Financial crisis – Subprime

It began with the subprime crisis which is mortgages at variable rates. Today, we’ll talk about it again after a year and a half passed.
There are loans premiums (which are loans at normal interest rates). Subprime loans are loans that were made to poor people. There are risks of non-repayment of these loans, which justified the bank margins slightly higher. However, the risk of officers was more important than the interest rate established.However, the bank took a mortgage on the property, ie that if households could not repay their property, they take their real estate. However, the real estate market continued to grow, thus justifying an interest rate relatively low.
The U.S. government sought the banks to lend to households to access private property.

• Banking Regulation

There was the introduction of prudential regulation. It exists in all OECD countries. The aim is to avoid the bankruptcy of a bank, and especially to avoid the financial difficulties of a bank will result in an inability to repay deposits. If ever a bank can not repay the deposits, it could repay the banks, there is a risk chain.
Indeed, it is necessary that the banks have a level as sufficient to meet the risks they take when they make loans. On the assets of a bank, there are credits but also securities. The idea is to require banks to have capital in excess of the percentage of those assets. (If a bank 100 to his credit, it should be, for example, 5% of its liabilities to assets).
Suppose a bank has 100 to his credit and 100 deposits. If there is a crisis, a bank could repay all of the assets of the bank, then she would get only 50. Indeed, the bank could repay all the depositors .
Suppose there is a prudential ratio of 50%. While the liability side, deposits are 50 and 50 of fons own. Then the bank repay depositors, but the loss to shareholders.
This is the basis of banking regulation to prevent banking crises.

• Secularization

Depending on risk, the rate of capital increases.
The U.S. banks that made subprime loans were required to have sufficient capital. Banks have found a trick to avoid increasing equity.They were given subprime loans, they are assets. They got rid of these assets by selling cons of liquid bodies. Securitizations These vehicles were borrowed by issuing securities, like bonds.The purpose vehicle emitting 100 titles but had no need fons own because it is not subject to banking regulations, ie no obligations of minimum capital. The purpose vehicle is financed by selling securities agencies.

Securitization vehicles bought subprime loans but also credit premiums. There were good credit and bad credit. The liabilities of securitization vehicles, there were bonds repayable in priority and bonds repayable once the bonds redeemable in priority have been redeemed.These securities were purchased by organizations (mutual funds, pension funds), but these vehicles did not have prudential ratios, not equity. They all of their flaws even minimal safeguards for the agencies, this is where the rating agency. These are private organizations whose primary function is to assess the risk taken when buying a title-type bond.

There are three rating agencies. These organizations were asked to record the securities issued by these vehicles. They gathered in front of vehicles that had appropriations nature of different risks. A feature is to mix between appropriations and varied nature of the securities they issue from very different. Rating agencies have had to intervene in the design (as defined mathematical-financial) of such securities, ie they were to go to AAA.
Therefore, they are found to give a note on something that they helped design the product. This situation is not very healthy.

• The accounting regulations

There is a debate on the accounting staff. The problem relates to the valuation of assets on the balance sheet assets (property, assets …). Traditionally, the method is to record the assets at historical cost, ie if you buy a machine 100, it puts it at 100 in our assets then disparaging. If a financial asset, it does not amortized. Throughout the world there are new IFRS accounting standards, in most organizations. This is a valuation of assets relative to market prices. If ever the price of an asset is 70 when you put 70 in assets. If ever, it increases when you make a profit. Otherwise, it was an accounting loss.

Problem: Market prices are volatile and the markets are not always rational. These market prices, that means he? If ever there is a crisis when one buys. Since worth the market price?

The problem is not so simple, there are only 3 methods for valuing assets:
The traditional, historical value, if ever you buy an asset at 100, there is no reason that it is still 100 in 2 years. The value of contracts to make sense if the market makes sense. The economic recovery, if ever a company buys a machine because it brings her earnings. The idea is to exploit this property on the sum of profits. It is the sum of the gains that I update and I think the economic value of these gains. However, it is based on forecasts.

• Explanatory Time line

The first stage began well before the crisis: the macroeconomic imbalance that we have throughout the world, ie the imbalance of payments current account. Including the U.S., Japan, China and other countries.For some economists, the real problem lies here, because they believed that the imbalances were unsustainable long term.

To redress the imbalances, it should increase interest rates to less consumption in the U.S.. The alternative was that China and Japan reduced their savings rate. This does not happen.

Step 2 in 2007, we reached the end of a cycle of relatively strong growth in the world (led by China). This resulted in inflationary pressures (classical), particularly noticed in the market for raw materials related to an imbalance between supply and demand. This has prompted central banks to start making a more restrictive monetary policy, ie higher interest rates. The activity began to slow, particularly in the housing market in the United States. Once interest rates rise, households bought less. Soon, a number of owners found themselves in a difficult situation. They could not repay their loans when the bank seized the property and sell it. It increases supply, which contributes to the slide in prices. He then had a crisis on the housing market and difficulties in repayment of subprime loans.

Step 3: problem with the vehicles. Securitization vehicles found themselves facing a liquidity problem and refund their own securities issued because they were unable to obtain money from the sale of their property. The banks have left the game because they have sold their loans to securitization vehicles. The rating agencies have found that special purpose vehicles will have difficulty repaying their titles. They then degraded their notes. At that time, the Fund managers then try to sell their securities. Therefore, the price of those securities collapsed. Securitization vehicles taking with them the Fund.

Step 4: Now that the banks concerned. There is a boomerang effect for banks. This theirs suddenly for reasons of reputation. The problem of the Fund is income from banks. Banks advised to purchase Fund shares. But these securities are now worth nothing. Consequently, banks have intervened by buying securities issued by the Fund. However, they have realized they were buying securities that were worthless, then what are the banks themselves, which will see massive losses, accounting. So, the banks must use their own merits, ie to appeal to shareholders. However, critics doubt that these securities, then the security price collapses in the financial market.
Then there is a crisis in summer 2008. The banks eventually will no longer lend money to each other. The interbank market was not working. There was a reaction of central banks and governments. In 2007, there was a restriction on monetary policy. In 2008, the banks saw the problem as subprime crisis spread. The first response of central banks is to adopt an expansionary monetary policy. The ECB has begun to lower its interest rates in mid 2008, unlike the Fed.

September 2008, reveals that this is insufficient because bank failures begin to multiply. The U.S. government, English intervened to save some banks. In September, the crisis affects a very large bank, Lehmann Brother. If ever the government does nothing, the bank will pay more such applicants.

The U.S. government found itself in a dilemma. Brother Lehmann is very involved in securitization vehicles, it loses a lot of money. Let the state saves Lehmann Brother but then I know the banks they can do those they saved, they will do forever. This is not a very good signal, because there will always be a safety net (Too Big To Fail). Either I did not save Lehmann Brother to send a good signal, but then there is a risk of a global catastrophe.

The government chose the latter. Brother Lehmann closed, other banks have been forced to devalue their assets in their accounts, which has aggravated the crisis. The problem is that today, more than any government would take the decision of running a bank such as the Lehmann Brother, because the crisis was global. The solution would arrive to find a way that no bank is too large, and that is get to the blackmailing states.

Step 5: The U.S. government leaves Lehmann Brother. This has turned into a systemic crisis, which affected all banks. Then the U.S. and European governments have said that other banks, they would save them. There was a monetary and fiscal policy. The BC lend money to banks and short term loans against collateral (securities absolutely no guarantees).

In September 2008, the central bank began to lend longer-term (up to 9 months) and to accept title less good qualities that U.S. government bonds (including assets of private companies). However, there were liquidity to banks, states have increased the equity of banks heavily.

Today the real economy provides output signals of recession. There are always debates on accounting regulations. Banking regulation should be extended to more and more organizations. How to limit the risks taken by banks? How to prevent them being too big? How to prevent further bubbles from forming?

Banks now have much cash when they finance the state. The banks reinvest in the shares, but is not there a risk? The next bubble is about borrowing …

You could refer to the link via Wikipedia.