FINANCIAL MARKETS 2018/07 GROUP 2-U SUBMISSION 1 GROUP MEMBERS: Lansana Kanneh Kwasi Owusu Offei Prince Wiredu Introduction This piece of work is a group work done by members of group Two (2)-U on the Financial Markets Course as the initial first submission due at the end of week 3. In this research paper, the global financial crisis is discussed, the causes of the crisis identified together with major policy and regulatory responses. Global Crisis A financial crisis can be associated with a bank run where investors are frightened and do not want to hold securities for fear of loss of value. (https://www.investopedia.com/terms/f/financial-crisis.asp) Investors rely on available information including financial statements to make decisions on whether or not to hold or invest in a particular security. An adverse information that is perceived as affecting the issuing entity ability to meet scheduled repayments will affect the demand and hence the interest rates associated with instruments.(WQU Financial Markets Compiled Notes Week 3 and 4). The continuation of this trend at the market level leads to financial crisis heralding a recession. The Global Crisis often referred to as the Global financial crisis, regarded as the worst financial crisis (Financial Crisis 2007-2008 Wikipedia), at its height in 2008, stock market prices fell and institutions’ financial instruments lost their value. Institutions (mainly banks) at the time had loaned to individuals with low credit ratings and therefore charged higher interest rates for the mortgage loans. As repayments eventually stalled the crisis ensued and the worlds’ most powerful financial institutions came crashing down and the housing market was in crisis. Banks sought to repossess houses and properties which were worth less on current value that the bank had loaned out. Banks ran out of cash and became cautious in granting more loans. Causes of the Global Crisis Several causes can be blamed for the global financial crisis. Amongst them are ? Sub-prime mortgage loans issued to individual with lower credit ratings ? Housing bubble that went burst
? Securitization of mortgages bundled together with low risk loans and sold off together as low risk securities ? Wrong Credit ratings ? Mark-to-Market Accounting ? Deregulation ? Off Balance Sheet Finance ? Over the Counter(OTC) trading Lending in the mortgage market was loosely controlled as banks were allowed grant credit facilities to individuals with low credit ratings for houses. Such people may not have been able to afford it and therefore less likely to repay the mortgage. Interest rate was low, credit was plenty and the demand for house where high leading to a relaxation of the rules. More credit facilities were granted to low-rated re-payers who were potential house owners. As house prices fell, the mortgage was worth more than the houses. This led to foreclosures as people increasing default in the repayment schedule. This was another key reason for the crisis as house prices were on the increase before the crisis suddenly fell and sustainably. Securitization of mortgage loans allowed lenders to package bad mortgages, together with other mortgages and sell them off as though they are a bunch of low-risk securities, The lack of transparency amongst key operators in the housing market with the idea that they can never being held accountable for their individual and collective deeds also helped cause the crisis. Market role players never really bothered if mortgages failed or not. All players were willing to trade in securities they knew was bad but believed they could not be held responsible for such trading. Everyone in the market concentrated on maximizing individual profit or gain until the system collapsed. Credit Rating Agencies also had a role in the financial crisis as they were responsible for assigning credit ratings to mortgage backed loans as they do for other bonds and institutions. Lenders and Borrowers relied heavily on these rating agencies which essentially failed them. Mark-to-market Accounting was another problem that made the crisis possible. Using Mark-to Market practices, institutions were allowed to value and report securities at current market prices was widely in use. This allowed institutions to report profit when the asset is actually making loss thereby misleading interested parties. Additionally, legislations were relaxed because of the level of confidence reposed in the system. This allowed financial institutions to engage on a large scale in unregulated and risky transactions in the market operation contributed to the crises. Allowing financial transactions that are meant to be adequately regulated and done in formally regulated institutions to be done by largely unregulated market players. Mortgage loans were allowed to be negotiated and dealt with outside the formal financial institutions which were regulated to unregulated institutions. Off-Balance Sheet Finance was another major cause for the global crisis as institutions opened and operated special purpose entities (SPE’s) which largely operated risky speculative investments and were kept off the books of the institution. By doing so, losses are effectively hidden from investors and therefore effectively deceived.
Securities Exchange Commission liberalized net capital rule to allow banks to attain very high leverage ratios. In addition, compliance to monitoring mechanisms was largely voluntary and therefore not binding. Derivatives were allowed to be traded over the counter which was completely unregulated and participants were unaware of the risks they were exposed to. Major Policy and Regulatory Responses Several regulatory responses were made to salvage the financial crises in the US, most of which dealt with consumer protection, executive pay, bank capital requirements, regulations for derivatives in addition to authority for the Federal Reserve to monitor and control important financial institutions. (Financial Crisis Wikipedia) The policy responses taken in response to the global financial crisis can be grouped into three categories viz; improving macroeconomic environment, promoting market stability and advancing structural repair (Turman E.M.2009). International responses addressed strengthening prudential regulatory standards, the threatened failure of big institutions, OTC derivatives market, risks arising from shadow banking. The policy makers and regulators intended that their responses lead to better regulation and coordination amongst financial institutions and the other role players. It was expected that regulations would lead to a reversal of the crisis and to avoid the occurrence of such in the future. The regulations could actually lead to the worsening on the situation if regarded as not enough or too tight to change the situation. Conclusion The global financial crisis was caused by several factors ranging from regulations and attitude of role players in the market which led to highly risky and thinly clad trading practices. Mortgage loans which were designed to help house owners finance their low interest mortgages actually turn to their point of pain. Many businesses collapsed and many people suffered whilst some other people escaped justice. Several responses were done to reverse the situation, say never gain and put the world economy on its footing once more. References http://www.globalissues.org/article/768/global-financial-crisis https://www.thebalance.com/2008-financial-crisis-3305679 https://en.wikipedia.org/wiki/Financial_crisis_of_2007%E2%80%932008 https://www.investopedia.com/terms/f/financial-crisis.asp https://www.canstar.com.au/home-loans/global-financial-crisis WQU Financial Markets Compiled Notes Week 3 and 4