Question

Frannie Mae and Freddie Mac that collapsed in 2008. The failure of Frannie Mae and Freddie Mac can be attributed to several weaknesses within the internal environment ranging from procedures and system failures to human capacity and ethical issues. Research and provide the following:

1) Identify five areas of risks that the bank failed to mitigate adequately that could have contributed to the crisis at the bank in 2008.

2) Present at least one argument for each risk you identified above to demonstrate why the poor management of that risk contributed to the demise of that financial institution.

3) Provide one or more sound recommendation(s) for each risk that you identified above that could have helped to mitigate or prevent the financial failure.

Answer 1

Answer : !

Banks failed to mitigate the followings risk as given below.

1.  Secured Funding/Triparty Repo Transactions • Risks arose from the increased use of short-term triparty repos to fund longer term illiquid assets and from clearing banks’ provision of intraday credit.

2. Deposit Trends • Vulnerable firms faced sustained outflows; firms perceived to be strong gained new deposits.

3. Interbank Deposits, Unsecured Funding, and the Foreign Exchange Swap Market • Counterparty concerns led to the near-cessation of interbank funding. • The funding available was increasingly concentrated in short-term tenors.

4. Firms underestimated the funding vulnerabilities created by prime brokerage.

5. The case of Lehman Brothers International (Europe) highlights the contagion risk that rehypothecation in insolvency proceedings poses for both firms and investors.

6. The near-failure of Bear Stearns highlights the “frictional” liquidity issues that arose as clients withdrew balances, creating a temporary need for funding.

Answer 2 : Arguments for the above risk are as follows.

1. Market events in September-October 2008 highlighted potential difficulties in the U.S. unwinding mechanism and in both U.S. and European protocols for dealing with troubled borrowers. From the borrower’s perspective, the daily unwinding of triparty repo transactions and the very short maturities of the loans mean that lenders can withdraw from a particular borrower in a matter of days and often overnight

2. The subsequent market stress had divergent effects on financial firms that were considered strong or too-big-to-fail and others that were perceived as susceptible to the stress.

3. The dollar-yen and dollar-euro swap markets dried up after Lehman’s collapse, posing a particular risk for certain European and Japanese firms that had chosen to finance illiquid U.S. dollar assets with short-term funding

4. The severity of the risks associated with securities lending activities—as with prime brokerage—caught many participants by surprise. Before the crisis, many market participants considered securities lending to be low-risk and liquidity-positive.

5. Almost all of the firms surveyed have sought to strengthen structures and processes to enhance the governance of liquidity. Firms were taking steps to improve the structure of their treasury, liquidity risk management, and related functions

Answer 3 : Methods for mitigating the above risk..

Areas for Continued Improvement Ten critical areas of needed improvement that are broadly relevant across firms emerged from the self-assessment results and interviews. Supervisors believe that considerable work remains in these areas, encompassing governance, incentives, internal controls, and infrastructure. The absence of action in some critical areas, such as the alignment of incentives and infrastructure-related matters, should raise questions for boards of directors, senior managers, and supervisors about the effectiveness and sustainability of recent changes. Supervisors will critically evaluate the progress on these and other issues. Firms have reported progress in their alignment with some industry standards related to areas explored below, such as those associated with corporate governance and with liquidity planning and monitoring. The SSG believes that some of the noted adjustments, such as modifications of reporting lines or expanded metrics in liquidity reports, may represent less time- and resource-intensive actions, or “low-hanging fruit.” Such changes must be ingrained in firm culture and must be validated by boards, senior management, auditors, and supervisors as to their effectiveness in bringing about desired results.