Assignment:
Discussion:
US financial crisis in 2008 has been investigated and analyzed by US congress, banking regulations and corporate governance. As you are in MBA program in US, it is essential for you to understand the root cause of the crisis and its impact.
Q: What is the root cause of the financial crisis in 2008 and its impact on domestic and international market?
Please do so using three articles provided from ProQuest in 300 words.
The US financial crisis of 2008 has been attributed to many causes (folly, fraud, greed and incompetence) rooted in actions by interdependent actors - from the state level to the organizational level and down to the individual level (Bernanke, 2009; Reinhart and Rogoff, 2009; Rosales, 2009; Taibbi, 2010). As the crisis unfolded, American shareholders lost nearly 10.2 billion USD (Kalwarski, 2009) and 45 per cent of the worldwide wealth was destroyed (Davies and Siew, 2009). Three of the largest bankruptcies occurred within the same time frame. Observers have pointed out that corporate boards did a very poor job of exercising their fiduciary duty to manage risk (ACCA, 2008; Kirkpatrick, 2009; S1074, 2009; FCICR, 2011).
Turnbull, S., & Pirson, M. (2012). Could the 2008 US financial crisis have been avoided with network governance? International Journal of Disclosure and Governance, 9(3), 238-263.
Hwang, J. (2014). Spillover effects of the 2008 financial crisis in latin america stock markets. International Advances in Economic Research, 20(3), 311-324.
The impact of the 2007-2008 financial crisis on the banking systems in advanced european countries. (2017). Applied Economics Quarterly, 63(2), 161-176.
Marketing practices led to the mortgage market meltdown:
- Greedy lenders preyed on unsophisticated and vulnerable borrowers.
- Aggressive lenders steered creditworthy borrowers into profitable but risky subprime loans.
- Lenders (and borrowers) committed fraud.
- The U.S. government failed to protect borrowers and encouraged loose lending standards.
- Loose lending standards destabilized the housing market.
Market forces led to the mortgage market meltdown:
- Subprime lending is not the same as predatory lending.
- A few lenders behaved badly, but borrowers should have been more diligent.
- The credit crisis was prompted by market forces such as rising home prices and declining incomes.
- Government encouraged subprime lending as important source of mortgage funds for the poor.
MARKETING PRACTICES LED TO THE MORTGAGE MARKET MELTDOWN
Johnston, T. C. (2009). MORTGAGE MARKETING PRACTICES AND THE U.S. CREDIT CRISIS. Academy of Marketing Studies Journal, 13(2), 11-23.
Frame, W. S. (2008). The 2008 federal intervention to stabilize fannie mae and freddie mac. Journal of Applied Finance, 18(2), 124-136.
US housing and mortgage markets became increasingly stressed during 2007 and 2008, largely as a result of house price declines in many parts of the country. Between 2007:Q2 and 2008:Q3 house prices declined 18.0% on a nationwide basis based on the S&P/Case-Shiller composite index. By contrast, over the same period, the OFHEO nationwide house price index fell 4.5%. While the magnitudes of decline in these repeat-sales indices differ - owing to coverage differences by geography, loan size, and loan quality this national decline in house prices is unusual.
House price declines resulted in a large number of borrowers having mortgage balances that exceeded the value of their homes - a condition often referred to as "negative equity". Economic theory and evidence suggest that negative equity is a necessary condition for mortgage default. Borrowers may face income disruptions that temporarily limit their ability to pay and have neither sufficient savings nor home equity to cover monthly living expenses. Other borrowers may default after finding themselves in a situation where their expectations of future house prices are such that they see little hope of attaining positive equity in the foreseeable future.
In any event, the house price declines witnessed in 2007 and 2008 have resulted in a tremendous wave of mortgage defaults and foreclosures that, in turn, has imperiled financial institutions with significant credit exposure to US residential real estate particularly exposure to rapidly declining markets and/or to riskier subprime borrowers and investors. Fannie Mae and Freddie Mac certainly fit this bill, as did thrift institutions operating on a nationwide basis like Countrywide and Washington Mutual.
Fannie Mae and Freddie Mac were not only singularly exposed to US residential mortgages, but also operated with a high degree of leverage, owing to a statutory minimum capital requirement of only 2.5% for on-balance-sheet assets and 0.45% for net off-balance sheet credit guarantees. Concerns about the GSEs' concentration of residential mortgage-related risk and leverage were a consistent theme raised by Federal Reserve officials throughout this decade (e.g., Greenspan 2005, Bernanke 2007).
As of mid-year 2007 (and prior to the beginning of the financial crisis), Fannie Mae and Freddie Mac maintained book equity values of $39.7 billion and $25.8 billion, respectively. This combined $65.5 billion in equity stood against almost $1.7 trillion in combined assets (3.9% capitalto-assets ratio) and another $3.2 trillion in net off-balance sheet credit guarantees. One year later, the two GSEs had expanded to almost $1.8 trillion in combined assets and $3.7 trillion in combined net off-balance sheet credit guarantees, but their capital cushions had begun to erode. During those four intervening quarters, Fannie Mae posted $9.5 billion in losses (although it did raise $7.0 billion in new equity) and Freddie Mac lost another $4.7 billion.
Moreover, mark-to-market accounting losses on 'available-for-sale' mortgage-backed securities substantially reduced equity through negative entries to 'accumulated other comprehensive income' on the GSE's balance sheets. As of June 30, 2008, Fannie Mae and Freddie Mac reported book values of equity of $41.2 billion and $ 12.9 billion, respectively. Perhaps more telling was that the GSEs' self-reported fair values of equity (i.e., the market value of assets less the market value of liabilities) as of the same date were $12.5 billion (Fannie Mae) and -$5.6 billion (Freddie Mac).