The Financial Crisis of 2008 can be traced back to 2007. This case study provides students with insights into the causes and reactions to the crisis to help avoid the same situation in the future.
Harvard Business Review (709036-PDF-ENG)
December 16, 2008
Case questions answered:
- Evaluate the events surrounding the financial crisis of 2008 as well as leading theories of its origin.
- Discuss different interpretations and opinions of the causes of the financial crisis.
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Case answers for The Financial Crisis of 2008
The Financial Crisis of 2008 can be traced back to 2007 when Freddies (Federal Home Loan Mortgage Corporation) stopped purchasing high-risk mortgages. Mittal and Bhalla (2010) assert that the credit crunch contributed to the financial crisis. Housing over-investment resulted in a real-estate bubble that busted into a series of events.
The actions of many institutions are linked to the chain reactions that led to the financial crisis. Nevertheless, the cause of the financial crisis is impossible and difficult to explain. The paper’s objective is to discuss key institutions, decisions, events and provide accounts of what-caused-what.
Rating agencies are considered among the institutions that contribute to the financial crisis of 2008. Rating agencies were inadequately regulated. The rating agencies have the responsibility to rate the weaknesses of securities.
Standard & Poor’s, Moody’s, and Fitch were the three rating agencies approved in 2008 (Mittal & Bhalla, 2010). Security rating by these three institutions was critical since other organizations such as SEC was influenced by their guidelines to set as a net capital rule. Securities rating agencies ratings are applied as benchmarks for state and federal legislation as well as for foreign regulatory schemes.
Following Standard & Poor’s Moody’s and Fitch’s decisions to assign risky securities investment a rating of top-triple A, financial institutions were misguided.
Such a decision resulted in selling mortgage-related securities, heightening the financial crisis of 2008 because when they were sold, homeowners defaulted on mortgages, which led to securities’ value collapse (Marciniak, 2015).
After the AAA rating, mortgage banks began offering mortgage-backed-securities (MBS), and investors were eager to invest in these MBS. Such activities led to Wall Street firms using these mortgages as collateralized debt obligations (CDOs). However, the value of these CDOs collapsed after MBS prices fell despite the high rating, and borrowers began defaulting.
Marciniak (2015) argues that these events set-off a vicious cycle, and banks reported large losses. Besides, dominant investment banks were required to raise emergency capital, and numerous mortgage lenders went bankrupt.
Since the banks’ capital was eroded, to maintain capital adequacy-ration, they cut-down lending. Such action drove the whole United States economy into recession.
According to Fortune (2008), the rating agencies Moody’s and S&P downgraded about 1.9 trillion dollars of mortgage-backed securities. The downgrade pressured financial institutions with MBS to lower their values demanding banks to raise additional capital.
Such activities lead to…