Structured investment vehicles have had some bad press recently thanks to their association with sub-prime securities. But, according to Morningstar’s Rachel Barnard, SIVs are not the investment nightmares they’ve been made out to be.
An SIV is simply a fund that borrows money to invest in a portfolio of securities. The SIV borrows money for a short time and pays a short-term borrowing rate, then invests that money in securities that pay higher interest rates.
SIVs have been considered a safe bet since the late 80s, but the credit and liquidity risks involved have some investors nervous. If the securities invested in an SIV lose their value, the SIV may not be able to pay off its creditors, scaring off potential lenders, which in turn leads to liquidity problems. Once the lenders bail out, buyers could do the same, forcing investors to sell the securities for less than they’re worth.
The companies most exposed to SIV risk are the banks that back them, and the companies that lend to them. Banks could be responsible for making up any losses incurred by the SIV, and lenders could be forced to eat the losses if SIVs can’t pay back the debt.