Question

The Financial Crisis of 2007 – 2009 was the worst economic downturn since the Great Depression of the 1930’s, and like that event had global repercussions and consequences. Also like the earlier crisis there were significant events that were under the control of policy makers that made the 2008 crisis worse, among these were lax banking regulations on home loans, a loosening of regulations that had prevented commercial banks from engaging in speculative behavior more typically reserved for investment banks and hedge funds (see also: The London Whale). Please contribute to our discussion this week by writing on ‘whether the crisis could have been prevented or significantly mitigated by better bank supervision’.

Answer 1

The financial crises of 2008 could have been prevented on a large scale with effective bank supervisions. Listing a few points below that could have helped preventing or mitigating the risk of the crises:

1. Strict guidelines should have been laid down by the Federal banks and other regulators to be followed by the commercial banks on the creditworthiness of the borrowers. Only those who qualified should have been given the mortgages.

2. The concept of interest only loans should have been eradicated, since the mortgage rates reset at high level and thus home owners are not able to pay their mortgages, and if the prices of the homes fall they cannot even sell the property for a profit.

3. The repackaging of the mortgage back securities should have been effectively supervised. The mortgage backed securities should be simple enough with all the rules being followed so that there is no ambiguity.

4. Action to be taken against banks that use too much leverage. Effective regulation of hedge funds and mortgage brokers.

5. The Fed must have better visibility of the banking activities conducted by the commercial banks to ensure the regulations are being adhered to and there are no malpractices.

6. Risk manager of Banks need to monitor the value at risk of the portfolio of the customers, the banks assets and liabilities as well.