Why Did Sponsor Banks Rescue Their SIVs?
58 Pages Posted: 6 Apr 2017
Date Written: February 23, 2017
At the beginning of the recent financial crisis, sponsoring banks rescued their structured investment vehicles (SIVs) despite having no contractual obligation to do so. I show that this outcome may arise as the equilibrium of a signaling game between banks and their debt investors when a negative shock affects the correlated asset returns of a fraction of banks and their sponsored vehicles. A rescue is interpreted as a good signal and reduces the refinancing costs of the sponsoring bank. If banks leverage is high or the negative shock is sizeable enough, the equilibrium is a pooling one in which all banks rescue. When the aggregate financial sector is close to insolvency, banks expected net worth would increase if rescues were banned. The model can be extended to discuss the circumstances in which all banks collapse after rescuing their vehicles.
Keywords: reputation risk, rescues, mispricing, implicit support, shadow banking system
JEL Classification: G2, G3
Suggested Citation: Suggested Citation