The Uses and Abuses of Structured Finance

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The discovery that Enron Corporation createdmany special purpose entities to hide assetsand debt from the general investing public hascreated a distorted view of the uses and legitimacyof structured finance and special purposeentities (SPEs). The general perception is thatstructured finance and SPEs serve no real economicpurpose but are used to mislead anddeceive the investing public. Lost in public andpolitical discussions of structured finance hasbeen the role of structured finance as a soundrisk management tool, dating back to the early1970s and widely used by many U.S. corporationsand financial institutions today.

Enron made perverse use of structuredfinancing vehicles that hardly conformed to prevailingindustry standards or convention.Indeed, many of Enron's vehicles were contrivedto hide or delay the impact of poor investmentdecisions, hide debt, and manipulate revenuestreams on certain derivatives transactions.Because of the simultaneous failure of a numberof the usual safeguards surrounding the use ofthose structures, Enron was able to create structuredfinancing partnerships that bore virtuallyno resemblance to those soundly constructed bymost corporations today.

In contrast, most structured finance transactionstoday are designed in such a way as to createan arm's-length distance between the originatorof the SPE and the investors in the SPE toachieve corporate separateness. Furthermore, thelegitimate purposes of structured finance transactions--risk management, liability management,accessing alternative funding sources, andmaximally leveraging internal expertise--have littlein common with the purposes for whichEnron created many of its SPEs.

Current efforts to revamp fundamentalaspects of structured finance because of Enron'sperverse application of a useful concept amountto "shooting the messenger" and will likely havethe effect of turning worthwhile projects intoeconomically unviable ventures if regulatory andcapital compliance costs are raised considerably,as they have been.

Barbara Kavanagh

Barbara T. Kavanagh is a principal at CP Risk Management LLC.