Reference no: EM133153934

The year 2011 was characterized by a sluggish economy and high unemployment when millions of Americans lost their homes and businesses closed. How did this happen? Back in 2008, there was a global banking crisis that was the worst since the Great Depression of the 1930s. Several major American investment banks went bankrupt, markets plummeted around the world, and there was a global recession. The causes of the crisis included failures in financial regulations in some countries, such as the United States, reckless behaviour by financial firms, excessive borrowing by households and investment banks, and a lack of accountability and ethics at many levels. 

Back even further, in 2000, the tech bubble burst. Share prices in high-tech companies fell dramatically and major financial frauds were discovered, including Worldcom, Enron, and Global Crossings. Governments wanted to keep consumers spending to head off an economic slowdown, so they chose to dramatically cut interest rates by over 5 percent, down to near 1 percent. Given this historic low cost of credit, consumers borrowed money, lots of it. By far the most significant borrowing related to home loans, that is, mortgages. By 2007, household debt rose to 127 percent of disposable income in the United States and Canadian household debt was climbing also. Home mortgages resulting from the housing boom became the biggest financial bubble in history. As more and more homes were purchased, housing costs rose rapidly.

While everyone wants a home, the reality is that not everyone can afford the cost of buying one. But with relatively cheap mortgage interest, many were buying homes, from first-time homeowners to long-time homeowners who wanted bigger and fancier houses. And banks were writing up mortgages for people who would not normally qualify. Banks typically look at the income of the borrower and assess the ability of the borrower to make the mortgage payments. But this criterion was overlooked more and more because the banks and everyone else believed that the prices of houses would continue to rise. These mortgages were called subprime mortgages. In 2004, subprime mortgages made up 10 percent of all mortgages. By 2006, this percentage doubled. 

These riskier mortgages became an international problem. After mortgages were written, the banks sold them to investment banks. The investment banks in turn bundled these mortgages into securities, selling them in the open market to investors. They were called mortgage-backed securities, or MBSs. 

MBSs have been traded since the 1980s as a safe investment, as only low-risk conventional mortgages were bundled. With the rapid increase in mortgages being written, more and more MBSs appeared. Investors liked the increasing return that was promised given the higher and higher percentage of sub-prime mortgages that made up the newer MBSs. And bank lenders wrote riskier and riskier mortgages because investment banks demanded them and the banks were passing on the risk to investment banks and investors. Given the involvement of banks, investment banks, and investors, it was very difficult to know where the risk was. Investors relied on ratings agencies, specifically Moody's and Standard and Poor's, for advice on safe investments. And these agencies were more than willing to oblige. Between 2000 and 2006 the number of AAA ratings exploded. MBSs were rated as AAA even though they consisted of a higher percentage of subprime mortgages.

The potential return from MBSs convinced the investment banks to request that the limits on the amount of money they could borrow to buy these securities be raised. In 2004, the SEC relaxed limits on leverage and these banks were allowed to take on as much risk as they liked. By 2007, the five largest investment banks increased their leverage significantly; they believed that housing prices would continue to go up and that MBSs were a good source of income.

In 2007, the real estate bubble burst and the growing recession left many homeowners unable to pay their mortgages, especially subprime mortgages. The number of foreclosures jumped 79 percent. As housing prices fell, many homeowners found themselves "underwater," with mortgages higher than the value of their homes. The financial incentive to pay their mortgages was gone, so they defaulted. The value of MBSs plummeted, leaving both investment banks and investors with hundreds of billions of dollars of defaulted mortgages with little chance of recouping the value of the mortgages. All the major investment banks were impacted; some consolidated, while others failed. 

Many countries and international companies, including Canadian banks and investors, had invested in the U.S. housing market through MBSs. They were all affected. Foreign markets collapsed, and the crisis went global.

As we look back on this time period, we realize that this financial crisis was the largest the world had ever experienced. Not since the Great Depression of the 1930s have we seen, on a global scale, rising unemployment, many failed businesses, plummeting consumer wealth, declining international trade, and the near-collapse of foreign governments, especially in Europe. At the writing of this text, we still do not fully comprehend the long-term impact of this crisis.

This is the case I need report on this case

 

Format

Use the following standard report format to organize your analyses:

Introduction - in a paragraph, briefly summarize the issues.

Problem Statement - in a sentence, describe the major problem that must be resolved.

Stakeholder Analysis - Consider the complexity of the situation and the potentially conflicting perspectives of at least three various stakeholders.

Alternatives - propose and analyze three alternative solutions, which must be supported by concepts in the text, or external research.

Recommended Solution - what would you advise? How will you implement your recommendation?

Conclusion - briefly summarize why your solution best resolves the problem.