Structured investment vehicles were a type of fund used in “shadow banking” to generate profits by borrowing at low interest rates and lending at higher rates. They were developed in 1988 but became extinct after the 2008 market volatility due to criticisms of inaccurate risk assessment and insufficient observation of creditworthiness.
A structured investment vehicle is a specific type of fund that has recently been used to generate profits in what some call “shadow banking.” In these types of funds, managers issue short-term securities at low interest, then lend long-term securities at higher interest rates to earn money on the borrowed principal.
Reports indicate that structured investment vehicles were developed in 1988 by major banks and used by various financial firms until 2008. Industry insiders have revealed that structured investment vehicles are no longer part of the general financial community.
The general method of raising capital for a structured investment vehicle, according to experts, was to sell commercial paper-based accounts. The volatility involved in this method of borrowing was a criticism of the structured investment vehicle. The structured investment vehicle fund manager would use the LIBOR or London InterBank offer rate to set interest rates.
Another criticism of the structured investment vehicle is that the fund managers were unable to accurately assess the risks involved because they did not sufficiently observe the creditworthiness of the securitized debts. Structured investment vehicles were rated, and industry experts point to examples of these funds being incorrectly rated. All of this led to the general extinction of these types of financial instruments, as market volatility in 2008 wiped out capital and threatened investors.
Critics of the structured investment vehicle also point out that it is absolutely necessary to take into account the true risk of default and not use statistical models as the only source of risk assessment. Financial professionals who are involved in discussing the risks of structured investment vehicles point to specific aspects of similar arrangements by traditional banks, where deposits (the borrowed capital) are federally insured and where banks routinely screen borrowers thoroughly. In general, the subprime crisis and other recent financial events have scared home equity lenders for not being careful when lending money. Securitized debts passed to third parties are largely to blame for the carelessness that characterized structured investment vehicles and similar types of loans.
In short, the structured investment vehicle was a type of financial arrangement with a fairly short lifespan. Finance experts can use it as an example of how market volatility can affect the actions of the financial community as a whole. It can also be used to help government, consumer, or investor advocacy groups discuss how to regulate emerging markets and financial practices.
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