The 2008 market collapse- Vu Nguyen

.docx

School

University of Houston, Downtown *

*We aren’t endorsed by this school

Course

6320

Subject

Accounting

Date

Apr 3, 2024

Type

docx

Pages

Uploaded by CorporalMole156 on coursehero.com

1 Vu Nguyen Professor Don Holmes ACC-6320 04/10/2023 The Fiasco of 2008 Financial Crisis The 2008 market collapse is considered one of the most significant and devastating financial crises in modern history. This crisis is commonly referred to as the subprime mortgage crisis or the Great Recession. It was caused by the collapse of the housing market, which led to a chain reaction throughout the global financial system. The collapse had far-reaching consequences, including massive job losses, a sharp decline in the global economy, and the loss of millions of homes and businesses. The 2008 crisis was caused by a combination of several factors, including the deregulation of the financial industry, predatory lending practices, and the creation of complex financial products. These factors led to the housing bubble, where a significant number of people were given loans they couldn't afford to repay. Many of these loans were sold to investors as mortgage-backed securities, which turned out to be worthless when the housing market collapsed. The market collapse began in late 2007 when housing prices began to decline. Many homeowners found themselves owing more on their homes than they were worth, leading to a wave of foreclosures. The crisis then spread throughout the financial system, as financial institutions that had invested in mortgage-backed securities began to suffer losses. This led to a shortage of credit, which made it difficult for businesses and individuals to obtain loans, causing

2 a sharp decline in the economy. To prevent a complete collapse of the financial system, governments around the world implemented a series of measures. These included the bailout of several large financial institutions and the implementation of economic stimulus packages to boost economic growth. The US government also implemented the Emergency Economic Stabilization Act of 2008, which authorized the use of $700 billion to purchase troubled assets from financial institutions. In conclusion, the 2008 market collapse was a devastating event that had far-reaching consequences. It was caused by a combination of factors, including the housing bubble, predatory lending practices, and the creation of complex financial products. Governments around the world implemented a range of measures to prevent a complete collapse of the financial system. However, the aftermath of the crisis was severe, with millions of people losing their homes and businesses and the global economy suffering for years. Lessons Learned from the 2008 Market Collapse The violations of ethical conduct related to the sub-prime lending related banking collapse were numerous and included: 1. Predatory Lending: Banks and mortgage companies engaged in predatory lending practices, which involved lending money to individuals who were unable to repay the loans. This resulted in many people defaulting on their loans and the eventual collapse of the housing market. Predatory lending refers to the unethical and sometimes illegal practices employed by lenders to take advantage of vulnerable borrowers. Lenders lure borrowers with promises of lower interest rates, but then charge hidden fees, penalties, and excessive interest rates, making it impossible for these borrowers to repay the loans. One of the most popular forms of predatory lending was the subprime mortgage, which targeted

3 individuals with low credit scores and income levels. Lenders approved these borrowers for home loans they couldn't afford and later charged them with high-interest rates, balloon payments, and adjustable-rate mortgages, leading to a surge in mortgage defaults and foreclosures. The consequences of predatory lending were far-reaching, and the housing market collapse in 2007-2008 was only the tip of the iceberg. Many people lost their homes, and the economy suffered a severe blow as a result. The financial crisis that followed led to widespread unemployment, business bankruptcy, and a recession that lasted for years. To prevent predatory lending, governments, and regulatory bodies have introduced laws and regulations to protect borrowers from unscrupulous lenders. These laws specify the types of practices that are considered predatory, and lenders who violate these laws may face legal and financial penalties. Borrowers are also encouraged to be more cautious and informed when seeking loans and to seek advice from financial experts before signing any loan agreements. 2. Securitization: Banks packaged the subprime loans into securities and sold them to investors without adequately disclosing the risks associated with these securities. These left investors unaware of the true value of the securities they were purchasing and exposed them to significant losses. This practice of securitization was a major contributing factor to the 2008 financial crisis. As the value of the subprime loans began to decline, the value of the securities backed by these loans also declined. Investors who had purchased these securities faced significant losses, which had a ripple effect throughout the financial system. Banks and other financial institutions that had invested heavily in these securities also suffered losses, leading to a wave of bankruptcies and bailouts. The lack of transparency in the securitization process and the failure of regulators to

4 properly oversee these practices played a key role in the financial crisis. As a result, regulations around securitization have been tightened to prevent a similar crisis from occurring in the future. As the old saying goes with great power comes great responsibility. The practice of securitization is a prime example of this adage. While securitization offers numerous benefits to investors and financial institutions, it can also cause significant harm if not handled properly. As we saw in 2008, the lack of transparency and oversight in the securitization process can lead to catastrophic consequences. The Rise and Fall of Subprime Loans Subprime loans were once seen as a lucrative investment opportunity. These loans were typically offered to borrowers with low credit scores or limited credit histories. While they carried a higher risk of default, they also offered higher returns for investors. Financial institutions soon began bundling these loans together into securities, which were sold to investors. Initially, these subprime-backed securities performed well. However, as the housing market began to decline, so did the value of these loans. Borrowers defaulted on their mortgages at an alarming rate, causing the value of the securities backed by these loans to plummet. The Domino Effect Investors who had purchased these securities faced significant losses. But it didn't stop there. Banks and other financial institutions that had invested heavily in these securities also suffered losses. Their balance sheets were severely impacted, leading to a wave of bankruptcies and bailouts. The lack of transparency in the securitization process played a major role in this crisis. Investors had no way of knowing exactly what was in the securities they were buying or how risky those

5 investments truly were. Regulators failed to properly oversee securitization practices or enforce regulations that were already in place. Securitization Regulations: Tightened Up In the aftermath of 2008, regulations around securitization have been tightened up to prevent another crisis from occurring. The Dodd-Frank Wall Street Reform and Consumer Protection Act included provisions to increase transparency and accountability in the securitization process. Today, financial institutions are required to disclose more information about the loans backing their securities. Investors are also required to perform more due diligence before investing in these securities. Regulators have been given more power to oversee securitization practices and enforce regulations. Today, financial institutions are required to disclose more information about the loans backing their securities. Investors are also required to perform more due diligence before investing in these securities. Regulators have been given more power to oversee securitization practices and enforce regulations. While these regulations have made the securitization process safer, it is important to remember that there are still risks involved in investing in any security. Investors must remain vigilant and do their due diligence before investing in any asset-backed security. 3. Conflict of Interest: Rating agencies paid by the issuers of securities assigned high ratings to subprime mortgage securities that turned out to be worthless. This was due to a conflict of interest, as rating agencies relied on issuers for business. What is a Rating Agency? Before we get started, let's first define what a rating agency is. A rating agency is an independent organization that assesses the creditworthiness of companies, countries, or financial instruments

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version