Financial Innovation And Its Effect On The Financial Crisis

1246 WordsMar 13, 20175 Pages
Another problem connected to the securitization of loans is the fact that the required off-balance sheet transactions increase the difficulty of determining a company’s true leverage. While off-balance sheet transactions are not necessarily a bad thing, they do disguise the true debt of a company in that they make it appear as if the obligation to repay the security investors falls on the SPV rather than the originator (Pala). Furthermore, a movement of assets to an SPV can result in the appearance of a reduction of leverage, which may make a company appear more attractive to investors, or in the case of a bank, allow them to decrease their capital requirements when they have not in fact de-levered and have simply moved items off of their…show more content…
Thus, the novelty and complexity of these new securities can result in grave misunderstandings about not only the functionality, but also the riskiness of certain forms of securitization. Involvement in the 2008 Financial Crisis The 2008 financial crisis is complicated, as are its many causes, however it is clear that poor understanding and lack of regulation of securitization played a significant role in bringing about the crisis. The problems began when housing prices started to decline in 2006, resulting in an unexpected increase in mortgage defaults as homeowners found themselves owing more on their mortgage than their houses were worth. When mortgages began to default, the collateral on mortgage-backed securities lost its value, which resulted in the failure of banks, GSEs and funds that had invested heavily in mortgage backed securities, and another related offerings (Schulz). These failures scared investors who quickly tried to recoup their investment, which resulted in essentially a run on the shadow-banking system that had developed around the issuance of asset-backed securities and related financial innovations—and the rest of the crisis is well known history that need not be reviewed. Securitization can be blamed in part for the crisis because were it not for its invention, the
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