that when the credit risk transfer mechanism froze in August, some core banks which arranged bridge financing for important private equity operations found it impossible to pass on the risk as usual. They are now unable to securitize and transfer the credit that they granted on the eve of the crisis (to the tune of over 200 billion).