Structured Investment Vehicles: The Unintended Consequence of Financial Innovation

Twenty years ago, structured investment vehicles (SIV) did not exist. During the two decades since their inception, SIVs grew to more than $400 billion in assets and represented about five percent of the U.S. corporate debt market. By the end of 2008, SIV assets had become virtually extinct. There are currently no remaining SIV assets that are not in bankruptcy or rating agency enforcement. In essence, SIVs are unregulated companies that engage in the banking business. Without deposit insurance, SIVs became subject to the rapid loss of funding that is generally known as a run on the bank. In an atmosphere of deception, people possessing a false sense of confidence bought houses they could not afford. The banks lent them the money and sold the mortgages to SIVs, which returned the cash to the banks to support more borrowing. This pattern was given further impetus in the presence of lower interest rates, resulting in significant market distortion. Regulators watched and did nothing. In the future, financial market participants must examine the incentive implications of financial innovation. In this case, financial engineering unleashed adverse incentives of which unregulated nonbank entities took advantage.