Institutions in the Global Financial Market Assignment (Essay Sample)

Institutions in the Global Financial Market
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Introduction
It has been eight years since the global financial recession that spread through 2007 to 2009 but its effects are still being felt even though financial institutions and governments throughout the world are working round the clock to stabilize the world economy.
Many factors have been speculated to having been the cause of the meltdown. What is evident is that most of these factors are directly related to failure in financial supervision and regulation and negligence in risk management and corporate governance by globally substantial financial institutions (Belke, 2008). Excessive subprime mortgage lending was the key factor that caused the crash but other factors including deregulatory legislation, making of highly volatile and risky investments by investors and poor oversight from institutions like Credit Rating Agencies cannot be ignored as they also impacted greatly on the crisis (Hoffman, 2009).
This paper will discuss in depth how excessive mortgage lending to persons with poor credit rating (subprime mortgage) caused a speculation on financial markets thus causing the 2008 financial crisis whose effect is still rippling through world economies.
Subprime Mortgages
These are loans that are made to individuals whose credit ratings have been impaired because they may not have the ability to pay back the loans consistently due to setbacks such as unemployment, medical emergencies and divorce. Therefore, lenders do not offer conventional mortgages to these type of borrowers as they are seen as having larger risk of defaulting the loan (Dooley and Hutchison, 2009).
Subprime mortgages are normally characterised by interest rates that are high above the normal prime loaning rates. This is because lenders compensate themselves for accepting the high risk of loaning to such borrowers.
The subprime crunch onset was when the United States housing bubble burst and peaked between 2005 and 2006. Initially, lenders had increased incentives on loans making borrowers to assume difficult mortgages with the hope they will have the ability to refinance them under more favourable terms. Interest rates on the loans started to go up as the cost of housing relatively dropped making it hard to refinance the loans (Hesse and Frank, 2008).
With expiry of easier initial borrowing terms, failure of housing prices to rise as anticipated and upward adjustment of interest rates, there was an exponential increase in the rate at which subprime mortgages and adjustable rate mortgages were being defaulted.
It is important to note that in the years that preceded the crisis, there was an upsurge in huge amounts of foreign currency entering the United States from established Asian economies and countries that produce oil. These funds together with low borrowing interest rates led to easy credit conditions that prompted borrowing. These made consumers to assume huge unprecedented debt loads and also enthused investors worldwide to take a risk in investing in the United States housing market (Pajarskas and Jočienė, 2015).
A decline in the housing prices led to heavy losses in many universal financial establishments which had heavily loaned out and capitalized in the mortgage based securities. The crunch protracted from the housing sector and encroached other sectors of the economy. Huge defaults and losses were recorded in those other economic sectors as well.
As the credit and housing bubbles grew, the financial system became more fragile due to a number of factors majorly being the negligence of the government and other relevant authorities to recognize the importance of financial institutions especially the hedge funds and investment banks that are popularly known as shadow banking systems (Hesse and Frank, 2008).
Hedge funds and investment banks were successfully able to mask their levels of leverage from regulators and investors by use of securitizations and derivatives off the statements of financial position. This made reorganisation of financial institutions in bankruptcy literally impossible and thus prompted the need for government bailouts. It was evident that shadow banks had become significant in credit provision to the United States economy even though they were not subject to the same regulations as regular banks. While providing loans, theses shadow banks and some regulated banks had assumed obligations beyond a financial cushion that could sufficiently absorb defaults and losses (Durguner, 2007).
The above described events negatively impacted on the ability of the financial institutions to lend and significantly slowed down the economic vibrancy of major global economies.
Regulatory Changes Undertaken To Combat Subprime Mortgages
In the summer of 2008 president George Walker Bush signed into law “The Safe Mortgage Licensing Act” in which loan originators are supposed to conform to some set standards. These standards include taking a licensing course, passing the national examination, agreeing to background checks and actually passing them and submitting finger prints.
President Bush also legislated a law “The Housing and Economic Recovery Act” which contained numerous things key of which is “The Troubled Asset Recovery Program Funds “that required all regulated financial institutions to accept capital whether they required it or not so that more financial institutions could avoid the vulnerability of falling again. When president Obama came to power, he reallocated “The Troubled Asset Recovery Program Funds” so ...