The following will be discussed in this chapter: Big assumption, misaligned incentives & pitfalls, good days turn bad, start of failure, sub prime global financial crisis, financial crisis, poor investors, desperate bank, lessons learned and action plans. | MBF-705 LEGAL AND REGULATORY ASPECTS OF BANKING SUPERVISION OSMAN BIN SAIF Session: Four Summary of Previous Session Credit rating agencies Mortgage Brokers Secondary Mortgage Markets The Mess Evolution of Home Mortgage New model of Mortgage lending Private sub prime mortgage process Reasons for forming of subprime mess 2 Agenda of this session Big Assumption Misaligned incentives & pitfalls Good Days turn Bad Start of Failure Sub prime Global financial crisis Financial Crisis Poor investors Desperate Bank Lessons Learned and Action Plans 3 Agenda of this Session Finance and Economy Investment devalued across the Globe Impact of Financial crisis across the Globe 4 Big assumptions Belief that modern capital markets had become so much more advanced than their predecessors that banks would always be able to trade debt securities. This encouraged banks to keep lowering lending standards, since they assumed they could sell the risk on. 5 5 Big Assumptions (Contd.) Many investors assumed . | MBF-705 LEGAL AND REGULATORY ASPECTS OF BANKING SUPERVISION OSMAN BIN SAIF Session: Four Summary of Previous Session Credit rating agencies Mortgage Brokers Secondary Mortgage Markets The Mess Evolution of Home Mortgage New model of Mortgage lending Private sub prime mortgage process Reasons for forming of subprime mess 2 Agenda of this session Big Assumption Misaligned incentives & pitfalls Good Days turn Bad Start of Failure Sub prime Global financial crisis Financial Crisis Poor investors Desperate Bank Lessons Learned and Action Plans 3 Agenda of this Session Finance and Economy Investment devalued across the Globe Impact of Financial crisis across the Globe 4 Big assumptions Belief that modern capital markets had become so much more advanced than their predecessors that banks would always be able to trade debt securities. This encouraged banks to keep lowering lending standards, since they assumed they could sell the risk on. 5 5 Big Assumptions (Contd.) Many investors assumed that the credit rating agencies offered an easy and cost-effective compass with which to navigate this ever more complex world. Thus many continued to purchase complex securities throughout the first half of 2007 – even though most investors barely understood these products. 6 Big Assumptions (Contd.) Most crucially, there was a widespread assumption that the process of “slicing and dicing” debt had made the financial system more stable. Policymakers thought that because the pain of any potential credit defaults was spread among millions of investors, rather than concentrated in particular banks, it would be much easier for the system to absorb shocks than in the past. Housing prices will keep going up all time 7 Misaligned incentives & pitfalls “churning” of capital “allows even an institution without a great amount of fixed capital to make a huge amount of loans, lending in a year much more money than it has If an individual or class of victims obtains a large judgment, the lender’s .
