Understanding the Credit Crisis of 2007-2008

1. What causes were the most important in creating the crisis?

a. Default rate Human excesses and false belief. Since early 1980s, there were a sharp increase in high risk mortgages plus the low interest rate. People were self-interest and greed. They hold false belief that REITs always valuable and it triggered them to engaged in many transactions fraught. At that time, many lenders also offered home loans to individuals with poor credit history (subprime borrowers) and apparently borrowers unable to make payment, then lenders tried to sell more products. However, no more people are willing to buy those products at that elevated price.

b. No financial transparency and misguided ratings. Bank report did not provide an accurate assessment of risk. Thus, they had problem with solvency. It also led difficulties in evaluating each other’s counterparty risk. Rating agencies profited at the issuance of an asset grade and not paid based on the actual performance. It paid by the issuer of securities, not by the purchaser.

c. The lax and absent regulation. As a result, nothing could stop dangerous actions of the lenders.

2. What are the preconditions for developing an MBS market?

a. Enough amount of mortgage loans in the market.

b. Supportive legal, tax, and regulatory framework for every key player.

c. Bond market should be existing.

d. Established primary market policies, procedures & operations, and market standardization.

e. Asset originators able to satisfy the precondition for securitization.

f. Developed capital market and appetite for MBS.

g. Economic incentives for securitization market participation.

h. The figure1show us after the 1980s the interest became lower and lower, and the investor wants higher return and lower risk.

i. Suitable laws and Acts facilitate MBS, such as National Housing Acts