More than five years have now passed since the housing bubble burst in spectacular fashion There are lessons to be learned on how to handle severe financial , they hovered around , for several years following the crisis.
Table of contents
- The 2008 Financial Crisis: Causes, Consequences and Lessons Learned
- IMF EXTERNAL RELATIONS DEPARTMENT
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- The Financial Crisis: Causes, Consequences and Lessons Learned | The Market Mogul
Thus, expectations are justified by the very action that sends prices up. The process continues and optimism about the market effect is the order of the day.
The 2008 Financial Crisis: Causes, Consequences and Lessons Learned
Prices climb even higher. Then, for reasons that endlessly will be debated, the bubble bursts.
Galbraith's quote refers to the market crash of that led to the Great Depression but could have easily been written for the dot-com, housing bubbles, and any financial bubble that has ever burst or will deflate in the future. A key error in most financial models supporting mortgages, and the exotic securities based off of them, was the assumption that housing prices do not go down.
Unfortunately, bubbles burst without notice and to this day there has not been a systematic way to avoid them. It is also very surprising how few people and entities predicted the timing of the bursting of the housing bubble or the severe adverse impact it would have on the U. In his lectures he detailed charts showing that the stock market and unemployment trends were on the same course as in the s, until the Fed intervened to stop runs on banks, money market funds and key related financial institutions, such as broker dealers and insurance giant AIG.
It is also important to note that the Federal Reserve is being cautious to not raise rates too quickly and contribute to a double-dip recession. This could very well end up being a precursor to the current situation as politicians fight to reduce deficits, boost taxes and pursue policies that could very well hamper a full economic recovery.
Takeaways for Banks Financial institutions are now subject to Dodd-Frank legislation that seeks to boost capital requirements and help avoid the failing of banks that are considered vital to the health of the overall economy. Bernanke did admit that regulation during the Credit Crisis was disjoined and failed to take a holistic approach to ensuring the health of the overall financial system.
Going forward, money center banks, as well as large broker dealers and insurance firms, will have higher capital standards to offset against loans going bad and balance sheet assets falling in value. Banks have also increased lending standards while most subprime loan originators have gone bankrupt. Arguably, lending standards have become too stringent in many instances, but this is hardly surprising given the severity of the number of loans that went bad in markets such as Florida, Arizona and Nevada.
As for politicians and others that will help create future bubbles, it appears they have not yet learned their lessons on how to recover from or avoid bubbles in the first place.
IMF EXTERNAL RELATIONS DEPARTMENT
The best advice might be to simply avoid investments that have had huge runs and increased in value in a short period of time. In addition, the Fed has issued draft regulation to tighten the lending standards for higher-risk mortgages under Federal law while Congress is considering ways to regulate mortgage brokers in the US for the first time. The second lesson is that the governance structure of the risk management system needs to be improved in financial firms in which the incentives are biased toward returns rather than the risks involved in attaining them.
Compensation schemes in many organizations focus on returns and, for the most part, ignore the risk taken to obtain such returns. The risk managers, because they are not profit centers and do not sell products or write trading tickets, tend to be ignored when profits are up.
Indeed, many of them apparently did sound the alarm bells before the crisis set in and were often disregarded as too out-of-touch with new structural trends, though not all firms downplayed the advice of their risk managers. The key is to ensure that top management hears both sides at equal volume, choosing the risk-return combination which best represents the risk appetite of the firm. The third lesson is that the incentives to use credit rating agencies and the incentive structures within credit rating agencies themselves need to be reexamined.
In the run-up to the crisis, the practices including incentives and modeling approaches of rating agencies were generating a large proportion of AAA-rated structured credit products. The credit rating agencies are considering how best to handle these issues.
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Securities Exchange Commission has also weighed in with its guidance. The fourth lesson is that investors need to perform their own due diligence and ask the right questions about the riskiness of the securities they are purchasing.
While ratings agencies are clearly an important and valuable part of our financial system, how the ratings are interpreted by end-users is also part of equation—and part of what has caused the structured products market to collapse. Again, incentives in the upswing of a cycle were such that this "search-for-yield" in a low interest rate environment outweighed careful risk analysis. Let me now turn to the public sector , which certainly shares some of the responsibility.
Two key lessons emerge. First, there is a need to refine the regulatory framework to avoid distorted incentives.
The desires of private sector investors and the actions of the intermediaries were indeed influenced by the regulations they faced. Probably the most widely cited problem to be uncovered is that capital regulations applied to banks encouraged them to store some of the new credit-related products in off-balance sheet vehicles. The maturity mismatch and the lack of transparency about the type of assets in these off-balance sheet vehicles started what has become a severe and chronic funding shortage. Second, supervisors and regulators need to have the incentives and resources to look hard and deep at possible flaws in the risk management systems of the institutions they oversee.
Often, stress tests did not stress the right areas or not enough; funding liquidity risks received inadequate attention; and holistic views across credit, market, and funding risks were not emphasized in part because of the recent and constant attention on Basel II regulations, covering primarily credit risk. An important third set of lessons relates to how to cope with the outcomes of crises of this new type. Bank resolution and deposit-insurance frameworks need to be strengthened and interagency coordination needs to be more effective.
Central banks should remain well-informed and involved in the ongoing analysis of risks of the major financial institutions in their economies. In the area of central banking, the lessons are particularly relevant, since how central banks respond can affect outcomes in the real economy. Without doubt, we can see that there were shortcomings in the existing emergency liquidity frameworks.
Obsolete tools and operational procedures have been replaced with others that are aimed at fixing the low volumes in interbank markets and getting these markets going again. Yet we still see that interbank and money markets more generally are not recovering as quickly as we had hoped. The evaluation of the set of new facilities and how well they have served their desired purposes is ongoing.
Issues of moral hazard are also at the heart of the problem.
The Financial Crisis: Causes, Consequences and Lessons Learned | The Market Mogul
First, the Fund can use its surveillance tools to monitor the situation as it evolves. As part of our multilateral surveillance, we can point to cross-border channels and linkages that may be difficult for the authorities in individual countries to see. Based on our work, we can provide an assessment of the situation and recommendations. In fact, we have provided a first set of policy responses to the issues raised in the crisis in our latest Global Financial Stability Report and in our report to the International Monetary and Financial Committee, one our main decision-making bodies at the Fund.