please giveback to my classmate paper

Description

New solution updates


Question

There are many lessons learned from the credit crisis of 2008-2009. Banks specialize in managing risk, but they failed to recognize that the mortgage-backed securities in which the invested were in fact riskier than their high ratings suggested. One clue to them should’ve been the higher returns that they were expecting from them. They were essentially caught off guard with their hands in the cookie jar when the market collapsed. They saw housing prices tank, and mortgage defaults skyrocket as mortgages were now worth more than the value of the houses. What lessons did they learn from this subprime mortgage situation? Arends (2013) gives six lessons that we should have learned from the crisis. One is that the reasoning of Wall Street and the investment community was flawed in thinking that the housing prices would continue to go up because they had never gone down in the past. The second is that the leaders of the investment and regulatory communities don’t necessarily know more than the average investor, since they didn’t see it coming and were caught off guard, including the Fed and the IMF. The third is that there is always a risk in having debt and that if not managed well it can be dangerous. The fourth is that we as a society are more risk-averse than we claim to be. Furthermore, we panic and do the wrong thing by selling off the assets at low prices instead of holding on to them in hopes of a rebound. Another lesson learned is that sometimes simple is better than complex. People that fared well invested in stocks of companies like Coca-Cola and McDonald’s which have steadily grown in value versus the complex MBS and derivatives which tanked. And lastly, cash is good, and we should always have some on hand. As an example, Arends (2013) mentions William Buffet who had plenty of cash and was able to take advantage of the low prices to buy other companies during the crisis. This credit crisis was caused in part because homes were easier to buy because of the excellent mortgage rates, and also less creditworthy people were able obtain new, non-traditional mortgage products (Stackhouse, 2011). Furthermore, the highly rated subprime mortgages were actually very high risk because most had adjustable rates, reduced documentation, high loan-to-value ratios, were used for cash-out refinances, and were originated through brokers and wholesale channels. We also learned that this high risk of the subprime mortgages was hard to spot because these mortgages were hidden in packages called mortgage-backed securities. It was even made more convoluted as these were sold in “collateralized mortgage obligations, collateralized debt obligations, and credit default swaps” (p.11). Moreover, people lost even more equity in their homes because they had taken out second mortgages, and home equity loans to take advantage of the low rates and the high housing prices. This was all fueled by the easily available credit. One takeaway from this is that short run choices sometimes have long run consequences that need to be considered beforehand. Another takeaway is that high levels of debt to people without good credit and an expectation of ever increasing housing prices are not realistic assumptions for success. And lastly, banks were not really risk diversified, and did not do a good job of managing their risks. A shining example of what to do right is the commercial banks which fared much better than the other banks during and after the financial crisis because they did not relax their mortgage loan requirements (Madura, 2013). In fact, because they “required more stringent standards for borrowers to qualify for commercial real estate loans,” the default rate was much lower compared to the home loan default rate (p.453). The other winning feature is that more commercial banks keep their commercial real estate loans that they originate, compared to home loans in which the great majority are sold off only to be retained in a servicing sense. There were indeed many lessons learned from the credit crisis and the subprime mortgage situation. The question is will these lessons be remembered or will they be forgotten as we experience economic growth and years of good returns. Hopefully, the many regulations enacted and put in place will help. Managing risks effectively and exercising diligence in granting credit is critical in helping to minimize the chances of a credit crisis happening again. Unfortunately, it is not easy with “agency problems” and the “moral hazard problems” focusing executives on achieving short term goals that benefit themselves rather than the shareholders (Madura, 2013). I think this personal greed contributed a lot to the credit crisis and subprime mortgage situation, and will be hard to prevent in the future. References Arends, B. (2013). Six lesson you should have learned from the financial crisis. The Wall Street Journal. Retrieved from:http://online.wsj.com/news/articles/SB10001424127887324665604579081223815849080 Madura, J. (2013). Financial markets and institutions (10 th ed.). Mason, OH: South-Western Cengage Learning. Stackhouse, J.L. (2011). Lessons learned from the financial crisis: What happened and where are we now? Dialogue with the Fed. Retrieved from:https://www.stlouisfed.org/banking/pdf/Dialogue-with-the-Fed-9-12-11.pdf Jul 25 2014 11:50 PM

 

Solution ID:608857 | This paper was updated on 26-Nov-2015

Price : $24
SiteLock