This Involves the Importance of understanding the quality of new credits that their businesses originated or purchased from others. There was the need of absence of covenants and market MAC clauses. In addition leverage levels need to be reduced those structural features beneficial to weaker borrowers which may include payment in kind/toggle features that permit borrowers to delay cash payment on coupons should be decreased. There was the need to reintroduce stricter limits on the use of facilities that lack covenants related to material changes in market conditions.
Also there was the need to verify the mortgage borrower’s source of income for repayment and underwriting a mortgage based on the rate consistent with bearing the obligation to maturity. Firms were also required to capture the concept of using better controls over indirectly sourced credits. The need to have relied less on the agency ratings in the CDO warehousing and packaging business and paying attention to internal assessment and the quality of the underlying assets was also required in order to avoid the subprime crisis.
Investors were required not to be too dependent on agency ratings as well for assessments of the risk inherent in certain exposures or relied too heavily on assumptions regarding diversification benefits that would turn out to be in accurate. All firms were required to conduct their own due diligence for lending businesses and be comfortable with both credit and price risk. This is the ability of firms to produce complete and accurate accounts of firm wide risk exposures to particular counterparties through their risk management and personnel.
There was the need of the importance of constant review and improve on credit risk and counterparty credit risk reporting and measurement systems and the need to have avoided concentrations. Also the issue of raising initial margins and the importance of valuation to margining processes. Monocline insures are firms that underwrite a single form of insurance where it deals with the credit protection. A direct exposure arises when an investor purchases derivatives from a financial guarantor against the default of an underlying issuer where loans or equity investment are made to the guarantor.
It was important for the firms to have exposures to direct and indirect financial guarantors who would insure the performance of high quality municipal bonds. However the growth in concentrations of financial guarantor counterparty risk highlight the need for firms to monitor the gross counterparty risks as well as the net market risks. Firms were required to understand the risks they had faced, measure and assess such risks appropriately and to take the necessary steps to reduce, hedge or otherwise manage such risk exposures.
Several lessons can be learned from the Subprime Mortgage Crisis. As earlier stated in the thesis statement, the Subprime crisis affected the U. S and European markets and economy. The implication for this is that the quality of loans lost value for six years running which implies that the industry grew in unsustainably. What is happening is that the Congress has been conducting sittings in a bid to react to the sub-prime crisis and the effect it had on the asset market securities.
What is implied here is that Central banks all over the world have equally showed concerns about the crisis and the potential effects that it causes. For instance, the United States Federal Reserve Bank is making attempts to limit the probabilities that this crisis could interfere with other financial markets as well as the economy by lowering the rate of discount as well as reducing the funds that the FED charges other banks for intra-bank transfers.
At the same time, the European Central Bank as well as other similar banks has been reducing their rates charges on bank borrowings. What needs to be understood are the effects which these measures have had on other banks. The above changes have definitely had direct effects on banks as opposed to the financial markets. In addition, changes in monetary, like reductions in the rates of interest, may not have the potential of working as quickly as is required or alternatively, do not have the capacity of reducing panics, reducing prices as well as the threats of systemic collapse.
This attention on banks, as opposed to markets, does not consider the prevailing trends aimed at disintermediation- or making companies able to access their most optimal source of funds, the capital markets, without the pain of having to visit banks or other financial dealers. The implications here is that mechanisms of protecting the financial systems which are not keeping up with the prevailing changes in the system. In a financial world which does not make use of intermediaries, it would be unreliable to depend on old protections.
This section therefore examines why the sub-prime financial crisis took place in spite of the series of existing protection mechanisms which are incorporated in financial regulation, the norms and customs of the market as well as the approach of market discipline undertaken by the administration of Bush. At the same time, we seek to explore the lessons this crisis can teach the world about the issue of protecting financial markets. In an attempt to establish the lessons which can be learned from the crisis, it is imperative to first understand the anomalies as well as the basic protections which did not work out well.
This will then be followed up establishing the reasons as to why these anomalies could have taken place. Several factors led to sub-prime mortgage crisis. First, if disclosure provided the investors with all the required information prior to investments, the irony then is why the investors still ended up with wrong investment decisions. The second dilemma arises from the issue of securitization as well as other types of structured finance, in pursuit of which not only the mortgage-backed but equally the asset backed securities are floated.
In this regard, it is common knowledge that organizations need to spread and diversifies risks to parties which are best suited to manage them. The issue of concern therefore is if there was something which went wrong with the application of this concept in the field of mortgages. The other concern is the unknown reason as to why a problem with the sub-prime mortgage-backed market of securities quickly influenced the prime mortgage-backed securities market as well as other asst-based securities.
At the sane time, the second administration of Bush held the expectations that its approach of market discipline would suffice, together with the prevailing protections, in protecting against the in stability of financial markets. The concern therefore is the unknown reason why this approach turned out to be unfavourable as well as the reasons the rating agencies failed to foresee the meltdown. Therefore, in discussing the lessons which can be learned from this crisis, the study makes use of these concerns as the bases of investigating the same.