Ivo Pezzuto - Miraculous Financial Engineering or Toxic Finance? The Genesis of The U.S. Subprime Mortgage Loans Crisis and Its Consequences on the Global Financial Markets and Real Economy
SMC University Working Paper Issue 12: 2008
Pezzuto, Ivo, Miraculous Financial Engineering or Toxic Finance? The Genesis of the U.S. Subprime Mortgage Loans Crisis and its Consequences on the Global Financial Markets and Real Economy (October 7, 2008). Available at SSRN: http://ssrn.com/abstract=1332784 or http://dx.doi.org/10.2139/ssrn.1332784
Ivo Pezzuto - Journal of Governance and Regulation volume 1, issue 3, 2012, c...Dr. Ivo Pezzuto
Journal of Governance and Regulation / Volume 1, Issue 3, 2012, Continued - 1
Pezzuto, I. (2012). Miraculous Financial Engineering or Toxic Finance? The Genesis of The U.S. Subprime Mortgage Crisis and Its Consequences on The Global Financial Markets and Real Economy
This document is a thesis submitted by Georgios Gialamidis for the degree of Master of Science in Banking and Finance at the International Hellenic University in November 2015. The thesis examines the impact of credit rating changes by Moody's, Standard & Poor's, and Fitch on bond yields and equity returns in five European countries (Portugal, Ireland, Italy, Greece, and Spain) during the 2008 economic crisis. It also analyzes information transfer between these countries and six other stable European countries (Germany, Austria, Switzerland, Sweden, Netherlands, and UK). Using event study methodology and regression analysis, the thesis finds credit downgrades had a more significant impact than upgrades, with Greece having the largest effect. It
The document is the June 2011 issue of MTBiz, the monthly business review publication of Mutual Trust Bank Ltd. It contains the following sections: national and international news, economic indicators for Bangladesh and other countries, domestic and international capital market reviews, commodity markets, profiles of a financial institution and enterprise of the month, and descriptions of Mutual Trust Bank's corporate social responsibility activities and new appointments.
The main article summarizes a report by the Financial Stability Forum on the factors underlying the 2007-2008 financial market turmoil. It identifies key weaknesses such as poor underwriting standards, flawed risk management by financial firms, weak investor due diligence, poor credit ratings agency performance, misaligned incentives, and regulatory failures that contributed
- The US economy remains fragile with indicators that the credit crisis may spread to commercial and corporate sectors, exposing secured lenders. Traditional underwriting tools may not be reliable and corporate borrowers' creditworthiness is at risk.
- Secured lenders that do not utilize modern risk management tools like UCC insurance and fail to properly perfect their security interests in collateral could experience reduced loan recoveries when defaults occur, depleting bank capital and potentially leading to insolvency.
- A wave of corporate bankruptcies is expected over the next few years, exacerbating risks to banks from documentation defects and challenges to their secured positions, with potential consequences for the FDIC insurance fund and taxpayers.
This study investigated loans default (problems loans) and returns on assets in Nigeria banks, employing the data of five banks for a period of five years (2010-2014), using the ordinary least squares (OLS) regression techniques to check the relationship between problem loans and returns on assets (ROA). The findings shows that a positive and significant relationship at 5% level of significance exist between problem loans and returns on assets, and a negative and significant relationship at 10% level of significance exists between loans and advances and returns on assets in Nigerian banks. A major suggestion is that banks in Nigeria should enhance their capacity in credit analysis and loan administration, while the regulatory authority should pay more attention to banks’ compliance to relevant provisions of Bank and other Financial Institutions Act (1991) and prudential guidelines.
Skiera, Bernd / Bermes, Manuel / Horn, Lutz (2011), "Customer Equity Sustainability Ratio: A New Metric for Assessing a Firm’s Future Orientation", Journal of Marketing, Vol. 75 (May), 118-131
Analysis of recovery determinants of defaulted mortgages in nigerian lending ...Alexander Decker
This document summarizes a research paper that analyzed the determinants of recovery of defaulted mortgage loans in the Nigerian lending industry. The study used logistic regression analysis on data from 3,197 defaulted mortgages from 1999-2011 at commercial banks and primary mortgage institutions in Nigeria. The results showed that GDP growth, borrower status, borrower default history, year as a borrower, bank relationship, loan supervision, collateral age, and collateral location were positively associated with loan recovery rates. Meanwhile, inflation growth, interest rates, collateral priority, and collateral revaluation were negatively associated with recovery rates. Other factors like loan-to-value ratio, loan size, and loan duration had insignificant but positive effects on recovery possibility.
Ivo Pezzuto - Journal of Governance and Regulation volume 1, issue 3, 2012, c...Dr. Ivo Pezzuto
Journal of Governance and Regulation / Volume 1, Issue 3, 2012, Continued - 1
Pezzuto, I. (2012). Miraculous Financial Engineering or Toxic Finance? The Genesis of The U.S. Subprime Mortgage Crisis and Its Consequences on The Global Financial Markets and Real Economy
This document is a thesis submitted by Georgios Gialamidis for the degree of Master of Science in Banking and Finance at the International Hellenic University in November 2015. The thesis examines the impact of credit rating changes by Moody's, Standard & Poor's, and Fitch on bond yields and equity returns in five European countries (Portugal, Ireland, Italy, Greece, and Spain) during the 2008 economic crisis. It also analyzes information transfer between these countries and six other stable European countries (Germany, Austria, Switzerland, Sweden, Netherlands, and UK). Using event study methodology and regression analysis, the thesis finds credit downgrades had a more significant impact than upgrades, with Greece having the largest effect. It
The document is the June 2011 issue of MTBiz, the monthly business review publication of Mutual Trust Bank Ltd. It contains the following sections: national and international news, economic indicators for Bangladesh and other countries, domestic and international capital market reviews, commodity markets, profiles of a financial institution and enterprise of the month, and descriptions of Mutual Trust Bank's corporate social responsibility activities and new appointments.
The main article summarizes a report by the Financial Stability Forum on the factors underlying the 2007-2008 financial market turmoil. It identifies key weaknesses such as poor underwriting standards, flawed risk management by financial firms, weak investor due diligence, poor credit ratings agency performance, misaligned incentives, and regulatory failures that contributed
- The US economy remains fragile with indicators that the credit crisis may spread to commercial and corporate sectors, exposing secured lenders. Traditional underwriting tools may not be reliable and corporate borrowers' creditworthiness is at risk.
- Secured lenders that do not utilize modern risk management tools like UCC insurance and fail to properly perfect their security interests in collateral could experience reduced loan recoveries when defaults occur, depleting bank capital and potentially leading to insolvency.
- A wave of corporate bankruptcies is expected over the next few years, exacerbating risks to banks from documentation defects and challenges to their secured positions, with potential consequences for the FDIC insurance fund and taxpayers.
This study investigated loans default (problems loans) and returns on assets in Nigeria banks, employing the data of five banks for a period of five years (2010-2014), using the ordinary least squares (OLS) regression techniques to check the relationship between problem loans and returns on assets (ROA). The findings shows that a positive and significant relationship at 5% level of significance exist between problem loans and returns on assets, and a negative and significant relationship at 10% level of significance exists between loans and advances and returns on assets in Nigerian banks. A major suggestion is that banks in Nigeria should enhance their capacity in credit analysis and loan administration, while the regulatory authority should pay more attention to banks’ compliance to relevant provisions of Bank and other Financial Institutions Act (1991) and prudential guidelines.
Skiera, Bernd / Bermes, Manuel / Horn, Lutz (2011), "Customer Equity Sustainability Ratio: A New Metric for Assessing a Firm’s Future Orientation", Journal of Marketing, Vol. 75 (May), 118-131
Analysis of recovery determinants of defaulted mortgages in nigerian lending ...Alexander Decker
This document summarizes a research paper that analyzed the determinants of recovery of defaulted mortgage loans in the Nigerian lending industry. The study used logistic regression analysis on data from 3,197 defaulted mortgages from 1999-2011 at commercial banks and primary mortgage institutions in Nigeria. The results showed that GDP growth, borrower status, borrower default history, year as a borrower, bank relationship, loan supervision, collateral age, and collateral location were positively associated with loan recovery rates. Meanwhile, inflation growth, interest rates, collateral priority, and collateral revaluation were negatively associated with recovery rates. Other factors like loan-to-value ratio, loan size, and loan duration had insignificant but positive effects on recovery possibility.
Jimmy Gentry presents "Digging Deeper into Key Areas" during the Reynolds Center for Business Journalism's annual Business Journalism Week, Jan. 3, 2014. Gentry is the Clyde M. Reed Teaching Professor at the University of Kansas' School of Journalism and Mass Communications.
The annual event features two concurrent seminars, Business Journalism Professors and Strictly Financials for journalists.
For more information about business journalism training, please visit http://businessjournalism.org.
A Fistful of Dollars: Lobbying and the Financial Crisis†catelong
Has lobbying by financial institutions contributed to the financial crisis? This paper uses detailed information on financial institutions’ lobbying and their mortgage lending activities to answer this question. We find that, during 2000-07, lenders lobbying more intensively on specific issues related to mortgage lending (such as consumer protection laws) and securitization (i) originated mortgages with higher loan-to-income ratios, (ii) securitized a faster growing proportion of their loans, and (iii) had faster growing loan portfolios. Ex-post, delinquency rates are higher in areas where lobbying lenders’ mortgage lending grew faster. These lenders also experienced negative abnormal stock returns during key events of the crisis. The findings are robust to (i) falsification tests using information on lobbying activities on financial sector issues unrelated to mortgage lending, (ii) instrumental variables strategies, and (iii) a difference-in-difference approach based on state-level lending laws. These results suggest that lobbying may be linked to lenders expecting special treatments from policymakers, allowing them to engage in riskier lending behavior.
Deniz Igan, Prachi Mishra, and Thierry Tressel, Research Department, IMF‡
October 14, 2009
In RiskMonitor, Allianz Global Investors (AllianzGI) together with Investment & Pensions Europe (IPE) magazine surveys European institutional investors’ perceptions of capital market, regulatory and governance risk.
Macro Risk Premium and Intermediary Balance Sheet Quantitiescatelong
The macro risk premium measures the threshold return for real activity that
receives funding from savers. Financial intermediaries’ balance sheet conditions provide a window on the macro risk premium. The tightness of intermediaries’ balance sheet constraints determines their “risk appetite”. Risk appetite, in turn, determines the set of real projects that
receive funding, and hence determine the supply of credit. Monetary policy affects the risk appetite of intermediaries in two ways: via interest rate policy, and via quantity policies. We estimate time varying risk appetite of financial intermediaries for the U.S., Germany, the U.K., and Japan, and study the joint dynamics of risk appetite with macroeconomic aggregates and monetary policy instruments for the U.S. We argue that risk appetite is an important indicator for monetary conditions.
Moderninizing bank supervision and regulationcatelong
This is the testimony of Chris Whalen to the Senate Banking Committee on March 24, 2009 about bank and financial institution regulation and supervision.
The document summarizes the subprime mortgage crisis and its global impact. It discusses how the crisis originated from risky lending practices involving subprime mortgages in the US housing market. This led to a contraction in liquidity and credit markets globally. Major financial institutions suffered huge losses totaling over $8 trillion. The crisis highlighted failures in mortgage underwriting, risky financial products, and lack of oversight that allowed risk to accumulate in the system.
This document outlines how the subprime mortgage crisis occurred through a network of connected players. Mortgage brokers and banks provided loans to subprime borrowers, which were then packaged into securities and sold to investors with the help of investment banks. Credit rating agencies certified these securities, and insurers provided insurance for them. However, this system was flawed as it relied on continually rising housing prices. When housing prices declined, subprime borrowers defaulted, causing losses for investors, banks, and other players. The crisis led to bankruptcies, government bailouts, and a major loss of wealth in global equity markets.
The document discusses trust in banks across different countries, with a focus on Ukraine and Belarus. It finds that trust in banks varies significantly between countries, with Ukraine having particularly low levels of trust compared to other nations. Low trust can cause people to save money at home rather than depositing it in banks, which has implications for economic growth as it keeps deposits out of the banking system. The document examines some factors that can influence trust in banks, such as institutional quality, historical experiences, economic conditions, and regulation.
Monday September 3 2012 - Top 10 Risk Management NewsCompliance LLC
The document discusses two quantitative models developed by the Bank of Canada to improve assessment of risks to the Canadian financial system:
1. The Household Risk Assessment Model (HRAM) assesses how household debt levels and shocks like interest rate increases or unemployment would affect financial stability.
2. The Macro Financial Risk Assessment Framework (MFRAF) models contagion effects between banks by taking into account counterparty exposures and funding liquidity risk. It integrates these factors to better evaluate overall systemic risk to the financial system.
The models provide tools to identify and measure emerging risks, forecast the probability of financial crises, and assess the impact of policy measures on financial stability.
Over the last 20 years, the banking industry has seen major consolidation, increased use of complex financial products, and a lack of high-quality data at financial institutions. During the 2008 crisis, key decision makers lacked adequate data on the interconnectedness of firms. Lessons learned are that enterprise stress testing should be routine and large firms need to improve data management. Regulators are now focusing on increasing transparency, liquidity risk management, and capital standards to address these issues.
This document discusses empirical research on the determinants of bank lending across countries. It proposes estimating equations to model domestic credit levels based on bank balance sheet and capital requirements approaches. The analysis will use data from 146 countries over 1990-2013 to examine how economic growth, banking system health, and external capital flows influence domestic credit after controlling for other factors. Key determinants expected to impact credit include deposits, interest rates, costs, capital levels, and macroeconomic conditions.
This document summarizes a study that uses a matched sample of individual loans, borrowers, and banks to investigate the effect of banks' financial health on the cost of loans for borrowers, while controlling for borrower risk and information costs. The key findings are:
1) Borrowers pay higher interest rates on loans from low-capital banks compared to well-capitalized banks, even after controlling for borrower risk.
2) This effect is most significant for borrowers where information costs are likely important.
3) When borrowing from weak banks, these high-information-cost borrowers tend to hold more cash, indicating costs to switching lenders.
4) The results provide support for
Adrian Blundell-Wignall, OECD: "An optimal bank structure?"Global Utmaning
This document discusses optimal bank structure and reforming business models of banks. It argues that separation of high risk securities activities from core deposit banks is essential. Risky activities such as derivatives, prime brokering and market making should be put in ring-fenced non-operating holding company subsidiaries if they exceed 10% of a bank's business. A simple leverage ratio of 5% for core deposit banks would make them safer. Separating risky activities prevents cross-subsidization of risk and guarantees, reducing bank size and risk taking.
This document summarizes a research paper that analyzed the determinants of credit risk in the Indonesian banking industry. Specifically, it examined how bank-specific variables like bank size, profitability, capital adequacy, and ownership structure influence the level of non-performing loans (NPL), which is used as a measure of credit risk. The document reviews several previous studies that also analyzed the relationship between credit risk and bank-specific factors in other countries. It then outlines the methodology that will be used in the research, including the data collection and analysis methods.
This document discusses over-indebtedness as a major risk for microfinance institutions (MFIs) that must be managed through an effective risk management framework. It outlines a common risk management feedback loop process that involves identifying, assessing, and prioritizing risks, developing strategies to measure and mitigate risks through operational policies, implementing policies, evaluating effectiveness, and revising policies as needed. Specifically for over-indebtedness, the document examines the drivers of over-indebtedness for MFIs and strategies they can use to mitigate this risk, such as controlling multiple borrowing, strengthening systems and lending discipline.
This document summarizes the findings of a survey of 819 lenders on their environmental risk management practices. The top challenges lenders face are: (1) lack of expertise to understand environmental reports and make risk-based decisions, (2) need for internal education and training on how environmental due diligence fits into the lending process, and (3) turnaround time constraints. While lender policies have evolved since the real estate downturn, many - especially smaller banks - still lack formal policies or training. As lending slowly increases, lenders need assistance justifying due diligence costs, basic training, and help balancing regulatory compliance with maintaining competitiveness.
Igor Livshits' discussion of "Endogenous Political Turnover and Fluctuations ...ADEMU_Project
This document summarizes and provides comments on the paper "Endogenous Political Turnover and Fluctuations in Sovereign Default Risk". The paper puts forth a clear story that political turnover and sovereign default risk are endogenously determined. A simple model is described where politicians' identities determine growth rates and their borrowing decisions affect default risk. However, some comments question whether the story is fully supported by data on growth, debt levels, and actual defaults. Technical assumptions about politicians and voters are also noted to possibly be at odds with empirical evidence. Overall, while an interesting mechanism, more work may be needed to map the implications to real-world politics and fiscal outcomes.
This document summarizes a study that investigated the determinants of commercial bank lending behavior in Nigeria. The study aimed to test how common factors like deposits, investments, interest rates, reserve requirements, and liquidity ratios affect bank lending. Regression analysis found the model to be significant, with deposits having the greatest impact on lending. The study suggests banks focus on deposit mobilization to enhance lending performance and develop strategic plans.
Effect of Liquidity Risk on Performance of Deposit Money Banks in Nigeriaijtsrd
This study examines the effect of the credit risk ratio on the financial performance of deposit money banks in Nigeria. Ex Post Facto research design was employed for the study. Sample sizes of five banks were selected from twenty banks quoted on the Nigerian Stock Exchange. Data were extracted from annual reports and accounts of the selected banks from 2010 to 2019. Using E view statistical tool to test the hypothesis, the study found that credit risk ratio significantly influences the financial performance of quoted deposit money banks in Nigeria It was recommended that bank managers should constantly engage in rigorous credit analysis, checking, default rate, the proportion of non performing loans, regularly or at least quarterly to enable them to maintain high asset quality to enhance the financial performance. Oraka, Azubike O | Ebubechukwu, Jacinta O "Effect of Liquidity Risk on Performance of Deposit Money Banks in Nigeria" Published in International Journal of Trend in Scientific Research and Development (ijtsrd), ISSN: 2456-6470, Volume-5 | Issue-4 , June 2021, URL: https://www.ijtsrd.compapers/ijtsrd42388.pdf Paper URL: https://www.ijtsrd.commanagement/other/42388/effect-of-liquidity-risk-on-performance-of-deposit-money-banks-in-nigeria/oraka-azubike-o
This document provides an overview of credit derivatives and their role in the 2008 financial crisis. It discusses how credit derivatives developed as a way for banks to transfer credit risk to meet capital requirements but spread risk to other entities. While intended as a risk management tool, credit derivatives contributed to the crisis by spreading counterparty risk without adequate understanding of the risks involved. The document outlines the key types of market participants in credit derivatives and how their roles changed over time.
Swedbank was founded in 1820, as Sweden’s first savings bank was established. Today, our heritage is visible in that we truly are a bank for each and every one and in that we still strive to contribute to a sustainable development of society and our environment. We are strongly committed to society as a whole and keen to help bring about a sustainable form of societal development. Our Swedish operations hold an ISO 14001 environmental certification, and environmental work is an integral part of our business activities.
Jimmy Gentry presents "Digging Deeper into Key Areas" during the Reynolds Center for Business Journalism's annual Business Journalism Week, Jan. 3, 2014. Gentry is the Clyde M. Reed Teaching Professor at the University of Kansas' School of Journalism and Mass Communications.
The annual event features two concurrent seminars, Business Journalism Professors and Strictly Financials for journalists.
For more information about business journalism training, please visit http://businessjournalism.org.
A Fistful of Dollars: Lobbying and the Financial Crisis†catelong
Has lobbying by financial institutions contributed to the financial crisis? This paper uses detailed information on financial institutions’ lobbying and their mortgage lending activities to answer this question. We find that, during 2000-07, lenders lobbying more intensively on specific issues related to mortgage lending (such as consumer protection laws) and securitization (i) originated mortgages with higher loan-to-income ratios, (ii) securitized a faster growing proportion of their loans, and (iii) had faster growing loan portfolios. Ex-post, delinquency rates are higher in areas where lobbying lenders’ mortgage lending grew faster. These lenders also experienced negative abnormal stock returns during key events of the crisis. The findings are robust to (i) falsification tests using information on lobbying activities on financial sector issues unrelated to mortgage lending, (ii) instrumental variables strategies, and (iii) a difference-in-difference approach based on state-level lending laws. These results suggest that lobbying may be linked to lenders expecting special treatments from policymakers, allowing them to engage in riskier lending behavior.
Deniz Igan, Prachi Mishra, and Thierry Tressel, Research Department, IMF‡
October 14, 2009
In RiskMonitor, Allianz Global Investors (AllianzGI) together with Investment & Pensions Europe (IPE) magazine surveys European institutional investors’ perceptions of capital market, regulatory and governance risk.
Macro Risk Premium and Intermediary Balance Sheet Quantitiescatelong
The macro risk premium measures the threshold return for real activity that
receives funding from savers. Financial intermediaries’ balance sheet conditions provide a window on the macro risk premium. The tightness of intermediaries’ balance sheet constraints determines their “risk appetite”. Risk appetite, in turn, determines the set of real projects that
receive funding, and hence determine the supply of credit. Monetary policy affects the risk appetite of intermediaries in two ways: via interest rate policy, and via quantity policies. We estimate time varying risk appetite of financial intermediaries for the U.S., Germany, the U.K., and Japan, and study the joint dynamics of risk appetite with macroeconomic aggregates and monetary policy instruments for the U.S. We argue that risk appetite is an important indicator for monetary conditions.
Moderninizing bank supervision and regulationcatelong
This is the testimony of Chris Whalen to the Senate Banking Committee on March 24, 2009 about bank and financial institution regulation and supervision.
The document summarizes the subprime mortgage crisis and its global impact. It discusses how the crisis originated from risky lending practices involving subprime mortgages in the US housing market. This led to a contraction in liquidity and credit markets globally. Major financial institutions suffered huge losses totaling over $8 trillion. The crisis highlighted failures in mortgage underwriting, risky financial products, and lack of oversight that allowed risk to accumulate in the system.
This document outlines how the subprime mortgage crisis occurred through a network of connected players. Mortgage brokers and banks provided loans to subprime borrowers, which were then packaged into securities and sold to investors with the help of investment banks. Credit rating agencies certified these securities, and insurers provided insurance for them. However, this system was flawed as it relied on continually rising housing prices. When housing prices declined, subprime borrowers defaulted, causing losses for investors, banks, and other players. The crisis led to bankruptcies, government bailouts, and a major loss of wealth in global equity markets.
The document discusses trust in banks across different countries, with a focus on Ukraine and Belarus. It finds that trust in banks varies significantly between countries, with Ukraine having particularly low levels of trust compared to other nations. Low trust can cause people to save money at home rather than depositing it in banks, which has implications for economic growth as it keeps deposits out of the banking system. The document examines some factors that can influence trust in banks, such as institutional quality, historical experiences, economic conditions, and regulation.
Monday September 3 2012 - Top 10 Risk Management NewsCompliance LLC
The document discusses two quantitative models developed by the Bank of Canada to improve assessment of risks to the Canadian financial system:
1. The Household Risk Assessment Model (HRAM) assesses how household debt levels and shocks like interest rate increases or unemployment would affect financial stability.
2. The Macro Financial Risk Assessment Framework (MFRAF) models contagion effects between banks by taking into account counterparty exposures and funding liquidity risk. It integrates these factors to better evaluate overall systemic risk to the financial system.
The models provide tools to identify and measure emerging risks, forecast the probability of financial crises, and assess the impact of policy measures on financial stability.
Over the last 20 years, the banking industry has seen major consolidation, increased use of complex financial products, and a lack of high-quality data at financial institutions. During the 2008 crisis, key decision makers lacked adequate data on the interconnectedness of firms. Lessons learned are that enterprise stress testing should be routine and large firms need to improve data management. Regulators are now focusing on increasing transparency, liquidity risk management, and capital standards to address these issues.
This document discusses empirical research on the determinants of bank lending across countries. It proposes estimating equations to model domestic credit levels based on bank balance sheet and capital requirements approaches. The analysis will use data from 146 countries over 1990-2013 to examine how economic growth, banking system health, and external capital flows influence domestic credit after controlling for other factors. Key determinants expected to impact credit include deposits, interest rates, costs, capital levels, and macroeconomic conditions.
This document summarizes a study that uses a matched sample of individual loans, borrowers, and banks to investigate the effect of banks' financial health on the cost of loans for borrowers, while controlling for borrower risk and information costs. The key findings are:
1) Borrowers pay higher interest rates on loans from low-capital banks compared to well-capitalized banks, even after controlling for borrower risk.
2) This effect is most significant for borrowers where information costs are likely important.
3) When borrowing from weak banks, these high-information-cost borrowers tend to hold more cash, indicating costs to switching lenders.
4) The results provide support for
Adrian Blundell-Wignall, OECD: "An optimal bank structure?"Global Utmaning
This document discusses optimal bank structure and reforming business models of banks. It argues that separation of high risk securities activities from core deposit banks is essential. Risky activities such as derivatives, prime brokering and market making should be put in ring-fenced non-operating holding company subsidiaries if they exceed 10% of a bank's business. A simple leverage ratio of 5% for core deposit banks would make them safer. Separating risky activities prevents cross-subsidization of risk and guarantees, reducing bank size and risk taking.
This document summarizes a research paper that analyzed the determinants of credit risk in the Indonesian banking industry. Specifically, it examined how bank-specific variables like bank size, profitability, capital adequacy, and ownership structure influence the level of non-performing loans (NPL), which is used as a measure of credit risk. The document reviews several previous studies that also analyzed the relationship between credit risk and bank-specific factors in other countries. It then outlines the methodology that will be used in the research, including the data collection and analysis methods.
This document discusses over-indebtedness as a major risk for microfinance institutions (MFIs) that must be managed through an effective risk management framework. It outlines a common risk management feedback loop process that involves identifying, assessing, and prioritizing risks, developing strategies to measure and mitigate risks through operational policies, implementing policies, evaluating effectiveness, and revising policies as needed. Specifically for over-indebtedness, the document examines the drivers of over-indebtedness for MFIs and strategies they can use to mitigate this risk, such as controlling multiple borrowing, strengthening systems and lending discipline.
This document summarizes the findings of a survey of 819 lenders on their environmental risk management practices. The top challenges lenders face are: (1) lack of expertise to understand environmental reports and make risk-based decisions, (2) need for internal education and training on how environmental due diligence fits into the lending process, and (3) turnaround time constraints. While lender policies have evolved since the real estate downturn, many - especially smaller banks - still lack formal policies or training. As lending slowly increases, lenders need assistance justifying due diligence costs, basic training, and help balancing regulatory compliance with maintaining competitiveness.
Igor Livshits' discussion of "Endogenous Political Turnover and Fluctuations ...ADEMU_Project
This document summarizes and provides comments on the paper "Endogenous Political Turnover and Fluctuations in Sovereign Default Risk". The paper puts forth a clear story that political turnover and sovereign default risk are endogenously determined. A simple model is described where politicians' identities determine growth rates and their borrowing decisions affect default risk. However, some comments question whether the story is fully supported by data on growth, debt levels, and actual defaults. Technical assumptions about politicians and voters are also noted to possibly be at odds with empirical evidence. Overall, while an interesting mechanism, more work may be needed to map the implications to real-world politics and fiscal outcomes.
This document summarizes a study that investigated the determinants of commercial bank lending behavior in Nigeria. The study aimed to test how common factors like deposits, investments, interest rates, reserve requirements, and liquidity ratios affect bank lending. Regression analysis found the model to be significant, with deposits having the greatest impact on lending. The study suggests banks focus on deposit mobilization to enhance lending performance and develop strategic plans.
Effect of Liquidity Risk on Performance of Deposit Money Banks in Nigeriaijtsrd
This study examines the effect of the credit risk ratio on the financial performance of deposit money banks in Nigeria. Ex Post Facto research design was employed for the study. Sample sizes of five banks were selected from twenty banks quoted on the Nigerian Stock Exchange. Data were extracted from annual reports and accounts of the selected banks from 2010 to 2019. Using E view statistical tool to test the hypothesis, the study found that credit risk ratio significantly influences the financial performance of quoted deposit money banks in Nigeria It was recommended that bank managers should constantly engage in rigorous credit analysis, checking, default rate, the proportion of non performing loans, regularly or at least quarterly to enable them to maintain high asset quality to enhance the financial performance. Oraka, Azubike O | Ebubechukwu, Jacinta O "Effect of Liquidity Risk on Performance of Deposit Money Banks in Nigeria" Published in International Journal of Trend in Scientific Research and Development (ijtsrd), ISSN: 2456-6470, Volume-5 | Issue-4 , June 2021, URL: https://www.ijtsrd.compapers/ijtsrd42388.pdf Paper URL: https://www.ijtsrd.commanagement/other/42388/effect-of-liquidity-risk-on-performance-of-deposit-money-banks-in-nigeria/oraka-azubike-o
Effect of Liquidity Risk on Performance of Deposit Money Banks in Nigeria
Similar to Ivo Pezzuto - Miraculous Financial Engineering or Toxic Finance? The Genesis of The U.S. Subprime Mortgage Loans Crisis and Its Consequences on the Global Financial Markets and Real Economy
This document provides an overview of credit derivatives and their role in the 2008 financial crisis. It discusses how credit derivatives developed as a way for banks to transfer credit risk to meet capital requirements but spread risk to other entities. While intended as a risk management tool, credit derivatives contributed to the crisis by spreading counterparty risk without adequate understanding of the risks involved. The document outlines the key types of market participants in credit derivatives and how their roles changed over time.
Swedbank was founded in 1820, as Sweden’s first savings bank was established. Today, our heritage is visible in that we truly are a bank for each and every one and in that we still strive to contribute to a sustainable development of society and our environment. We are strongly committed to society as a whole and keen to help bring about a sustainable form of societal development. Our Swedish operations hold an ISO 14001 environmental certification, and environmental work is an integral part of our business activities.
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The new era of globalization, propelled by the rapid technological advancements and widespread concern for sustainable development goals, seems to be headed for a bright and promising future, driven by an unprecedented groundbreaking potential. It’s a very exciting moment for dynamic, highly competitive and innovative firms and startups to engage these days in international business, thanks to a vibrant and highly interconnected global business environment, eagerly driven knowledge-sharing communities, and ease of access to smart and seamless enabling technologies. Yet, globalization is currently facing also very serious challenges whose root causes seem to be deep and complex and if they are not fully understood and properly addressed by political leaders and multilateral institutions, they may potentially threaten to derail the existing world order. This article aims to provide a broad overview of the major opportunities and challenges of the new era of globalization and to stimulate reflections, debates, and possible new visions and strategic directions in order to create a more sustainable, socially inclusive, competitive, innovation-driven, and prosperous future for all stakeholders in the global market.
This document provides background on Rajani Ramaseshan and his career in structured finance. It summarizes Rajani's education and career path working in securitization at major banks. It then describes the global financial crisis beginning in 2007 and its impact on the structured finance market. Rajani is tasked with researching past financial crises to better understand the 2007-2009 crisis and assess the future viability of securitization. Brief summaries are provided of four major crises: the Asian financial crisis of 1997, the Long-Term Capital Management crisis of 1998, the technology bubble burst of 2000, and the factors that contributed to the global financial crisis of 2007-2009.
FIN 4303 – RVEFinancial Markets and InstitutionsSpring 2019G.docxcharlottej5
FIN 4303 – RVE
Financial Markets and Institutions
Spring 2019
Group Project – Research Paper
Your team is an independent panel hired by the Chairman of the Finance Committee of the House and Senate to investigate the Subprime Mortgage Crisis and its aftermath. In 10 weeks, you will report your findings to the Committee.
The written report to the Committee is to include:
Part I (50%)
1. Summarize the subprime mortgage crisis and its aftermath in a chronological format, highlighting only significant events that occurred. Be sure to include the starting point, as you see it.
2. Outline the role that each party played in the subprime mortgage crisis. Identify the names of the companies that played a major role and briefly provide an update of their present status:
a. Mortgage companies/ brokers
b. Subprime borrowers
c. “Money center” banks
d. Investment bankers
e. Mortgage credit insurers (Freddie Mac, Fannie Mae, Ginnie Mae)
f. Credit rating agencies (the big 3)
g. Investors (Pension funds, hedge funds, global investors)
3.
Identify the winners and losers from this financial event. Clearly state your reasons.
4.
Describe the magnitude of the effects to the national and international economy, through data and statistics, and present your opinions about whether AIG should have been allowed to fail.
Part II (50%)
1. Summarize the actions already taken until now by the Federal Reserve and Federal Government to ease the credit crisis.
2. Based on your research and your knowledge of the current economic environment, forecast economic growth and the direction of interest rates in the following one year and outline a series of recommendations for the Finance Committee to consider to control the effects of the financial crisis and avoid an occurrence in the future. Specify which ones you believe would be the most effective. Consider practicality, timeless, cost, timeframe and effect of implementation.
Recommendations could cover governmental policy or action, monetary policy, regulatory, and private industry.
3. The Ethics Committee also wants the panel to identify which parties should be investigated for potential ethics violations and the potential role they played that would be considered unethical behavior during the credit crisis. Begin with a definition of ethical standards in business.
4. This crisis is the most serious economic crisis in the world history. European countries also suffer another wave of financial crisis. Summarize what the European debt crisis is and how would the European debt crisis play out? What really caused the Eurozone crisis? Are Americans responsible for European woes?
The written report is due on April 24 at 2:00 PM. Groups are required to electronically submit a copy of your report using Canvas Course Mail. The report must be presented in professional manner and must be submitted before deadline. Late project will be assessed a penalty of 10% points per day. Each group will be responsible for subm.
The document summarizes some of the key risks facing the international banking system. It discusses how sovereign debt crises are destabilizing markets and economic growth is sluggish in developed nations. Banks face challenges including high credit risks in Europe, regulatory changes, and demanding customers. The main risks identified include default risk if borrowers fail to repay, financial risk from capital structure and debt levels, and business risk from uncertainty in markets and income.
FEDERAL RESERVE BANK OF ST. LOUIS REVIEW SEPTEMBEROCTOBER 200.docxmydrynan
FEDERAL RESERVE BANK OF ST. LOUIS REVIEW SEPTEMBER/OCTOBER 2008 531
The Credit Crunch of 2007-2008:
A Discussion of the Background,
Market Reactions, and Policy Responses
Paul Mizen
This paper discusses the events surrounding the 2007-08 credit crunch. It highlights the period
of exceptional macrostability, the global savings glut, and financial innovation in mortgage-backed
securities as the precursors to the crisis. The credit crunch itself occurred when house prices fell
and subprime mortgage defaults increased. These events caused investors to reappraise the risks
of high-yielding securities, bank failures, and sharp increases in the spreads on funds in interbank
markets. The paper evaluates the actions of the authorities that provided liquidity to the markets
and failing banks and indicates areas where improvements could be made. Similarly, it examines
the regulation and supervision during this time and argues the need for changes to avoid future
crises. (JEL E44, G21, G24, G28)
Federal Reserve Bank of St. Louis Review, September/October 2008, 90(5), pp. 531-67.
that the phrase “credit crunch” has been used
in the past to explain curtailment of the credit
supply in response to both (i) a decline in the
value of bank capital and (ii) conditions imposed
by regulators, bank supervisors, or banks them-
selves that require banks to hold more capital
than they previously would have held.
A milder version of a full-blown credit crunch
is sometimes referred to as a “credit squeeze,”
and arguably this is what we observed in 2007
and early 2008; the term credit crunch was already
in use well before any serious decline in credit
supply was recorded, however. At that time the
effects were restricted to shortage of liquidity in
money markets and effective closure of certain
capital markets that affected credit availability
between banks. There was even speculation
T
he concept of a “credit crunch” has a
long history reaching as far back as the
Great Depression of the 1930s.1 Ben
Bernanke and Cara Lown’s (1991) classic
article on the credit crunch in the Brookings
Papers documents the decline in the supply of
credit for the 1990-91 recession, controlling for
the stage of the business cycle, but also considers
five previous recessions going back to the 1960s.
The combined effect of the shortage of financial
capital and declining quality of borrowers’ finan-
cial health caused banks to cut the loan supply
in the 1990s. Clair and Tucker (1993) document
1
The term is now officially part of the language as one of several
new words added to the Concise Oxford English Dictionary
in June 2008; also included for the first time is the term
“sub-prime.”
Paul Mizen is a professor of monetary economics and director of the Centre for Finance and Credit Markets at the University of Nottingham
and a visiting scholar in the Research Division of the Federal Reserve Bank of St. Louis. This article was originally presented as an invited
lecture to the Groupemen ...
The document summarizes arguments about the causes of the 2007-2008 global financial crisis. It discusses how a combination of easy credit, rising housing prices, subprime mortgages, and systemic linkages between financial institutions led to a crisis larger than expected losses could explain. The regulatory framework failed to mitigate moral hazard or consider how interlinkages could spread shocks, while quantitative models underestimated risks. Overall, globalization and asymmetric information exacerbated systemic risk in the financial system.
This document summarizes the outlook for the global economy and structured finance markets in early 2008. It finds that while economic growth has decoupled internationally, global credit markets remain tight due to concerns about the U.S. economy flirting with recession. Within structured finance, the near-term outlook is poor, but there is long-term optimism if the industry addresses issues through improved transparency and standardization. Housing prices and the U.S. job market will be key indicators to watch in determining if and how deep a recession may be.
Lesson 6 Discussion Forum Discussion assignments will beDioneWang844
Lesson 6 Discussion Forum :
Discussion assignments will be graded based upon the criteria and rubric specified in the Syllabus.
550 Words
For this Discussion Question, complete the following.
1. Review the two articles about bank failures and bank diversification that are found below this. Economic history assures us that the health of the banking industry is directly related to the health of the economy. Moreover, recessions, when combined with banking crisis, will result in longer and deeper recessions versus recessions that do occur with a healthy banking industry.
2. Locate two JOURNAL articles which discuss this topic further. You need to focus on the Abstract, Introduction, Results, and Conclusion. For our purposes, you are not expected to fully understand the Data and Methodology.
3. Summarize these journal articles. Please use your own words. No copy-and-paste. Cite your sources.
Please post (in APA format) your article citation.
Reply to Post 1: 160 words and Reference
Discussion on Bank’s failures and its diversification
Over the last two decades, business cycle volatility has decreased in the US. For example, some analysts claimed that companies handle inventory better today than ever, or that advances in financial systems have helped smooth industry volatility. Some emphasized stronger economic policy. Banking changes were also drastic in this same era, contributing to the restructuring and convergence of massive, global banking institutions in a better-organized structure. The article (Strahan, 2006) points out that some regulatory reform driven by individual countries rendered it possible for banks to preserve their resources and income by gradually diversifying from local downturns. Both low state volatility rates and a decline in partnerships between the local market and the central banking sector is a net influence on the diversification in banks. Considering the less fragile state economies following these intergovernmental financial reforms, there are some signs that financial convergence – while certainly not the only piece of the puzzle – has been less unpredictable.
Another article (Walter, 2005) argues that a long-standing reason for bank collapses during the crisis is a contagion, which contributes to systemic bank failures and the collapse of one bank initially. This indicates why several losses in the crisis period were unintentional, which ensured that the banks remained stable and endured without contagion-induced falls. The response to the contagion was the central government’s deposit policy, bringing an end to defaults. Nevertheless, since the sequence of errors began in the early 1920s, well before contagion was evident, the underlying trigger must be contagion.
Now it seems like the bank sector has undergone a shake-out that was worsened during the crisis by the deteriorating economic conditions. Although the reality that incidents occurred almost syno ...
The Subprime Crisis & Implications for Microfinance (SVMN, 05/18/08)Dave McClure
Presentation on the US Subprime Crisis & Impact / Implications on Microfinance, by Katherine McKee, CGAP, to the Silicon Valley Microfinance Network (SVMN.net).
FINAL TAKE-HOME ASSIGNMENTThe final take home has 2 parts, 2 equ.docxAKHIL969626
FINAL TAKE-HOME ASSIGNMENT
The final take home has 2 parts, 2 equally weighted critical thinking essays on moral hazard and socially responsible finance.
Moral Hazard Critical Thinking Essay Assignment
The prompt
The term “moral hazard” has been in the news over the past few years. What does this mean? Why is it a concern to many financial institution and market observers? What role, if any, did it play in the financial crisis of the last decade? What, if anything, do you think should be done about it?
Your essay should be 2 pages (approximately 500 words).
Content Grade Rubric
Student:
Prompt
4
3
2
1
0
Score
What does the term “moral hazard” mean?
Fully defined
Partially defined
Incorrectly defined
Not answered
Why is it a concern to many financial institution and market observers?
Fully explained
Partially explained
Incorrectly explained
What role, if any, did it play in the financial crisis of the last decade?
Fully explained
Partially explained
Incorrectly explained
What, if anything, do you think should be done about it?
Thoughtful, complete answer
Partial answer
Inappropriate answer
Socially Responsible Finance Critical Thinking Essay Assignment
The prompt
In recent years, there has been a growing debate around “socially responsible finance”. Demand for opportunities labelled as “socially responsible investments” (SRI) has increased, behavioral finance and institutional “nudging” are receiving more attention, and corporate governance of institutions is broadly discussed. Overall, potential returns as well as conflicts of interest, environmental and social impact are more closely scrutinized. What are the origins of this movement? What role do you think knowledge about behavioral finance and SRIs should play in future personal and professional decisions?
The details
Your essay should be 2 pages (approximately 500 words).
Student:
Prompt
4
3
2
1
0
Score
What are the origins of SRI? How does it work in practice?
Fully explained
Partially explained
Incorrectly explained
Not answered
What is the evidence to date about whether SRI investments outperform or underperform non-SRI investments?
Fully explained
Partially explained
Incorrectly explained
What is the origin of behavioral finance? In which decisions can be found?
Fully explained with citations
Partially explained/no citations
Incorrectly explained
Is there evidence of institutional “nudging” benefiting main street?
Thoughtful, complete answer
Partial answer
Inappropriate answer
How do you think reading about behavioral finance and SRIs will affect future personal and professional decisions?
Thoughtful, complete answer
Partial answer
Inappropriate answer
Sheet1LMH10090H80M70L605040302010NumberRisk NameFull Risk CostRisk ProbabilityFactored Risk costRisk Impact to ProjectRisk Mitigation PlanPoint of ContactExpected Risk Retire date1$20,00020%$4,000L2$03$04$05$06$07$08$09$010$0$0$0
10
1
2
3
4
5
6
8
9
7
Sheet2
Sheet3
Oral Testimony of
...
The document discusses the role of institutional investors in propagating the financial crisis of 2007-2008. It states that institutional investors like mutual funds, pension funds, hedge funds, and insurance companies contributed to the crisis through their large and professional investments. While institutional investors enjoy benefits due to the scale of their investments, their actions also amplified the crisis. The document cites the example of hedge fund Magnetar Capital and insurance company AIG as institutional investors that played a role in the crisis.
This document provides a summary and comparison of risk management theories from Hennie van Greuning, Joël Bessis, and Dennis Uyemura. It discusses the major categories of risk that banks face, including credit risk, country risk, performance risk, liquidity risk, interest rate risk, market risk, foreign exchange risk, solvency risk, and operational risk. While the theorists generally agree on the types of risks, there are some differences in how some risks are defined or categorized. The document will examine these risk management theories in the context of the current US mortgage crisis.
This document provides an overview of country risk analysis. It discusses the history and sources of country risk data, including rating agencies. Various methodologies are described for analyzing economic, financial, and geopolitical factors that influence a country's risk level. The document outlines the key components of a comprehensive country risk analysis, including evaluating a country's economic policies, financial system, and strengths/weaknesses. The overall goal is to assess risk exposure and set appropriate pricing for credit or investment decisions involving that country.
The sub-prime crisis highlighted issues with credit risk measurement in retail mortgage lending. Factors like plummeting interest rates pre-2005, lack of oversight on new risky products, and an active CDO market that enabled easy risk transfer contributed to the crisis. However, credit scoring approaches, which became prevalent during this period of innovation, also share some blame. Credit scoring focuses only on past payment history and does not fully capture borrowers' ability to repay, especially given changing macroeconomic conditions. This led to underestimation of risk. Going forward, credit risk measurement needs a more holistic approach that considers a borrower's full financial profile and macroeconomic factors. Outsourcing some aspects of the underwriting process could also
Ivo Pezzuto - Predictable and Avoidable: What's Next?Dr. Ivo Pezzuto
Abstract:
The author of this paper (Dr. Ivo Pezzuto) has been one of the first authors to write back in 2008 about the alleged "subprime mortgage loans fraud" which has triggered the 2008 financial crisis, in combination with multiple other complex, highly interrelated, and concurrent factors.
The author has been also one of the first authors to report in that same working paper of 2008 (available on SSRN and titled "Miraculous Financial Engineering or Toxic Finance? The Genesis of the U.S. Subprime Mortgage Loans Crisis and its Consequences on the Global Financial Markets and Real Economy") the high probability of a Eurozone debt crisis, due to a number of unsolved structural macroeconomic problems, the lack of a single crisis resolution scheme, current account imbalances, and in some countries, housing bubbles/high private debt.
In the book published in 2013 and titled "Predictable and Avoidable: Repairing Economic Dislocation and Preventing the Recurrence of Crisis", Dr. Ivo Pezzuto has exposed the root causes of the financial crisis in order to enables readers to understand that the crisis we have seen was predictable and should have been avoidable, and that a recurrence can be avoided, if lessons are learned and the right action taken.
Almost one year after the publication of the book "Predictable and Avoidable: Repairing Economic Dislocation and Preventing the Recurrence of Crisis", the author has decided to write this working paper to explore what happened in the meantime to the financial markets and to the financial regulation implementation.
Most of all, the author with this working paper aims to provide an updated analysis as strategist and scenario analyst on the topics addressed in the book "Predictable and Avoidable" based on a forward-looking perspective and on potential "tail risk" scenarios. The topics reported in this paper relate to financial crises; Government policy; financial regulation; corporate governance; credit risk management; financial risk management; economic policy; Euro Zone debt crisis; the "Great Recession"; business ethics; sociology, finance and financial markets.
This working paper aims to contribute to the debate about the change needed in the banking and finance industries and to supervisory frameworks, in order to enhance regulatory mechanisms and to improve global financial stability and sustainability.
Conclusion: This paper aims to demonstrate that, in spite of the artificially reduced volatility in the markets, systemic risks have not been reduced after the global financial crisis and that, currently (September 2014), adverse scenarios seem to be much more likely than previously expected by regulators and supervisory authorities, due to the prolonged massive accommodative monetary policies, the increased economic and geo-political risks, and some incomplete or unfit financial regulation. Thus, the stress testing models, their underlying assumptions, and the supervisory aut
The document summarizes a presentation given by the Financial Management Association of New Hampshire on safeguarding cash and investments during turbulent economic times. The presentation addressed the current financial crisis, economic outlook, condition of the financial industry, cash management options, and investment policy guidelines. Panelists discussed issues like capital adequacy, the future of securitization and universal banking, and strategies for preserving capital while generating yield.
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This document provides a summary of reviews and endorsements for the book "Predictable and Avoidable: Repairing Economic Dislocation and Preventing the Recurrence of Crisis" by Ivo Pezzuto. The book analyzes the causes of the 2007-2008 global financial crisis and proposes reforms to prevent future crises. It incorporates interviews with thought leaders and experts. Reviews praise the book for its unbiased, fact-based analysis and comprehensive explanation of the crisis origins and solutions. The book is recommended for academics, professionals, and students interested in the crisis.
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Ivo Pezzuto - Miraculous Financial Engineering or Toxic Finance? The Genesis of The U.S. Subprime Mortgage Loans Crisis and Its Consequences on the Global Financial Markets and Real Economy
1. Electronic copy available at: http://ssrn.com/abstract=1332784
ISSN 1662-761X Issue: 12/2008
Ivo Pezzuto
Miraculous Financial Engineering or Toxic Finance?
The genesis of the U.S. subprime mortgage loans
crisis and its consequences on the global financial
markets and real economy
2. Electronic copy available at: http://ssrn.com/abstract=1332784
Abstract
In the fall of 2008, the U.S. subprime mortgage loans defaults have turned into Wall
Street’s biggest crisis since the Great Depression. As hundreds of billions in mortgage-related
investments went bad, banks became suspicious of one another’s potential undisclosed credit
losses and preferred to reduce their exposure in the interbank markets, thus causing interbank
interest rates and credit default swaps increases, a liquidity shortage problem and a worsened
credit crunch condition to consumers and businesses. Massive cash injections into money
markets and interest rates reductions have been assured by central banks in an attempt to
shore up banks and to restore confidence within the financial system. Even Governments have
promoted bail-out deal agreements, protections from bankruptcies, recapitalizations and bank
nationalizations in order to rescue banks from disastrous bankruptcies.
The credit crisis originated in the previous years when the Federal Reserve sharply
lowered interest rates (Fed Funds at 1%) to limit the economic damage of the stock market
decline due to the 2000 dot.com companies’ crisis. Lower interest rates made mortgage
payments cheaper, and the demand for homes began to rise, sending prices up. In addition,
millions of homeowners took advantage of the rate drop to refinance their existing mortgages.
As the industry ramped up, the quality of the mortgages went down due to poor credit
origination and credit risk assessment. Delinquency and default rates began to rise in 2006 as
interest rates rose (Fed Funds at 5,25%) and poor households across the US struggled to pay
off their mortgages. Many of them went bankrupt and lost their homes but the pace of lending
did not slow.
Banks have transformed much of the high-risk mortgage debt (securitizations) into
mortgage-backed securities (MBS) and collateralised debt obligations (CDO), and have sold
these assets on the stock markets to financial firms and insurance companies around the
world, transferring to these investors the rights to the mortgage payments and the related
credit risk. With the collapse of the first banks and hedge funds in 2007 the rising number of
foreclosures helped speed the fall of housing prices, and the number of prime mortgages in
default began to increase. As many CDO products were held on a “mark to market” basis, the
paralysis in the credit markets and the collapse of liquidity in these products let to the
dramatic write-downs in 2007. When stock markets in the United States, Europe and Asia
3. continued to plunge, leading central banks took the drastic step of a coordinated cut in interest
rates and Governments coordinated actions that included taking equity stakes in major banks.
This paper written by the Author (on October 7th, 2008) at the rise of these dramatic events,
aims to demonstrate, through solid and fact-based assumptions, that this dramatic global
financial crisis could have been addressed and managed earlier and better by many of the
stakeholders involved in the subprime mortgage lending process such as, banks’ and
investment funds management, rating agencies, banking and financial markets supervisory
authorities. It also unfortunately demonstrates the corporate social responsibility failure and
the moral hazard of many key players involved in this crisis, since a lot of them probably
knew quite well what was happening but have preferred not to do anything or to do little and
late in order to change the dramatic course of the events.
About the Author
Ivo Pezzuto
Born in Italy and raised in the U.S.A., Professor Ivo Pezzuto, is a Marketing, Strategy &
Business Development Faculty at Swiss Management Center since 2006 and a Marketing,
Finance and Strategy Subject Leader at other Business Schools since 2003. He is also a
Principal Management Consultant. Prior to his current international academic and consulting
experience he has a successful track record of over fifteen years of corporate career in Europe
as manager, senior manager, vice president (i.e., Chief Risk Officer of European Division),
and advisor of leading global banks, financial services institutions and multinational
organizations such as, ING Advisory, Citigroup, Diners Club, American Express, Accenture,
Fidis (Fiat Group’s financial service holding). He is also an Advisor to Gerson Lehrman
Group of New York and Standard & Poor’s Vista Research of New York. He holds a BS
degree from New York University Stern School of Business; an MA in Economics and MBA
degree from SDA Bocconi School of Management, Milan, (Italy), and has attended several
executive development seminars in Europe (i.e., ISTUD and SDA Bocconi School of
Management) and in the U.S.A. (i.e., Accenture Center for Professional Education) on
management consulting, marketing, strategy, credit risk management and general
management topics. He has also undertaken doctoral research work (DBA) on strategic
management at Swiss Management Center.
4. “There's none so blind as those who will not see” (The Prophet Jeremiah)
Most economists and financial analysts identify amongst the main causes of the
current global financial crisis, the U.S. Federal Reserve’s low interest rates policy (Fed funds)
of the latest years with the resulting credit euphoria of both lenders and borrowers, the more
”relaxed” credit initiation policies and procedures, the overwhelmingly positive expectations
on the real estate market growth and prices increases, and the massive use of badly controlled
innovative financial engineering tools.
Although these solid and fact-based arguments certainly represent a relevant and
accurate portion of the “big picture” and help identify and explain some of key determinants
of the global financial turmoil, the degree of complexity reached by the phenomenon and its
global spread seem to suggest a more interrelated and articulated set of responsibilities than
the ones represented by the more aggressive expansionary US monetary policy, the less
rigorous credit policies and some adverse economic and market conditions.
There is no doubt that in today’s globalized world and highly integrated financial
markets the wave of profits and losses (from capital, monetary, equity, debt, derivatives,
commodities, liquidity, foreign exchange markets) moves very quickly across the five
continents. The speed of communication devices, online and real-time decision support
systems, advanced ICT architectures and computer-based solutions have certainly simplified
but also amplified the benefits and threats associated to global financial trading, since the
higher interrelations and integration leads also to a higher level of complexity.
A more thorough and in–depth analysis of how the U.S. subprime mortgage loans
crisis has originated and evolved, seems to reinforce the idea that this dramatic financial event
is predominantly related to the underestimated complexity generated by the exponential
growth of innovative financial engineering products (derivatives), by the SPVs (Special
Purpose Vehicles), by the too ambitious short-term oriented bonus/profitability/capital gains
objectives of banks’ management and their shareholders, by speculators, and by a major
5. failure of banks, rating agencies, and banking and financial markets’ supervisory authorities
to proactively and timely assess and mitigate the exploding crisis.
An evidence of this assumption is proved by the difficulty of many experienced credit
and financial analysts to believe that all the risk management specialists of banks and
financial institutions involved in the subprime mortgage loans crisis, simultaneously lost
control of their portfolio risk and had no clue about what was really happening in their
organisations even at the very senior management levels.
Even more incredible to believe is that the subprime mortgages loans portfolios have
deteriorated so suddenly and unexpectedly that risk managers, internal auditing teams,
external independent auditors, rating agencies, banks management, industry and investment
analysts and banking and financial markets supervisory authorities (i.e., FED and SEC and
others) have not perceived the dangerous rising burden of risks or at least have seriously
underestimated the potential blast. This is quite difficult to believe, indeed, given that in the
US mortgage lending market two semi-governmental agencies alone, like mortgage giants
Fannie Mae and Freddie Mac, account for over sixty percent of the total national mortgage
lending industry.
The banks’ subprime mortgage loans securitizations have received in many cases
investment grade ratings (i.e., Fannie & Freddie – AAA rating) from the leading rating
agencies (i.e., Standard & Poor’s, Moody’s and Fitch) for the placement of their securitized
mortgages loans as structured products and derivatives (i.e., CDOs - Collateralized Debt
Obligations, ABS – Asset-Backed Securities, MBS Mortgage-Backed Securities). This is a
very convenient way of funding the business especially with a AAA ratings (low default risk
= low cost of debt capital (WACC) from the well-known CAPM methodology). This generous
low-risk assessment of the rating agencies has recently led many investors and economic
journalists to declare serious concern about a possible conflict of interests in the relationship
between the two parties (banks and the rating agencies). Furthermore, the securitization
process was expected to make the markets safer through diversification and distribution of
risks to a wide spread number of investors and investment portfolios globally. CDOs are
offered in trances of increasing seniority (equity/first loss, mezzanine, senior, super-senior).
At the more senior level of debt, investors are able to obtain better yields than those available
on more traditional securities. CDO issuers usually hedge their position by selling credit
6. default swaps (CDS) on the reference portfolio. The counterparties in the hedging transaction
are the ones who actually sell credit risk to the CDO buyers.
Other doubts that seem to confirm the unlikely hypothesis that senior bankers, rating
agencies analysts and fund managers were unaware of the subprime crisis escalation are
represented by the traditional preventive and pro-active fact-based risk management
approaches and philosophy of most North-American banking and financial services
institutions. Credit and financial risk management specialists of the retail and investments
banks, rating agencies and mutual funds are highly qualified professionals rigorously trained
to make fact-based decisions on the debt (lending)/securities/derivatives portfolios, who rely
heavily on highly advanced and state-of-the-art metrics, statistical models and computer-
based technologies to assess credit, operational, market and financial risks.
In addition to these powerful tools, these professional also use a set of standard
internal policies and procedures and risk review processes which allow them to have a high
level of confidence in the governance of their risk management
American banks have a long tradition of expertise in the mortgage lending and
unsecured lending industry and in proactively managing their portfolios with state-of-the art
credit risk management techniques which generally include timely and systematic use of early
warning indicators (KPIs) sourced from credit scoring systems (application and behavioural
scoring from FICO, NextGen, VantageScore, and the CE Score), bureau scores (from credit
bureaus like Equifax, Experian, and TransUnion), portfolio aging and vintage analyses,
delinquency/roll rates/flow rates analyses, internal ratings-based approaches, external rating
agencies’ models, classified accounts for corporate exposures, Basel II models,
CreditMetrics, Credit Portfolio View, CreditRisk+, Merton OPM/KMV Moody’s, Reduced
Form KPMG/Kamkura, VaR, Algorithmics models, and so on.
It is difficult to believe that all the retail and investment banks, insurance companies,
and mutual funds involved in the subprime crisis with the availability of these state-of-the art
metrics, risk assessments models and senior managers expertise, were simultaneously not able
to spot the problem at an early stage of the threat. They were, instead, extremely talented at
convincing leading rating agencies of the good quality (low probability of default) of their
mortgage portfolios (including the risky subprime segments) in order to transform these
“risky assets” (mortgages loans receivables) into apparently low risk securitizations and very
convenient funding for the banks.
7. These securitized subprime mortgage loans were then used as underlying assets or
collateral of complex and high volatility structured products and derivatives (i.e., CDO, ABS,
MBS) and placed in the mutual funds, pension funds and hedge funds portfolios and sold all
over the world to institutional investors as low risk (AAA rating) investments with very
attractive return rates (profitability). With this strategy the financial engineering “miracle”
was actually invented. Contrarily to the established investment techniques principles (low
risk/low returns and high risk/high return) the financial engineering miracle has created the
(low risk/high return) paradigm, at least in the short-term. Most stakeholders of this
innovative banking approach must have been very happy about the miracle at least in the
beginning. Rating agencies’ risk models have certainly underestimated the impact that
widespread defaults in a declining home price environment could have on the value of
complex financial engineering products like the CDOs.
As good risk managers know quite well, lending portfolios’ deteriorations do not
occur overnight (even in the subprime segments) if the credit origination and credit risk
management process are managed properly. At least many risk managers should not receive
significant unexpected surprises simultaneously, having in their banks different credit
policies, corporate strategies, and constantly reviewed and audited processes.
Many leading secured and unsecured lending organizations in the US/UK use
profitability-based models (NPV models) to systematically monitor portfolio performances
and to forecast/plan portfolios projected trends/results. It seems a bit awkward and difficult to
believe that some of the best risk managers and savvy financial analysts of the world have
suddenly “missed the boat” causing the dramatic bankruptcies (i.e., Douglass National Bank,
Hume Bank, First Integrity Bank, IndyMac, Silver State Bank, Lehman Brothers, Washington
Mutual and others) or severe losses of many prestigious banks and investment firms,
mutual/private/hedge equity funds and insurance companies which had to be saved by the
Governments recapitalizations/debt-equity swaps, or by the acquisitions/takeovers of
competitors or investors (i.e. Bear Stearns, Countrywide, Merrill Lynch, Hbos, Aig, Northern
Rock, Fannie Mae and Freddie Mac, Fortis, Bradford & Bingley, Morgan Stanley and others).
The reasonable explanation for a crisis of this magnitude and the hypothesis that this
paper is aiming to state, is that a combination of a number of complex and highly interrelated
factors have strongly contributed to this global financial turmoil. The factors are related to
economic elements, to the corporate governance of banks and financial institutions, to the
8. U.S. Government monetary policy, to the lack of rigorous supervisory controls in the banking
industry and financial markets, to the high leverage credit culture of people in the U.S.A. and
the U.K., to the banking management culture and philosophy, to the role played by the rating
agencies.
To be more specific, the combined factors which have probably strongly contributed
to the subprime issue are related to:
1) the low interest rates introduced in the last years in the U.S. market (expansionary
monetary policy) to stimulate aggressive growth of the credit industry (mortgage
lending) and to sustain a steady growth of the real estate industry;
2) the high level of leverage of both the U.S. citizens (consumer credit/mortgage
lending) and the U.S. banks and financial institutions (through the use of a remarkable
increase of the innovative, complex and highly volatile financial engineering products
such as securitizations and derivatives placed on external vehicles - SPVs);
3) the “credit euphoria” of both mortgage lenders and borrowers in the US market,
generated by the low interest rates and the more relaxed credit origination terms
applied by banks, has facilitated the level of credit risk increase in particular in the
subprime customer segment. It has also allowed at least in the short term the US GNP
growth and an improved position in the Balance of Payments;
4) the profitability incentives/objectives of the management of banks, investment
firms, and mutual funds that combined with low interest rates and rapid mortgage
portfolio growth have probably stirred even more speculative behaviours of bankers,
shareholders and investors to pursue more aggressively short-term financial benefits.
This last assumption is demonstrated by the unusual salary and bonus increases in the
last few years of CEOs of U.S. banks, investment firms, an other financial institutions. It is
possible that the “credit boom euphoria” might have shifted the attention of many CEOs and
9. senior managers of these organizations from their core business (professional lending and
investment management) and organizational/industry culture (lending and credit management,
portfolio risk/return-based decision making, and systematic risk reviews and audits) to a more
aggressive short-term orientation. They might have closed one eye or maybe even two
sometimes, to pursue immediate profitability benefits rather than focusing on the long-term
sustainability, profitability, growth and brand awareness and reputation of their financial
institutions.
Although this hypothesis sounds, as it is, quite worrying and alarming about the
ethical and professional integrity of some of the bankers and financial gurus involved in the
subprime crisis, the gloomy assumption does not explain, however, why the rating agencies
have apparently not immediately reported the mortgage portfolios’ deteriorations
downgrading these assets (mortgages receivables/securitizations/or the financial institutions)
or raised issues/warnings about the risky SPVs. Even the banking and financial markets
supervisory authorities in U.S. (FED, SEC) and other countries (ECB, BOE, and others)
apparently have investigated the problem when it was already quite too late.
The role of the Central Banks is to contribute to financial stability. Financial stability
is a situation where financial markets, payments and settlements systems and financial
institutions function smoothly and can withstand shocks. This involves monitoring the
financial system closely. Now in this case things seem to have gone in a totally different
direction.
It results quite difficult to believe that the U.S. banking and financial markets
supervisory authorities were totally unaware of the subprime mortgage loans crisis,
considering that the two mortgage lending giants, Fannie Mae and Freddie Mac, which
manage a portfolio of above sixty percent of the overall U.S. mortgage lending market, are in
fact government-sponsored enterprises" (GSEs). This means that they are privately owned,
but receive support from the Federal Government, and assume some public responsibilities.
When Fannie Mae and Freddie Mac on September 6, 2008 requested a 200 billion dollars
rescue plan, they were still rated AAA. The same occurred with Lehman Brothers, since a few
hours before its bankruptcy announcement on September 14th
, 2008 was still rated as an
investment grade (A rating) organization.
Perhaps there has not been sufficient attention to the risk management aspects of
mortgages loans and derivatives, or perhaps there has been limited auditing and supervisory
10. controls, but one thing which is sure is that, at least in the short-term, the rapid portfolio
growth has certainly strongly contributed to the salary and bonus increases of CEOs and top
managers, to the ROI of the banks and hedge and private equity funds, to the dividends and
capital gains of the shareholders, and to the growth of the US. Economy.
These are the risks of short-termism!
Now, however, has come the time to mend the broken pieces and to start paying the
bill of all this big mess. Looking at the accrued loss figures and the new potential ones (other
institutions that may go bankrupt and the threat of global recession) the “bill” might become
a bit too expensive. Since we have identified who have been the winners of the financial
engineering miracle, at least in the short-term, we can easily identify as well who the losers of
this “gambling-with-the-risk game” will be.
The extent of the fallout of the global financial crisis in terms of social costs are still
highly unknown.
For sure these poor victims of this risky business will be taxpayers who will have to
refund the governments’ rescue plans for the banks involved in the crisis, but also the people
who have variable-rate mortgage loans and other financial products with similar flexible rates
at least in the short-term. The reason for this penalization is related to the liquidity problem of
banks that for many months did not trust one another any more and have preferred not to lend
their counterparts on the interbank markets (short-term monetary markets), thus causing an
increase in the interbank offered rates and subsequent increase in the interest rates of the
variable-rate mortgage loans and other adjustable-rates unsecured lending products.
Furthermore, there are those who have lost their homes and jobs, and the companies
that might go bankrupt because of a potential recession or stagflation that further reduce
consumer spending. Other losers will be the banks themselves, private equity and hedge funds
or insurance companies and individual investors who still hold tossic subprime products in
their portfolios or derivatives with underlying assets or collateral represented by risky
subprime mortgage loans (unless they will be adequately recapitalized by
Governments/taxpayers). Companies might also be affected by this crisis, without the
necessary financial support from banks, especially the SMEs, due to their weaker negotiating
power, they will experience more selective and expensive pricing for their borrowings due to
the credit crunch.
11. And now after the first “financial tsunami” of the subprime mortgage crisis what else
should we expect? A second potential wave of undeclared losses from other banks and
financial institutions which might challenge the governments’ rescue plans or a new potential
crisis affecting other financial products such as, credit cards, revolving cards, personal loans,
leasing products, bank acceptances, overdrafts, commercial papers and so on.
It is difficult to know what the consequences of this crisis will be. One thing which is
surely known is that in the U.S. and in the U.K. markets the average household debt as
percentage of income (instalment-to-borrowers’ income ratio) is approximately 130% versus
a ratio of 40%-50% of a country like Italy.
The dramatic effect of the very high level of leverage of banks’ customers (mortgage
loans borrowers) in addition to the high level of leverage of mutual funds, private equity
hedge funds and SPVs (Special Purpose Vehicles) with external (SPVs) portfolios
concentrated on highly volatile financial engineering products (i.e., derivatives,
securitizations) has increased significantly in recent years the risk factors in the U.S. lending
industry. In particular the placement of these credit receivables in SVP, external to the banks,
have moved away the risky subprime portfolios from the banks accounting books, generated
funding at very convenient terms (with AAA ratings) and have allowed subsequent use of
these assets (securitized subprime mortgages) as collateral for derivatives products (CDO).
Furthermore, this securitization strategy has allowed the SPVs to benefit of more convenient
capital adequacy requirements from the banking supervisory authorities (lower equity and
more profitability) since they were holding derivatives in their portfolios rather than regular
mortgages loans portfolios (trading book).
American banks have strongly increased in recent years the use of securitizations,
derivatives and SPVs and progressively reduced the traditional funding mix (represented
primarily by the interbank market facilities, bank current and savings accounts, bank deposits,
repos and bonds).
A massive and intensive CDO derivatives trading between investments banks, mutual
funds, private equity funds, and other institutions has then spread the innovative and
“explosive” financial engineering products all of the world making almost impossible to
understand how many funds and organizations are exposed to these tossic derivatives and
which bank has originally issued the mortgage subprime loans.
12. The greater worrying concern then becomes, how do SVPs, investments funds,
financial analysts, rating agencies and banking supervisory authorities monitor the quality of
these mortgage portfolios which represent the underlying assets or collateral of complex CDO
derivatives after their placement/trading on the markets occurs. Who is supposed to control
portfolio risk deteriorations and assure timely and controlled risk assessment and disclosure
on the markets? In Europe and other parts of the world Basel II has already been introduced
in its advanced implementation approach (Advanced Basel II Capital Adequacy Framework)
with the well-known pro-cyclical effects/problems, but in the U.S.A. the “Advanced
Approaches Rule” has become effective only on April 2008, and starting from January 2009,
the US banks that will implement the Basel II Advanced Approaches will be subject to a three
years transitional floor period for potential capital reductions versus current risk-based capital
rules.
Probably no one has really assured the necessary end-to-end controls in this complex
process. Banks or banks’ management involved in the subprime lending were concentrated to
boost convenient funding, portfolio growth (through massive origination of subprime and Alt-
A mortgage lending), and profitability and to transfer credit risk to other counterparts, through
securitizations, with moral hazard responsibility; the rating agencies have based their
evaluations on pro-cyclical models and perhaps engaged in conflict of interest; and the
investment banks, private equity funds, mutual funds and hedge funds have been too busy
trading and speculating frantically on these toxic derivatives everyday, trying to maximize
their short-term profitability while aiming to effectively control credit risk through advanced
risk management and portfolio diversification strategies, CDOs trances and the use of CDS.
A Basel III and specific supervisory regulations will certainly need to be launched
quite soon to overcome some of the shortcomings of the pro-cyclical effects of Basel II also to
introduce adequate risk assessments for securitized assets, derivatives and SPVs.
The average level of leverage (debt) of the American families and in particular of the
subprime segments (higher risk profiles) is very high and difficult to sustain in adverse
macroeconomic conditions. The lack of rigorous and timely controls on credit policies,
underwriting procedures, and portfolios risk monitoring of the rating agencies, banking
supervisory authorities, corporate governance members, and internal auditing and risk
management teams, associated with the opportunistic and short-term orientation of
13. speculators on derivatives and short selling, have seriously contributed to the subprime
mortgages fallout.
Certainly a mortgage loan borrower with a higher risk profile (subprime) and a high
probability of credit default or bankruptcy (which is applicable in the U.S. also to
individuals), who is also likely to lose either his/her job or home purchased on credit
(mortgage loan) or both, will probably have, sooner or later, a very hard time also to
reimburse any type of credit exposure.
Furthermore, in case of a generalized worsening of the economic conditions the
financial crisis may affect also the real economy with a significant decrease of consumer
spending and consumer confidence levels. These conditions, if not offset by effective and
timely economic stimuli of the governments and central banks (monetary policies, fiscal
policies, investments, or adequate government protections and financial supports) will have a
inevitable negative impact on the banking industry and in particular on the consumer and
retail banking segments.
The situation may certainly improve in the medium-term with massive financial plans
(recapitalization) from Governments and central banks to shore up the banks and investment
funds, otherwise the risks will remain very high due to the lack of trust among banks.
The lack of reassurance of the investors who would scramble for liquidity, might
cause in such difficult financial situations the risk of a potential implosion of the financial
institutions. In these circumstances, as it has occurred in mid-October 2008, the signs of
dramatic risks are the very high rates of credit default swaps (which are typically traded OTC
and without a regulated marketplace) and the high rates of interbank rates (i.e., Libor,
Euribor) which remained very high for a while, regardless of the massive central banks cash
injections, interest rates reductions, and government bail-out deal agreements, protections
from bankruptcies, commercial papers markets coverage and bank nationalizations.
The challenge we face today is that Governments and other institutions have to clean
up the mess, save the global financial markets from their collapse, avoid a global recession,
re-establishing some credibility and confidence in the banking and financial markets and in
the consumers’ minds. The social costs of this ruthless game may be quite high and in Europe
(eurozone countries) this may further worsen at least in the short/medium term some
14. countries’ difficulties to comply with the Maastricht convergence criteria due to their higher
budget deficits and national debts.
The Governments intervention to shore up the banks and investment funds through
bail-out deal agreements and the Troubled Asset Relief Program may prove to be useful in the
short-term but it may also generate additional problems related to market distortions, thus
somehow penalizing the “ethical financial institutions” in favour of the unethical ones.
According to the famous lessons of “Chicago School”, there is no better and fair judge
than the market to punish or reward “good” and “bad” players in the marketplace. The central
issue in this very dramatic case is not whether one should prefer the theories of the Chicago
school, (i.e. Frank Knight, Friedrich von Hayek, Ronald Coase, George Stigler, Milton
Friedman, Robert Fogel, Gary Becker, Richard Posner, Robert E. Lucas) associated with
neoclassical price theory and libertarianism and with the view that regulation and other
government intervention is always inefficient compared to free market, to the theories of
Keynes about the need of Governments’ interventions to come out of a serious recessionary
crisis or depression.
The issue in this very serious financial crisis is that certainly “pragmatism” calls for
immediate and effective rescue plans to save banks, financial markets and the overall
international economic stability, nevertheless, interfering with the market mechanisms can be
a very danger policy since it may generate serious distortions if not well orchestrated.
The failure in this financial crisis is not due to economic philosophies (Libertarianism
versus Keynsianism) but rather to the lack of ethical values and behaviours of many players
involved in the subprime mortgage lending and securitization/CDOSs trading process.
The Third Pillar of Basel II was introduced to increase market discipline through
enhanced transparency and disclosure in addition to the Second Pillar’s supervisory review
mechanisms. The Third Pillar was meant to develop a much more robust global risk-adjusted
capital measure based on expected increase in transparency. Basel II has addressed also some
issues related to securitizations.
The Governments’ interventions, although reasonable, have certainly partially
undermined the key central role of the market discipline as the true unbiased and independent
regulator of the ethical or unethical behaviours of banks and financial institutions involved in
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