Topics: Subprime mortgage crisis, Mortgage, Fannie Mae Pages: 6 (1927 words) Published: March 15, 2013
The definition of Asymmetric Information involves two parties, and which one party has more superior information and normally will not disclose the truth or harmful situation of a transaction to another party. The asymmetric information provided by the banks on the Collateral Debts Obligations is one of the causes that led to the sub-prime crisis in 2008 & 2009. Collateral Debts Obligations are financial instruments that are pooled by many sub-prime mortgages and sold to investors with attractive higher promised yields than normal bonds. Defaults and foreclosure increased and losses impacted the financial institutions that contribute to the crisis.

A financial institution is an institutions concerning finance, which is defined as managing money among individuals, businesses and governments. Some examples for financial institutions are mainly banks; retail or investment bank, insurance company, stockbroking, asset management and finance company. They are the intermediaries of financial markets. In the past, things were simpler and banks were only making loans and taking in deposit or withdrawal from individuals and businesses. Bankers were more discipline and manage their risk carefully. However, due to the fast paced technology change and The Agency Theory, agents want to take risk to show results and good performance. In order to deliver better profit, they bring in a diverse range of products and activities. The government normally regulates these financial institutions and today we have banks selling insurance products and insurance company selling banks products. Adding to the advanced technology today, just one click consumers can move their money quick and effectively. (Banking has changed: What does it mean for consumer? Investopedia)

The role of a rating agency is to assess the financial strength & creditworthiness of companies and governmental entities, and their ability to meet the interest and principal payments on their bonds and other debt. Rating agency normally studies the specific debt issue and thus high rating will increase the investors’ confidence. The few examples of rating agency are Moody’s, Fitch Ratings and Standard & Poor. However, not all ratings from the agency are accurate, in the ratings for Collateral Debts Obligations the initial ratings were excessively high (AAA) or top management grade quality ratings. This resulted in a failure to incorporate the high risk inherent in non-creditworthy customers in the underlying mortgage. Thus, rating agency fallen after the crisis and some being sued for giving misleading ratings. This is supported by article from The Business Times (2007) “Investors have begun to sue Moody’s and others because of Bear Stearns credit debacle”. This sub-prime mortgages collapsed and created chaos in the global financial system. Bear Stearns investors around the world begun to approach lawyers to sue the company for the losses incurred. Both raters from Moody’s & Fitch’s admitted and acknowledged responsibilities that they did not expect the housing market in US to deteriorate in such a quick time. However this was all too late when the sub-prime crisis happened. (Gretchen Morgenson, The New York Times).

What is sub-prime crisis? What are the major causes of the sub-prime crisis and how does all this banks, rating agency, investors and even the government contributes to the sub-prime crisis of 2008-2009? In the article from The Business Times Singapore on “A quick guide to the sub-prime issues”, it stated that HSBC, the world’s third largest bank had their 50 percent earning wiped out by sub-prime losses from it US branch. Mortgages companies either go bankrupt or put themselves up for sale, same for Bear Stearns brokerage house and BNP Paribas announced the suspension of their funds due to the US mortgages. Fannie Mae and Freddie Mac, two US government-sponsored giants have been bailed out and the bankruptcy of the Lehman Brothers. The nation was...
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