Structured Finance, Risk Management, and the Recent Financial Crisis

By Dionne, Georges | Ivey Business Journal Online, November/December 2009 | Go to article overview

Structured Finance, Risk Management, and the Recent Financial Crisis


Dionne, Georges, Ivey Business Journal Online


Structured finance is often mentioned as the main cause of the latest financial crisis. But rather, as this author argues, it was the result of poor risk management, agency problems in the securitization market and poor rating and pricing standards, among a myriad of other causes. The author prescribes strong steps to prevent a re-occurrence.

Structured finance includes all advanced financial arrangements that serve to efficiently refinance and hedge any economic activity beyond the scope of conventional forms of traditional financial instruments (debt, bonds, and equity). Examples of structured-finance products include Collateral Debt Obligations (CDOs), Asset-Backed Commercial Paper (ABCP) and Credit Default Swaps (CDSs). The emergence of structured finance has changed the role of banks and the functioning of financial markets. In Canada, structured finance is now a very important activity that has completely modified the links between borrowers, lenders, and investors.

Structured finance is often mentioned as the main cause of the latest financial crisis. However, as this article will demonstrate, structured finance and its complex products per se did not trigger the financial crisis. In fact, it was the risk management policies and practices employed by institutions engaged in structured finance that were problematic, and to a large extent, brought on and propagated the latest crisis around the world.

Some large banks went bankrupt, while several governments and central banks had to rescue many other financial institutions. While these bailouts were intended to protect the financial markets in the short run, they will not solve the underlying problems. In this article, we emphasize the important role that sound risk management can play in restoring investor confidence in the capital markets.

Structured finance

Structured finance is a multifaceted concept. For many years, it was associated with derivative products and viewed as a fairly insignificant factor in economic and financial markets. Yet structured finance has become an important - albeit, hidden - factor in the economy since the 1990s, and an increasingly pertinent topic of discussion since the onset of the most recent crisis.

The influence of structured finance on the trading of financial products has produced several notable effects on the organization of retail credit and financial markets, effects which are now starting to be understood and explained. For example, structured finance has improved the liquidity of transactions and the management of credit risk. These effects have varied over the recent years and have complex consequences.

Structured finance has greatly affected financial products. It has spawned the creation of increasingly complex products of all kinds, in particular those linked to the securitization of credit risk, such as CDOs. These financial products introduce sophisticated mathematical instruments and complex security and contract design that demand the collaboration of players in various disciplines. They also require high-powered computational capacities and the competent management of large databases. Because of their liquidity, these products call into question the historical methods of regulating financial markets and the traditional management of monetary policy.

The creation of structured finance was mainly motivated by the transfer of credit risk, through the use of credit derivatives (e.g. CDSs) and banks' securitization of loans, to investors. For example, the selling of bank loans to trusts serves to transfer banks' credit risk via structured products to various groups of investors such as pension funds, industrial and service corporations, hedge funds or even other banks. The market for CDOs has grown very rapidly since 2000. Banks are the most active players in this market, although insurance companies, pension funds and hedge funds are gaining ground. With the growth of hedge funds and their demand for higher-yielding securities, sellers improved their ability to transfer their credit risk, particularly the more risky tranches (or equity tranches) of the structured products. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Note: primary sources have slightly different requirements for citation. Please see these guidelines for more information.

Cited article

Structured Finance, Risk Management, and the Recent Financial Crisis
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen
Items saved from this article
  • Highlights & Notes
  • Citations
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Search by... Author
    Show... All Results Primary Sources Peer-reviewed

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.