This link has been bookmarked by 4 people . It was first bookmarked on 26 Sep 2008, by Charlie Gibbons.
-
26 Sep 08
-
-
- the bubble in home prices, fueled by the ready availability of credit, resulted in an underestimate of the risks of residential real estate;
- the peaking of residential home prices in 2006, combined with lax lending standards were followed by a very high rate of delinquencies on subprime mortgages in 2007 and a rising rate of delinquencies on prime mortgages;
- losses thereafter on the complex “Collateralized Debt Obligations” (CDOs) that were backed by these mortgages;
- increased liabilities by the many financial institutions (banks, investment banks, insurance companies, and hedge funds) that issued “credit default swaps” contracts (CDS) that insured the CDOs;
- losses suffered by financial institutions that held CDOs and/or that issued CDS’s;
- cutbacks in credit extended by highly leveraged lenders that suffered these losses.
There has been a “domino-like” character to the financial crisis that is now readily apparent to all:
-
-
Had policy makers reined in the increasingly irresponsible subprime mortgage lending practices that were apparent earlier this decade—the proliferation of “no-doc” loans, often taken out with little or no equity from subprime borrowers, and frequently on adjustable terms with seductively attractive initial “teaser” interest rates, all on the widely held assumption that home prices would continue to rise—it is likely that this crisis would been largely, if not entirely, avoided. When there is a significant probability that an asset market is in a speculative bubble, it is time to tighten lending standards, not loosen them.
-
Had Federal policymakers in both the Congress and the Administration not pressed so hard on “affordable housing goals” that encouraged lenders to extend and borrowers to take out loans that could not be reasonably serviced unless home prices continued to rise, and which Fannie and Freddie began to buy in large volumes in the last several years, Fannie and Freddie may have escaped the fate that has befallen them.
-
- Had the credit rating agencies whose stamps of approval were key to the sale of CDOs and other complex securities that later suffered losses been more transparent in how their ratings were provided and in the limited nature of the data on which they were made, it is likely that these securities would have been much more difficult to sell, and thus in turn, that subprime mortgages would not have been so easily originated.
- Had regulators done a better job monitoring the risk exposures of commercial banks, especially through their creation of off-balance entities known as “Structured Investment Vehicles” (SIVs), the market for CDOs would not have been so deep (the same is true for the state insurance regulators who oversaw the “monoline” insurers that insured CDOs and AIG, the nation’s largest insurer, that issued them).
-
- Had policy makers not permitted investment banks to vastly increase their leverage so that they were far more exposed to failure when they suffered losses from their various investments, the previously independent investment banks may have been able to avoid their forced alliances with commercial banks (or, in the case, of Lehman, failure).
- And had financial institutions followed their own internal risk management guidelines, then it is possible that the current crisis would not be so deep and that the face of both of the commercial and investment banking industries would now not be so radically changed.
-
First, financial instruments and institutions should be more transparent.
-
- For mortgages: simpler disclosures, counseling in advance for subprime borrowers, and perhaps a default contract from which people could opt out; and further restrictions on the design of high-cost mortgage contracts, along the lines proposed by the Federal Reserve.
- For asset-backed securities: public reporting on characteristics of the underlying assets.
- For credit ratings agencies: greater clarity in presenting ratings across asset classes, reporting of the ratings agencies’ track records, and disclosure of the limitations of ratings for newer instruments.
- For commercial banks: clearer accounting of off-balance-sheet activities.
- For derivatives, especially credit default swaps: facilitate the formation of a clearinghouse, which should reduce counter-party risk; and to encourage the standardization of these contracts, impose higher capital requirements on CDS’ that are customized.
-
Second, financial institutions should be less leveraged and more liquid.
-
- For commercial banks: capital requirements for off-balance-sheet liabilities and required issuance of uninsured subordinated debt.
- For investment banks: regulation and supervision of capital, liquidity, and risk management.
- For bond insurers: higher capital requirements.
- For insurers: an optional system of federal chartering and regulation, aimed primarily at protecting their safety and soundness.
Third, financial institutions should be supervised more effectively, with greater regard for systemic risks.
-
Would you like to comment?
Join Diigo for a free account, or sign in if you are already a member.