Friday, March 2, 2012

Innovation, Regulation and Financial Bubbles: The Evolution of Structured Investment Vehicles

[Author: Michael Ehrlich, New Jersey Institute of Technology]

Financial bubbles, where asset prices have increased rapidly only to be followed by a subsequent crash, are as old as history. Kindleberger dates the first of “The Big 10 Financial Bubbles” as The Dutch Tulip Bubble of 1636 (Kindleberger and Aliber, 2005, page 9). Reinhart and Rogoff subtitled their book as “Eight Centuries of Folly” and refer to 12th Century China and the European Middle Ages (Reinhart and Rogoff, 2009). In this paper, we briefly review some of the common elements and paths that financial bubbles take with the focus on the interplay of leverage, innovation and regulation as bubble enablers. It will then use the recent experience of Structured Investment Vehicles (SIVs) as a case study to illustrate these points.

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