SEMINAR MANAGEMENT CONTROL SYSTEMS
The subprime crisis can be described as a series of events with the so-called
‘savings glut’ as Ben Bernanke described as a starting point. Low interest rates and
rising house prices created an opportunity for financial innovation. Credit quality
mattered little because if a buyer couldn’t make the payment, the lender would repossess
the house and sell it quickly in a hot market. When rates started to climb, lenders began
to increase the volume of exotic loans to keep buyers coming. When repossessed houses
couldn’t sell so easily, the credit quality of buyers did matter. The result was a subprime
The objective was to examine the management of financial services industry and
determine the role incentives play in its success and failure. Specifically, we determined
whether key management personnel used proper incentives to:
a) Control risk (credit and reputation).
b) Create the right corporate culture.
c) Customize the compensation system.
Incentives are usually tied to performance. They can be long term or short term.
“Short-term incentives usually are very specific performance standards. Long-term
incentives are intended to focus employee efforts on multiyear results.”
Collateralized debt obligations (CDOs) are mortgages bundled into a pool and
securities sold against it. Securities sold by the mortgage pools were further bundled and
claims against them were sold. “Rating agencies went along certifying senior tranches
with the highest credit rating, even though they had little sense of their default
properties.” Due to the ‘savings glut’, these instruments were purchased by foreign
countries, pension funds and insurance companies looking for a good return on little risk.
So they thought.
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