When the house prices begin to fall, the sub-prime borrowers are going to suffer. Not only they are not able to pay their existing debt, they are also stuck having to pay a much larger mortgage payment. This causes many of these borrowers to not be able to pay for their house payments. So for the financial institutions, they are going to lose their money that they invested because the borrowers are not able to pay the loan payment. On the other hand, banks have a very big problem also because they rely on this these financial institutions to invest in the pool of mortgages investment product. Financial institutions no longer wants to invest and do not trust the bank anymore. If no wants want to buy them, where the banks get the money to offer the loans?
The banks also suffer from the lost for those borrowers who failed to make payment. As a result, the banks increase the mortgage interest rate to cover loses and hopes that can pay more. Sadly, the effect is opposite and this even makes the conditions worst. More and more borrowers failed to pay their monthly loan payment due to the interest rate increases. Crisis happens. Financial Institutions’ role and responsibilities is to intermediate the public’s money responsibly by complying with applicable laws and regulations. They are to allocate their resources responsibly, lending and investing in activities that are socially responsible, making the appropriate due diligence and according to international best practice. Promoting financial education to clients and also promoting products ethically. Finance and insurance instruments are usually complex, and if they are not, they will make them so. This requires customer’s education, especially when they expand to lower income populations. Pressure to obtain profits makes financial institutions tend to promote complex products without considering clients’ capacity or needs or addressing markets that does not need them and neglecting those who do, but that provide for greater risks for the institution. Credit rating agencies are the ones to assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves. In some cases, the servicers of the underlying debt are also given ratings. They played a very important role at various stages in the subprime crisis. They have been highly criticized for understating the risk involved with new, complex securities that fuelled the United States housing bubble, such as mortgage-backed securities (MBS) and collateralized debt obligations (CDO).
Impact on the crisis
Credit rating agencies are now under scrutiny for giving investment-grade, "money safe" ratings to securitization transactions (CDOs and MBSs) based on subprime mortgage loans. These high ratings encouraged a flow of global investor funds into these securities, funding the housing bubble in the U.S. An estimated $3.2 trillion in loans were made to homeowners with bad credit and undocumented incomes (e.g., subprime or Alt-A mortgages) between 2002 and 2007. These mortgages could be bundled into MBS and CDO securities that received high ratings and therefore could be sold to...