The Global Economic Environment
EMBA 683 - Fall 2011
Case: U.S. Subprime Mortgage Crisis - Policy Reactions
1) What are the causes behind the U.S. Subprime mortgage crisis? Is one cause more responsible than another? The first and more important factor that lead to the subprime mortgage crisis was governments creation of Freddie and Fannie. This move by the government to intercede the private financial industry sector eventually lead to the US government being the largest lender of mortgages in the US. In addition to the flawed notion that government should determine who and how a borrow qualifies for mortgage loan is disconcerting in and of itself, but this also marked a fundamental change in banks models of originate and hold to originate and sell. Lenders, including Banks, no longer bared the risk of retaining the loans on their balance sheets as long as the borrowers borrowing criteria were met. In return, the lenders did not care how risky the loans were because they would no longer "Hold" the loans on their balance sheet, as they would now "sell" the mortgages to Freddie and Fannie." This model lead to the increase disparity of lenders further removing themselves from the borrower and ultimately the risk of the transaction. The US Subprime mortgage crisis was ultimately created by an unprecedented supply of low cost funds that lead to artificial demand in housing. Another tool that increased the supply of funds was the creation of CDO's. The financial markets believed that if by bundling a lot of bad loans you ultimately diversified your risk as an investor. In my opinion, I simply don't see how more bad loans makes a more sound investment, but unfortunately more "government sponsored," or at least appointed, rated agencies rated CDO's as AAA. The fact that rating agencies such as Moody's or S&P rated these portfolios as high as AAA gave a false sense of security to investors as they sought higher returns for ultimately proved to be...
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