Name: Ho Hei Man
Course: CCGL 9030
The Credit Crisis of 2008
In the fall of 2008, a financial crisis originated from the U.S. resulted in losing trillions wealth, which affected not only U.S. itself, but all over the world. In this paper, I discuss factors leading to the credit crisis in 2008, explain policies that could have prevented it from happening, and state which of the proposed plans for reforming the financial industry would have the best chance of succeeding. The disscussion of this report is mainly based on the HBS report on the financial crisis.
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They bought mortgages and transformed them to funds and sold it to the investors who want to invest in the US to earn money. It helped increase the hosing price.
While some borrowers could not afford such a high hosing price, they defaulted. The decreasing in the demands of home and the increasing in the supply of home led to deflating of the housing bubble. The banks and those who bought the mortgage product were in trouble and triggered off the global credit crisis.
2.3 The subprime problem
Emerging of the mortgage-backed investment, the demand of the mortgages increased. However, as most of the potential homebuyers already had a mortgage, banks started to seek new buyers in order to supporting the demand of the mortgage. To attract buyers, banks allowed subprime buyers to buy mortgages that only require a little money down and limited documentation. However, those buyers had a higher chance to default their payments. They tended to sell their house at a profit when they were not able to meet the payments. As more and more houses were being sold, the supply increased and lowered the hosing price. In 2006 and 2007, when the price of the housing price dropped, those house owners would be unwilling or unable to pay off their loans. The mortgage-backed investment lost support and no one wanted to buy it anymore that led to the credit crisis.
Securitization is a process that allows banks to transform a future revenue into an asset that can be used for further lending. Banks transformed the high-risk mortgage debt into collateralized debt obligations (CDOs) ,mortgage-backed secure- ties (MBSs) (Culver, 2010) and they sold these products to different investors by categorizing them into different risk which based on mortgage payments from the homeowners. By repackaging them, banks can receive better ratings from those rating agencies to attract investors. However, it increased the complexity of the products and the whole series of financial activities became risky as the banks were lacking in a financial cushion sufficient to uptake large loan defaults or losses in the newly created products. As such, when more and more mortgage defaulted while banks could not make up the loss, banks can only go bankruptcy. Thus, securitization did not make the market safer, but it led to a widespread of risk to all over the world.
2.3 Poor judgment of the rating agencies
The subprime mortgages loan received grade ratings from the rating agencies, such as Standard & Poor’s, Moodys. However, due to the competition between different rating agencies, they have to cater to the needs of the banks, which hired them. Some of them, like Moody’s, changed the rating guidelines to attract more customers while the rating grades they gave out were overestimated and misled those investors around the world. Those rating agencies also tended to promise the high-expected...