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The Unravelling - Chapter 10

The Unravelling - Chapter 10

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Published by ritholtz
Dr. Henry Tabe is the author of The Unravelling of Structured Investment Vehicles: How Liquiditiy Leaked Through SIVs: Lessons in Risk Management and Regulatory Oversight.

His book on SIVs traces their origins in the late 1980s to their eventual collapse in the wake of the credit crisis, highlighting critical factors that contributed to the sector’s demise
Dr. Henry Tabe is the author of The Unravelling of Structured Investment Vehicles: How Liquiditiy Leaked Through SIVs: Lessons in Risk Management and Regulatory Oversight.

His book on SIVs traces their origins in the late 1980s to their eventual collapse in the wake of the credit crisis, highlighting critical factors that contributed to the sector’s demise

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Published by: ritholtz on Jul 02, 2011
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07/05/2011

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Chapter 10: Lessons learned
T
he collapse of SIVs was a seminal event in the history of modernfinance. The event received extensive media coverage during thecrisis, as noted in Chapter 9, and may remain teachable for decades tocome because of its richness as an epitome of the flaws of the globalfinancial markets in the couple of decades leading up to the crisis. If thecorrect lessons are learned, similar risk management and regulatoryfailures may be avoided as credit loosens again and the crisis becomes adistant memory.SIVs seemed like ordinary spread-lending businesses in the fixedincome markets, operating under strict investment, funding andreporting guidelines. They were relatively boring and unknownstructures, even to some finance professionals, until they burst into thelimelight in August 2007 at the onset of the crisis. Few commentatorsunderstood what they were even after their disappearance and resortedto depicting them simply as evil structures conjured up by banks toconceal toxic subprime exposures. As noted in previous chapters, thesenotions are misguided and ill-informed.It would be relatively easy to conclude that the emergence of SIVs some20 years before their demise was itself an error, and that the only lessonlearned should be to avoid establishing such vehicles in the future.However, this reductionist view cannot accommodate some of thebenefits that the sector brought to the capital markets, particularly theprovision of funding to financial institutions and originators of securitized assets through structured financings. The InternationalMonetary Fund believes that repairing the global securitization marketisthekeytoasustainablerecovery
20
;theFinancialStabilityBoardwould
20
IMF ,
GlobalFinancialStabilityReport 
, October 2009, pp. 32-33, 80-115.
203
Lessonslearned
 
like a relaunch of securitization in order to support the provision of credit to the real economy
21
and the US Federal Reserve as well ascentral banks in Europe have had to step in to provide liquidity to thesecuritization markets. These words and actions point to a recognitionof the role played by the alternative banking sector in intermediatingglobal capital flows from savers to borrowers. This financialintermediation function erstwhile performed by the sector makes itsstigmatization tantamount to throwing out the alternative bankingbaby with the bathwater. The challenge here as in all other forms of banking should be to devise ways of channelling capital flows such thatfinancial stability and economic growth are re-established andstrengthened.An analysis of the collapse of SIVs and other structured credit vehiclesreveals multiple lessons that can be learned, whatever acronyms areadopted for alternative banks in the future. This should help preventsuch collapses and the resulting instability to the financial system. Thischapter is dedicated to exploring the lessons that can be learned whilehighlighting institutions that would do well to demonstrate that thelessons have been heeded.
Regulatory supervision of bank-like structures
Banks, insurance companies, pension funds and hedge funds were theprimary sponsors and managers of SIVs. It is the role of regulatorsto ensure that such sponsoring institutions adhere to minimum capitaladequacy standards in accordance with the risks they assume. Whereregulators allow institutions to hold assets off-balance-sheet that
21
FSB,
Improving Financial Regulation, Report of the Financial Stability Board of G20 Leaders 
,September 2009, pp. 11-12.
204
TheUnravellingofStructuredInvestmentVehicles
 
could end up on-balance-sheet, the stability of sponsoring institutionsmust be considered. Where the likelihood of consolidation is high,regulators must ensure increased capital requirements at the sponsoringentity as well as the requisite expertise to manage incoming assets. It isperhaps noteworthy that almost all bank, insurance company andpension fund sponsors took on such additional assets with little or nocapital adjustment. In addition, the sponsors suffered no significantadverse rating action or faced significantly higher capital adequacyrequirements resulting solely from rescuing their SIVs, although thismayhavebeenafortuitousoutcome.Regulators will, in future, likely be called upon to study the incentivesand risks inherent in off-balance-sheet structures so that they canascertain the true domicile of risks assumed to be passed on to thecapital markets through such structures. The FSA’s call for regulatorsto incorporate sectoral analytical capabilities
22
in their micro-prudentialpolicies and procedures should help close the knowledge and skills gapand ensure that timely solutions can be implemented to avert collapsesthat can have severe consequences for the financial system. Where thereis potential for risk to return to balance sheets, regulators may considernot only an increase in capital adequacy requirements for sponsors as aremedy, but also bringing some off-balance-sheet entities under theregulatory umbrella. This would allow central banks the confidence toextend short-term lending facilities directly to these institutions if theybelieve that such support would help to stabilize the financial system.These were the types of actions contemplated by the US Treasury in thedying days of the SIV sector when decisive action only a few monthsearlier may have stood some chance of success. Less damage had been
22
FSA,
TheTurnerReview:Aregulatoryresponsetotheglobalbankingcrisis 
, March 2009, p. 89.
205
Lessonslearned

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