Who Was to Blame for the Banking Crisis?

Topics: Subprime mortgage crisis, Bank, Financial crisis of 2007–2010 Pages: 5 (1974 words) Published: June 3, 2012
The banking crisis of the late 2000s, often called the Great Recession, is labelled by many economists as the worst financial crisis since the Great Depression. Its effect on the markets around the world can still be felt. Many countries suffered a drop in GDP, small or even negative growth, bankrupting businesses and rise in unemployment. The welfare cost that society had to paid lead to an obvious question: ‘Who’s to blame?’ The fingers are pointed to the United States of America, as it is obvious that this is where the crisis began, but who exactly is responsible? Many people believe that the banks are the only ones that are guilty, but this is just not true. The crisis was really a systematic failure, in which many problems in the system led to an eventual meltdown.

The banking crisis began in USA and more precisely in its subprime mortgage market. The introduction of the Collateral debt obligations, the rising prices of property and the overall seemingly attractive, but actually toxic assets, all led to the eventual collapse of the economy. Government-sponsored enterprises, like Fannie Mae and Freddie Mac, facilitated the boom of this market, by supplying households with modest income with low rates of interest and small down payments. This led to an increase in prices and attracted many new investors. Mortgage-backed securities and CDOs, issued by big investment banks took over the GSEs business. MBSs are basically securities, backed by mortgages, which represent the claim of the cash flows on that mortgage. CDOs are also asset-backed securities, in which the payments to the investor are organized in different tranches, which usually have different credit ratings. CDOs value is based on a pool of securitized debt, like car loans, student loans, bonds, etc. These instruments are often criticized in hindsight, as it is now clear that they were not priced accordingly to their actual risk, and their complexity was not that easily comprehended by many of the buyers. The credit rating agencies played an important role in that shift, as they gave investment grade, and even AAA, ratings to many of the instruments mentioned above, even though the individual borrowers were much riskier. The belief was that even if an individual cannot repay his or her loan, the pooling of borrowers reduced the default risk. The possibility of a bearish movement of the housing market, which would devalue the mortgages, was not given much consideration. Even the Federal Reserve chairmen at that time period – Alan Greenspan and Ben Bernanke, dismissed that possibility. Furthermore, the investment banks that were going to sell the instruments, paid for their rating by the agencies. This is a clear conflict of interests. The CRAs can be blamed for giving high ratings to securities, which obviously did not deserve them. This led many investors to making bad investment decisions. The borrowers and the investors are, of course, also responsible for their actions. The former took on mortgages that they simply could not repay and the latter made badly informed decisions. All of this led to the eventual crisis in the mortgage market in the USA. Many big financial institutions were brought down, because their assets in this market lost much of their value. Prominent examples were Bear Sterns and Lehman Brothers. Alan Greenspan is also often criticized for being part of the problem. During the time he was chairman of the Fed, he led a loose monetary police of extremely low interest rates. His critics say that this move resulted in a rise in commodity prices and in the forming of financial bubbles, most notably the subprime mortgage bubble.

This crisis brought great turmoil in the financial world. However, responsibility cannot only be sought in the mortgage market. The structural problems in the big financial institutions, and their use of financial instruments, which led to overexposure, could have been triggered by a crisis in a different market,...
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