RiskTech Forum

SAS: Unpacking the Financial Crisis

Posted: 27 March 2009  |  Source: SAS

In September 2008, the subprime mortgage crisis emerged as a global economic crisis that rocked the world’s financial system and triggered responses from governments of many countries. On October 3, 2008, the Emergency Economic Stabilization Act of 2008 was signed into law to provide for a troubled asset relief program (TARP). Under this program a $700 billion liquidity pool was made available to purchase or insure any troubled assets and to cover any administrative and custodial expenses associated with purchasing, insuring, warehousing and selling those assets.

Government officials felt tremendous pressure to take swift action because they feared that the global financial system might collapse. However, the global financial markets have remained unstable with elevated systematic risk indicators, despite some significant financial market adjustments through a series of interventions carried out by the US Department of the Treasury and the Federal Reserve System. According to the Global Financial Stability Report (GFSR), the International Monetary Fund (IMF) estimates that losses on US subprime assets and securities will total $1.45 trillion — more than 59 percent above April 2008 estimates of $945 billion.

The crisis has caused the US economy to continue to shrink. On October 30, 2008, the US government confirmed that the gross domestic product (GDP) declined at an annual rate of 0.3 percent in the third quarter, the largest contraction in seven years, while consumer disposable income declined 8.7 percent, the biggest drop on record.

Based on these and other facts, it is entirely possible that the $700 billion initial allocation will prove insufficient to accomplish what is needed. The fact is that financial firms face simultaneous pressures posed by a reduction in assets, difficulties in raising capital and challenges associated with implementing new business models. Hence, it is vital that we first seek to understand what is going on (that is, what caused the crisis, who played an active role in bringing it about, and what processes and controls failed to prevent it from reaching its enormous scope and scale). Failure to define a problem fully before solving it can result in flawed strategies that waste precious time and resources.

In the business world, we call these “Ready, Fire, Aim” strategies. Only too often, they occur when there is never sufficient time devoted to fixing things right in the first place, but always enough time to repair them over and over again.

It is in this spirit that we devote this paper to surveying various opinions concerning the causes of the current financial crisis; its impact, consequences and implications; and, finally, the role of loan underwriting, which we see as being at the core of the problem.

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