The Problem Posed By Securitisation

The world’s financial system was almost brought down in 2008 by the collapse of Lehman Brothers that was a major international investment bank at that time. The government sponsored these banks’ bailouts that were funded by tax money in order to restore the industry. Before the crisis, banks were lending irresponsible mortgages to subprime borrowers who had poor credit histories. These mortgages were purchased by banks and packaged into low-risk securities known as collateralized debt obligations (CDOs). CDOs were divided into tranches by its default risk. The ratings of those risks were determined by rating agencies such as Moody’s and Standard & Poor’s. However, those agencies were paid by banks and created an environment in which agencies were being generous to ratings since banks were their major clients.

Rep. Barney Frank (D-MA) explains the old system of lending and the new securitization process. Matt Demon narrates how the home buyers repaid their loans to lenders, and consequently, the lenders sold the loans to the investment banks which combined the mortgage loans with other credit loans creating a collateral debt obligation a complex derivative. The collateral debt obligation sold to investors who paid the rating agency to evaluate the CDO's. The home buyers were now paying investors through this

The financial crisis of 2007-2009 resulted from a variety of external factors and market incentives, in combination with the housing price bubble in the United States. When high levels of bank and consumer leverage appeared, rising consumption caused increasingly risky lending, shown in the laxity in the standard of securities ' screening and riskier mortgages. As a consequence, the high default rate of these risky subprime mortgages incurred the burst of the housing bubble and increased defaults. Finally, liquidity rapidly shrank in the United States, giving rise to the financial crisis which later spread worldwide (Thakor, 2015). However, in the beginning of the era in which this chain of events took place, deregulation was widely practiced, as the regulations and restrictions of the economic and business markets were regarded as barriers to further development (Orhangazi, 2014). Expanded deregulation primarily influenced the factors leading to the crisis. The aim of this paper is to discuss whether or not deregulation was the main underlying reason for the 2007/08 financial crisis. I will argue that deregulation was the underlying cause due to the fact that the most important origins of the crisis — the explosion of financial innovation, leverage, securitisation, shadow banking and human greed — were based on deregulation. My argument is presented in three stages. The first section examines deregulation policies which resulted in the expansion of financial innovation and

27). You now had highly leveraged mortgage loans, with a decreasing 30-year conventional mortgage rate, and rising home prices (Exhibit 1 & 3). According to the National Bureau of Economic Research the trifecta of, “rising home prices, falling mortgage rates, and more efficient refinancing lured masses of homeowners to refinance their homes and extract equity at the same time, increasing systemic risk in the financial system” (Belsie). As home prices continued to rise from 2000-2006 (Exhibit 1), individuals could then refinance their homes, collect their equity, and then use that money to purchase another home with no background information needed. As Michael Lewis mentions in The Big Short, “Steve Eisman’s baby nurse and her sister said they owned six townhouses in Queens. After they bought their first one, and it’s value rose, the lenders came and suggested they refinance and take out $250,000-which they used to buy another” (Lewis, 2010, p. 98). This would eventually happen multiple times as home prices rose until they owned five townhouse. Moving forward, it was the brokers & lenders who would fall next in line of greasing up the doomsday machine. From 2003 to 2006 sub-prime mortgage lending as a percentage of all mortgages originated tripled in quantity, of which for than 75% would be securitized into collateralized debt

This paper is about how did “Shadow Banking” precipitate the financial Crises. Then discusses the impacts of the crisis on the major financial institutions.

Since the onset of the financial crisis 2008, the sovereign debt crisis in western economies and the new financial regulation with Basel III coming up, the financial industry faces the challenge of reinventing itself. The ring-fence for Commercial and Investment Banking, and new economic and regulatory capital requirements will determine the kinds of products banks will be able to distribute. It will have a huge impact in the Investment Banking business, which will suffer tough regulation and supervisory procedures. At the same time, credit risk models will be reviewed because they have failed to predict the crisis of 2008. The current financial and economic crisis doesn’t have any precedent in the past.

When charted across the largest financial institutions during the 2008 Financial Crisis, it delivers great results. It would have targeted Fannie Mae, Freddie Mac, Morgan Stanley, Bear Stearns, and Lehman Brothers as the most fragile institutions. Moreover, the model could detect the problems as early as the first quarter of 2005, making it a promising predictive tool. Such a risk-measurement instrument can be useful for firms of all sizes: from medium to large-scale funds, to the largest institutional investment houses.

Demand became so aggressive that too many securitizers and lenders believed they were able to create and sell mortgage backed securities so quickly that they never put their shareholders’ capital at risk and hence did not have the incentive to evaluate the credit quality of what they were selling. Pressures on lenders to supply more “paper” collapsed subprime underwriting standards from 2005 forward. Uncritical acceptance of credit ratings by purchasers of these toxic assets has led to huge losses. It was the failure to properly price such risky assets that precipitated the crisis. In recent decades, a vast risk management and pricing system has evolved, combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology. A Nobel Prize was awarded for the discovery of the pricing model that underpins much of the advance in derivates markets. This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year because the data inputted into the risk management models generally covered only the past two decades, a period of euphoria. Had instead the models been fitted more appropriately to historic periods of

The recent financial crisis has a huge impact on systemic Important Financial Institutions; it’s distressing effect can be felt in almost every business area and process of a bank. A fairly large literature investigates the impact of financial crisis on large, complex and interconnected banks. The great recession did affect banks in different ways, depending on the funding capability of each bank. Kapan and Minoiu (2013) find that banks that were ex ante more dependent on market funding and had lower structural liquidity reduced supply of credit more than other banks during crisis. The ability of banks to generate interest income during the financial crisis was hampered because there was a vast reduction in bank lending to individuals and

The investment banks, and subsequent stock brokerage firms, was regulated by the Security and Exchange Commission. The banking entities, in this portion of the financial sector, were used to dealing in high risk business that were structured on the business’ equity and debt capital, instead of the commercial banks’ deposits of customers. The activities in this sector of the financial system were underwriting stocks and bonds, insurance markets, the investments in subprime debt markets and mortgages.

You now know why people do securitization and why people risk getting their hands and clothes stained with soot. The benefits are too good to be true, it’s as low risk as you want it to be, you can share the blame with your friends and co-workers, and lastly, it is all recorded on one neat, clean, and organized Balance sheet. The cons are also easily summarized by the pros, the reward is as big as you want it to be so the more money you put in the bigger the risk and the bigger the loss if it all goes under, this was the main tone of the financial crisis of 2007 big risk big

In 2008, the whole world encountered the biggest crisis on the economy generally in the finance sector. One of the essential driving factors of this was the deregulation in the finance industry. It permitted financial organizations to be engaged with offsetting the risk in fund exchange with the derivative. As a result, the financial institutions (like banks) claimed for more mortgages that would support derivatives trade that was profitable (Scott, 2010).

Foreign investors starving for fixed income securities that also had returns better than government securities, decided to invest in mortgage back securities provided by Fannie Mae and Freddie Mac. In order to take advantage of the savings glut Wall Street firms began to package many of these sub-prime mortgages together and create what was known as a mortgage backed security.1 A mortgage backed security, was an asset backed security that was secured by a collection of upwards a several hundred mortgages. The issue was the mortgage back securities provided by Fannie, Freddie, and investment banks were given good ratings by rating agencies such as Standard and Poor’s and Moody’s, even though these assets were toxic. They gave the mortgage back securities good ratings, because their risk assessment models solely used previous housing data, and did not include any possibility of a fall in housing prices.3 As a result, overseas investors believed they were getting secure assets with above average returns, but instead they were getting very toxic assets instead. So the interest in these mortgage back securities continued the flood of savings, continuing the suppression of interest rates and maintained the status quo.2 Banks lent out these sub-prime mortgages at a prolific rate because even if the borrower foreclosed, banks were still able to make a profit, as they resold a higher priced house.

The introduction of financial sector reforms in India has led to innovations in financial markets and instruments. One of the most prominent developments in the international finance in recent times that is likely to assume even greater importance in future is ‘securitisation’. Securitisation is the process of pooling and re-packaging of homogenous illiquid loans into marketable securities. Increased pressure on operating efficiency, on market niches, on competitive advantages, and on capital strength, all provide fuel for rapid changes. Securitisation is one of the solutions to these challenges. 2. Reserve Bank of India, as a facilitator, has attempted to explore the intricacies of securitisation as a process of

My analysis of securitization processes will be supported by a number of multimedia and scholarly discourses, ranging from case studies from across the world to econometric analyses using