Question

Credit Crisis of 2008–2009 Lessons Learned Your postings should be qualitative and provide substantive depth that advances the discussion. Banks specialize in risk management. These banks invested heavily in mortgage backed securities expected fairly high returns from these highly rated financial instruments However, banks did not expect the credit crisis of 2008–2009 and the default rates due to declines in housing prices causing people to owe more than the house was worth. What are some lessons learned due to the subprime mortgage situation? Provide at least one link to information supporting your opinion.

Answer 1

The lesson learnt in the after math of the 2008 financial crisis and due to the sub-prime mortgage situation points out at the structural weaknesses that were present in the banking industry and the financial securities market. The first lesson to be learned is that AAA rating is not an assurance of anything. Highly rated financial instruments became the primary cause of losses for several entities and hence the first lesson is that ratings are subjective and are not objective in nature and hence does not carry with itself a high level of assurance and guarantee with regards to returns and future performance of a financial instrument.

The second lesson learnt is that the use of complex financial instruments like CDOs (collateralized debt obligations) and CMOs (collateralized mortgage obligations) will lead to financial miscalculations and the level of miscalculations will be amplified due to use of leverage. This will lead to creation of new risks which could not have been envisaged by the security owners in the first place.

The third lesson that was learnt was with regards to deficient accounting rules. These rules further complicated and worsened the crisis. The accounting rule required banks to mark their securities marked to value and in a situation of crisis when the normal market scenario melts away banks have no option but to book massive and large write downs. This exacerbated the liquidity and solvency scenarios of banks. Thus the lesson here is that accounting rules should be made flexible and should be changed in case of extreme situations or highly uncertain or abnormal situations.

Link that supports my opinion:

https://www.moneyshow.com/articles/guru-14299/