Comparative Roles of Different Institutions
We will cover following topics
Introduction
In this chapter, we delve into the distinct roles played by various types of institutions during the 2007-2009 financial crisis. Understanding the contributions and failures of banks, financial intermediaries, mortgage brokers and lenders, and rating agencies is essential to grasp the complexity of the crisis and its far-reaching impacts.
Roles of Banks in the Crisis
Banks, both commercial and investment, held a central position in the crisis. Investment banks were deeply involved in securitization, creating complex financial products. Commercial banks extended loans, including subprime mortgages, which were later bundled into mortgage-backed securities (MBS) and collateralized debt obligations (CDOs). When housing prices fell and borrowers defaulted, these institutions faced substantial losses, eroding confidence in the financial system.
Financial Intermediaries and Their Impact
Financial intermediaries like hedge funds and money market funds contributed to the crisis by investing heavily in risky mortgage-backed securities. Their interconnectedness amplified the contagion effect, as losses led to massive withdrawals, straining the entire financial ecosystem.
Role of Mortgage Brokers and Lenders
Mortgage brokers and lenders played a role in originating subprime mortgages with lax lending standards. These loans were bundled into MBS without adequate assessment of creditworthiness. When borrowers defaulted, the value of MBS collapsed, triggering a chain reaction of losses across the financial system.
Influence of Rating Agencies
Rating agencies were tasked with evaluating the risk of MBS and CDOs. However, conflicts of interest arose as they were paid by the issuers for their ratings. This led to inflated ratings for complex securities, creating a false sense of security for investors who relied on these assessments.
Conclusion
Examining the roles of different institutions in the financial crisis underscores the interconnectedness of the financial system and the ripple effects of their actions. The crisis highlighted the need for improved risk assessment, transparency, and ethical considerations across all financial players to prevent similar events in the future.