...Research Proposal: Finance; (Financial Engineering, Financial Mathematics & Risk Management) By:Syed Asad Raza Naqvi Index Introduction and Background………………………………………………………………………….3 Interested areas for research and further study (Research Proposal)……………….3 Further explanation of the intended research topics………………………………………..4 Securitization…………………………………………………………………………………………………..4 Credit Derivatives…………………………………………………………………………………………….6 Hybrid Products……………………………………………………………………………………………….7 Re-Securitization……………………………………………………………………………………………..8 Contribution of these products towards Financial Crisis…………………………………..8 Improper Risk Management role in Financial Crisis………………………………………….9 Risks………………………………………………………………………………………………………………..10 Market Risk……………………………………………………………………………………………………..11 Credit Risk……………………………………………………………………………………………………….11 Liquidity Risk……………………………………………………………………………………………………11 Interest Rates and the Financial Crisis………………………………………………………………12 Relation between low interest rate and financial crisis…………………………………….12 Role of Rating Agencies……………………………………………………………………………………14 Structure Finance Products and Rating Agencies……………………………………………..14 Regulations Then and Now………………………………………………………………………………15 BASEL II……………………………………………………………………………………………………………16 Enhancements of Basel II…………………………………………………………………………………18 The Resecuritisation Exposure Using IRB Approach………………………………………….18 The Resecuritisation Exposure Using Standardized Approach…………………………...
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...How did Financial Reporting Contribute to the Financial Crisis? Mary E. Barth & Wayne R. Landsman a a b Graduate School of Business , Stanford University , Stanford, CA, USA b Kenan–Flagler Business School , University of North Carolina at Chapel Hill , Chapel Hill, NC, USA Published online: 07 Jul 2010. To cite this article: Mary E. Barth & Wayne R. Landsman (2010) How did Financial Reporting Contribute to the Financial Crisis?, European Accounting Review, 19:3, 399-423, DOI: 10.1080/09638180.2010.498619 To link to this article: http://dx.doi.org/10.1080/09638180.2010.498619 PLEASE SCROLL DOWN FOR ARTICLE Taylor & Francis makes every effort to ensure the accuracy of all the information (the “Content”) contained in the publications on our platform. However, Taylor & Francis, our agents, and our licensors make no representations or warranties whatsoever as to the accuracy, completeness, or suitability for any purpose of the Content. Any opinions and views expressed in this publication are the opinions and views of the authors, and are not the views of or endorsed by Taylor & Francis. The accuracy of the Content should not be relied upon and should be independently verified with primary sources of information. Taylor and Francis shall not be liable for any losses, actions, claims, proceedings, demands, costs, expenses, damages, and other liabilities whatsoever or howsoever caused arising directly or indirectly in connection with, in relation to or arising out of the...
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...How did Financial Reporting Contribute to the Financial Crisis? Mary E. Barth Graduate School of Business Stanford University Stanford, CA, 94305 mbarth@stanford.edu. Wayne R. Landsman Kenan-Flagler Business School University of North Carolina at Chapel Hill, Chapel Hill, NC 27599 wayne_landsman@unc.edu. May 2010 Forthcoming, European Accounting Review, 2010 We appreciate comments from seminar participants at the Bank of Spain, Rob Bloomfield, Elicia Cowins, Hilary Eastman, Gavin Francis, Christian Kusi-Yeboah, Jim Leisenring, Martien Lubberink, Richard Rendleman, David Tweedie, and an anonymous reviewer. We acknowledge funding from the Center for Finance and Accounting Research at UNC-Chapel Hill and the Stanford Graduate School of Business Center for Global Business and the Economy. Electronic copy available at: http://ssrn.com/abstract=1601519 How did Financial Reporting Contribute to the Financial Crisis? Abstract We scrutinize the role financial reporting for fair values, asset securitizations, derivatives, and loan loss provisioning played in the Financial Crisis. Because banks were at the center of the Financial Crisis, we focus our discussion and analysis on the effects of financial reporting by banks. We conclude fair value accounting played little or no role in the Financial Crisis. However, transparency of information associated with asset securitizations and derivatives likely was insufficient for investors to assess...
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...The Role of Accounting in the Financial Crisis: Lessons for the Future S.P. Kothari kothari@mit.edu 617-253-0994 and Rebecca Lester rlester@mit.edu MIT Sloan School of Management E60-382, 30 Memorial Drive Cambridge, MA 02421 December 14, 2011 ABSTRACT: The advent of the Great Recession in 2008 was the culmination of a perfect storm of lax regulation, a growing housing bubble, rising popularity of derivatives instruments, and questionable banking practices. In addition to these causes, management incentives, as well as certain US accounting standards, contributed to the financial crisis. We outline the significant effects of these incentive structures, and the role of fair value accounting standards during the crisis, and discuss implications and relevance of these rules to practitioners, standard-setters, and academics. This article is based on a presentation by Deputy Dean and Professor SP Kothari of the Sloan School of Management, Massachusetts Institute of Technology, at Baruch College on October 25, 2010. 1 Electronic copy available at: http://ssrn.com/abstract=1972354 The Role of Accounting in the Financial Crisis: Lessons for the Future I. Introduction The Great Recession that started in 2008 has had significant effects on the US and global economy; estimates of the amount of US wealth lost are approximately $14 trillion (Luhby 2009). Various causes of the financial crisis have been cited, including lax regulation over mortgage lending,...
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...Focus THE CAUSES OF THE FINANCIAL CRISIS1 MARTIN HELLWIG* Introduction For the media in Germany, the cause of the financial crisis is obvious: Blinded by greed, bank managers thought only about their bonuses and miscalculated badly in betting on American subprime mortgages when the very name of these securities should have alerted them to their risks. If an economist suggests that the matter might be more complicated, he is denounced as a homo exculpans, a person who will excuse anything that managers do.2 If we look at the numbers, however, we see that there is something more to be explained. According to the Global Financial Stability Report of the International Monetary Fund (IMF) of October 2008, losses on non-prime mortgage-backed securities in US residential real-estate amount to some 500 billion dollars. This figure is both too small and too large. The figure is too small in the sense that losses of 500 billion dollars by themselves cannot explain why the financial system worldwide has been so devastated by the crisis. Around 1990, losses of savings and loans institutions in the United States were said to amount to some 600 to 800 billion dollars. A decade later, losses on NASDAQ and on the New York Stock Exchange amounted to 1.6 trillion dollars in the calendar year 2000, 1.4 trillion dollars in the calendar year 2001, and again 2.7 trillion dollars in the calendar year 2002. Neither episode caused a worldwide financial crisis. At the same time, the figure of 500...
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...bubble is, some of the reasons for the bubble, was it preventable, how it kept growing, how it burst and how it has affected our economy. By definition a housing bubble is a temporary condition caused by unjustified speculation in the housing market that leads to a rapid increase in real estate prices. As with most economic bubbles, it eventually bursts, resulting in a quick decline in prices. The end of a housing bubble is hard to predict given the fact that economic conditions can change without warning. If a housing bubble swells to an extremely high level, the aftermath of a burst may set the housing market back years. There is little consensus as to the cause of the housing bubble that precipitated the financial crisis of 2008. Numerous explanations exist: misguided monetary policy; a global savings surplus; government policies encouraging affordable homeownership; irrational consumer expectations of rising housing prices; inelastic housing supply. Some explanations, based on macroeconomics, posit that the bubble was caused by excessively easy monetary policy. Thus, some scholars have argued that the Bubble was the result of the Federal Reserve holding interest rates too low for too long, resulting in artificially cheap mortgage credit and stoked housing demand. Other scholars have pointed to the global savings glut that pushed down interest rates....
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...The Role of Financial Institutions & Risk Management in Subprime Crisis Vikrant Joshi The Role of Financial Institutions & Risk Management in The Subprime Crisis This paper discusses the role of financial institutions & their risk management strategies in the subprime mortgage crisis. The downturn in the housing and mortgage markets precipitated the first phase of the financial crisis in August 2007 when the solvency of a number of large financial firms was threatened by huge losses in complex structured financial securities. Why did these firms have such high concentrations in mortgage-related securities? Given the information available to firms at the time, these high concentrations in mortgage-related securities violated basic principles of modern risk management. Introduction: This paper analyzes the role of financial institutions in the light of risk management and corporate governance in the events leading to the subprime crisis. This paper explores the following question: Given the tremendous advances in financial risk measurement and management, why was the solvency of large and complex financial firms threatened by large losses in the mortgage market? First, the subprime mortgage market was about $1.3 trillion. Even a very high percentage loss in this market seemed manageable, given the overall size of U.S. and world debt markets. Commonly cited reasons such as high mortgage defaults in 2006 and 2007 do not provide a sufficient...
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...absorber” - Canada’s experience following the Asian Crisis - commodity prices and the Canadian dollar world price of raw materials fell by 30 percent, world is prepared to pay less for our raw materials. This led to dramatic depreciation of CAD. - compare BC and Ontario situations. BC produced a lot of raw materials whose demand fell. The core of manufacturing in Canada is in Ontario (and Quebec) and the resource sectors are largely in the West and very East. When Asian economies go under the tank and reduce their demand for raw materials – the BC economy goes down, they can’t sell stuff to Asia anymore. But the Canadian dollar depreciates by 10 or 15 percent. A depreciating currency helps everybody who is exporting given whatever the price you’re exporting at. Depreciation is a net plus to Ontario, because its machines, etc. gets a bump up in exports. The boost to Ontario offsets the negative to BC somewhat. What happened in 2002-2006 when world demand increased (China and India phenomenon and U.S economic boom) drove up prices, the Canadian dollar appreciated. Ontario was damaged while the East and West of Canada boomed. 2. Describe and explain the connection(s) between the “financial sector” and the “real economy”. Why is this connection relevant to the appropriate policy response (in Canada, say) to the global financial crisis of 2007-09? When financial markets are functioning well, they play a background role in the overall behavior of the real economy. At the...
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...Mini-Case #2 Financial crisis, Home Mortgages, Credit Markets, Financial Institutions, Moral Hazard, Adverse selections, CONCEPTS IN THIS CASE: Mortgage defaults sub-prime mortgages mortgage-backed security defaults write off wealth effect moral hazard adverse selection You have been hired to manage a depository institution, such as a bank. The top management team is very concerned to avoid the similar massive defaults on home mortgages as in 2007. You are being asked to explain factors behind the financial crisis and explain the role of government in minimizing the adverse impact of the crisis on the financial system. You start with some background information on how a wave of defaults on home mortgages threatened the health of any financial institutions that had invested in home mortgages either directly or indirectly through investment in mortgage-backed securities. Mortgage-backed securities were perceived to be sound investments as they were rated by legitimate rating agencies. Before the crisis happened, banks had mistakenly believed that an innovation and securitization of their long-term assets could eliminate their exposure to mortgage defaults and minimize their interest rate risk and even make them more profitable. When the mortgages started to go bad, many investment funds ‘blew up” and couldn’t repay the loans they had taken from the banks. The banks had to “write off” the loans they had made to the investors. Doing so reduced their reserves and lending...
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...Richardson and I. Walter DOI: 10.1561/0500000025 Manufacturing Tail Risk: A Perspective on the Financial Crisis of 2007–2009 By Viral V. Acharya, Thomas Cooley, Matthew Richardson and Ingo Walter Contents 1 Introduction 2 How Did We Get There? 2.1 2.2 2.3 The Panic of 1907 and Its Aftermath Bank Competition, Financial Innovation and Risk-Taking in the Last Decades of the 20th Century Risk-Taking Incentives of Financial Institutions 249 253 253 258 264 3 The New Banking Model of Manufacturing Tail Risk 4 Alternative Explanations of the Financial Crisis 5 Conclusion A Appendix: Tail Risk in the Rest of the World References 273 292 311 314 320 Foundations and Trends R in Finance Vol. 4, No. 4 (2009) 247–325 c 2010 V. V. Acharya, T. Cooley, M. Richardson and I. Walter DOI: 10.1561/0500000025 Manufacturing Tail Risk: A Perspective on the Financial Crisis of 2007–2009 Viral V. Acharya1 , Thomas Cooley2 , Matthew Richardson3 and Ingo Walter4 1 2 3 4 Stern USA, Stern USA Stern USA Stern USA School of Business, New York University, New York, NY 10012, vacharya@stern.nyu.edu School of Business, New York University, New York, NY 10012, School of Business, New York University, New York, NY 10012, School of Business, New York University, New York, NY 10012, Abstract We argue that the fundamental cause of the financial crisis of 2007–2009 was that large, complex financial institutions (“LCFIs”) took excessive leverage in the form of manufacturing tail risks that were...
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...- The role of financial institutions and the different types of financial institutions Depository Institutions: 1. They offer deposit accounts that can accommodate the amount and liquidity characteristics desired by most surplus units 2. They repackage funds received and deposits to provide loans of the sie and maturity desired by deficit units 3. They accept the risk on loans provided 4. They have more expertise than individual surplus units in evaluating the creditworthiness of deficit units 5. They diversify their loans among numerous deficit units and therefore can absorb defaulted loans better than individual surplus units could (Commercial Banks, Savings Institutions, Credit Unions) (Finance Co, MF, Security Firms, Insurance Co, Pension Funds) - The various types of risk and ways to manage risk Systemic Risk- The spread of financial problems among financial institutions and across financial markets that could cause a collapse in the financial system. Credit Risk – the risk of loss from default on credit Market Risk – the risk of loss from changes in interest rates or market value of securities or other assets Operating Risk – the risk of loss from operating activities, e.g. fraud, systems or operational errors. - Causes of the financial crisis, key lessons learned and forces that will change financial services in the future a. Causes: Mortgage originators sold mortgages...
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...What role did the accounting profession play in the recent subprime mortgage crisis? What could they have done differently? In all businesses, accounting is the backbone that holds them together. In stating this, the demise of the subprime mortgage industry lies within the bad practices of mortgage companies, banks and financial institutions. Allowing the lending of billions of dollars to non-credit worthy individuals was a disaster waiting to happen. During the 1980’s the subprime market comprised of approximately 5% loans and by 2005 they were at a record-breaking 20%. The decisions that allowed the increase of so many subprime loans have put this country in financial turmoil. The Subprime loan market allowed lenders to make loans to non-credit worthy borrowers, which included no-credit or bad credit individuals and those with stated income. These loans were attractive to a vast number of people because it was an offer borrowers couldn’t refuse. The little to no credit requirements and Interest-only and Adjustable-rate loans made borrowers believe they could live the American dream. The failure of risk management in these cases compromised the securitization of loans and debt obligations. The inability and/or lack of accounting principles have contributed to this country’s financial crisis, not to mention the global impact from defaulting on subprime loans. These issues still play an important role of the finance industry today. Now that the government has had to step in...
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...yielded higher returns than government bonds (Fligstein and Habinek, 2011). When the American mortgage market broke down it quickly spread to other countries, and the global financial crisis was a fact. In this paper I will start off by explaining the background for the mortgage crisis in the US. Afterwards I will try to elaborate how this could spread across the world and make the crisis global. Finally I will discuss why this crisis has been so slow in resolving itself since many countries still struggle in the aftermath of the crisis. My thesis is that: The decline in investment opportunities in several countries in the European Union caused investors in some of the richest countries to buy mortgage backed securities from the US. When these mortgage backed securities defaulted, the crisis turned global. The American mortgage crisis: When the American banking sector gradually got deregulated during the 80s and 90s, the banks came up with new and creative ways to reach out to new costumers. Basically it is conventional economic wisdom to not lend out money to people with bad financial credibility, but an innovation in financial alchemy changed this. By the early 1990s investment banks realized that mortgages could be gathered, packaged and sold as profitable bonds in an assumingly huge market. Securitization made consumers get mortgages cheap and easy, so the market for mortgage-backed securities grew at a fast rate alongside increased housing prices (Fligstein and Goldstein...
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...The Mortgage and Financial Crises: The Role of Credit Risk Management and Corporate Governance William W. Lang Federal Reserve Bank of Philadelphia Ten Independence Mall, Philadelphia, PA 19106 Phone: 215-574-7225 E-mail: William.Lang@phil.frb.org Julapa Jagtiani Federal Reserve Bank of Philadelphia Ten Independence Mall, Philadelphia, PA 19106 Phone: 215-574-7284 E-mail: Julapa.Jagtiani@phil.frb.org February 9, 2010 Abstract This paper discusses the role of risk management and corporate governance as causal factors in the onset of the financial crisis. The downturn in the housing and mortgage markets precipitated the first phase of the financial crisis in August 2007 when the solvency of a number of large financial firms was threatened by huge losses in complex structured financial securities. Why did these firms have such high concentrations in mortgage-related securities? Given the information available to firms at the time, these high concentrations in mortgage-related securities violated basic principles of modern risk management. We argue that this failure was a result of principal-agent problems internal to the firms and to breakdowns of corporate governance systems designed to overcome these principal-agent problems. Forthcoming in Atlantic Economic Journal (2010) JEL Classification Numbers: G01, G18, G21, G28 Keywords: Financial Crisis, Risk Management, Corporate Governance, Subprime Crisis _________________________ The opinions expressed in this paper...
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...Running head: THE FEDERAL RESERVE AND THE FINANCIAL CRISIS The Federal Reserve and the Financial Crisis Laura Brotherton Strayer University Principles of Economics ECO 100 Professor Isley March 13, 2013 The Federal Reserve and the Financial Crisis Government-sponsored enterprises (GSEs) are financial services corporations established by Congress with the hope of enhancing the flow of credit to certain targeted sectors of the economy making them more efficient and transparent. They also intend to reduce the risk to investors and other suppliers of capital. GSE’s make homeownership more available by injecting liquidity into the mortgage market. The GSE purchases mortgages from banks which provide cash for those banks to make additional guaranteed loans to borrowers. Securitization is a financial practice of pooling various types of contractual debt such as mortgages, auto loans or credit card debt obligations and selling this debt as bonds, pass-through securities, or collateralized mortgage obligation (CMOs) to various investors. Principal and interest on the debt, underlying the security, is paid back to the various investors regularly. The complexity inherent in securitization can limit investors' ability to monitor risk, and that competitive securitization markets may be particularly prone to sharp declines in underwriting standards. Bad mortgage products and practices are a trigger. Moreover, low interest loans allow more and more people...
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