Recommendations of Great Depression. Recommendations of Subprime Mortgage Crisis. The subprime mortgage crisis requires responses to the massive unaffordable mortgage payments, stresses in overall financial system caused by huge losses on mortgage-backed investment, and credit practices surrounding the granting of mortgages. In our assignment, there are several recommendations that were suggested to the subprime mortgage crisis.
First of all, subprime crisis has been the result of individual incentives and the lack of accountability which has caused the present dilemma (Chandran, 2008). Therefore, a greater accountability in the form of stricter norms against the lenders that should be applied as the disaster can be curtailed at the first link of the chain.
Currently, both traditional and structured credit products are graded at the same way. In fact, the analysis of structured credit products was often based on models with faulty assumptions, for instance the continuously rising of house prices, and seriously underestimated of the actual risk. As the model and assumptions used to evaluate structured credit products were not disclosed, investors were unable to evaluate properly both the securities and the rating given.
In response, John (2008) suggested that credit rating agencies should make their processes more transparent. For example, publish the sufficient information about the assumptions that underlying their credit rating models and methodologies, as well as clearly differentiate the rating given to complex products from those given to traditional instruments. Moreover, a formal and periodic reviews of those assumptions and rating are encouraged to imply. This would indicate whether the actual mortgages were credit-worthy and properly originated in the case of mortgage-backed securities.
In addition, mortgages were made to home purchasers who normally would not qualify for them and were presented as being of much higher quality than they actually were. Therefore, credit standards were relaxed for most classes of loans as homebuyers found themselves in mortgages that were inappropriate for their financial circumstances, and underwriters of securities backed by mortgage who purchased mortgages that were excess risky than they seemed.
To solve this problem, John (2008) recommended a better underwriting standards by originators of mortgages. A key recommendation included state licensing of mortgage brokers who are willing to accept a stringent supervision and regulations. This will indeed improve the quality of mortgages that those brokers create. Relatively, in order to improve existing regulation rather than launch a new layer, an oversight of all mortgage originators should be more consistent, limit by certain minimum standards, and embrace an effective enforcement mechanism (John, 2008).
Finally, one of the more disturbing revelations of the subprime crisis is that major financial institutions are unable to estimate their actual exposure to losses resulting from mortgage-backed securities accurately. Thus, central bank should take rapid steps to require firms in improving their risk management practices and regulations. And firms should be required to establish or meet liquidity and capital standards that are sufficiently stringent to enable the firms to survive even in times of severe systemic stress.
In nutshell, religion and international financial regulations effort to improve their capital standards and regulation. Such improvements would enable investors in better evaluating the true condition of financial institutions and give regulators a better understanding of the risk that a particular institution could pose to the financial system.
Recommendations of European Sovereign-debt Crisis
Bruyckere et al. (2012) motivated the recommendation that put public finances on a sustainable track are a necessary ingredient, especially in the countries with high debt levels. That means, a credible commitment to reduce debt levels over time may probably require efforts at the domestic level, and enforceable coordination at the European level as well as some form of debt consolidation.
In terms of policy implications, Bruyckere et al. (2012) also made several suggestions to alleviate the contagion between bank and sovereign risk. That is, the ambition of policymakers and supervisors should be to make banks more robust, make public finances more resilient and weaken the bank and sovereign link, aim to decrease the probability of contagion and decrease the intensity of the risk spillovers when contagion occurs.
On the bank side, the degree of capital adequacy should be turns out to be more crucial. In addition, bank should be restricted stringently in their reliance on money market funding. On the sovereign side, making public finances more sustainable and ensuring that resolution mechanisms are in place to deal with distressed banks are important policy objectives. Finally, Bruyckere et al. (2012) has made an evidence that not only bank supervision and recapitalization mechanisms should be executed at the designed level through the European Stability Mechanism, but also those deposit insurance and bank resolution, as well as the associated burden sharing arrangements have to implemented on a European scale.
As Great Depression, Subprime Mortgage Crisis, and European Sovereign-debt Crisis as the examples, we found out that those counterparties who involved in banking crisis have the same inventive structures that they misallocated capital and mismanaged risk. They only did what their incentive structures were designed to focus on short-term profits and create excessive risk. In such circumstances, this is not the first time that those who believe in free and unregulated markets have come running to the government for bailouts. Hence, Stiglitz (2008) has suggested a variety solutions for the deep systemic problems as bellow:
Financial institutions should correct incentives for executives, reduce the scope for conflicts of interest and improve shareholder knowledge about the dilution in share value as a result of stock options. Those counterparties should mitigate the incentives for taking excessive risk and short-term focus that has so long prevailed.
Create a financial product safety commission, in order to ensure that products bought and sold by financial institutions are safe for “human consumptionâ€.
Create a financial systems stability commission to take an overview of the entire financial system, recognize the interrelations among the various parts, and to prevent the excessive systemic leveraging that have just experienced.
Impose other regulations to improve the safety and soundness of financial system.
Issue stronger consumer protection laws that prevent predatory lending.
Launch a better competition laws. This is because the absence of competition made the result that financial institutions have been able to prey on consumers through credit cards partly.
These suggestions will not ensure that we will not have another banking crisis in future, but will make it less severe than it otherwise would be.
