The bonus culture & management incentives in banks were a key factor in the Irish and US Crisis. The system was flawed from the beginning; bankers took risks to get short term bonus, with no regard to long term consequences to the economy. Within the financial system the bonus culture is unique. The banks present a high percentage of it award based on bonus driven remuneration. For the employees of the bank it became a high percentage of their annual salary. This gave bank employees the incentive to offer risky loans and mortgages.
During the boom years from the mid 90’s to 2006 in the U.S. housing market experienced a boom. During this period many mortgages were offered to people who were in the high risk category of defaulting. This was very relevant in the investments bankers took, including in the profile of mortgages they gave out. The culture that evolved was get as many mortgages on the books as possible, even if the recipient of the mortgage was not a sound investment and in many cases had not the wages to cover the mortgages they received from the banking institutions. Ridiculous coverage of 100% mortgages was being issued to folks who could never ever pay back the loan. These customers did not have to go through the normal credit checks, these loans became known as subprime loans. These high risk mortgages were processed as securitisation; this is a financial practice of combining mortgages into one large pool. Most of the pools became mortgage – backed security (MBS) and were traded on the financial markets by firms such as Fannie Mae and Freddie Mac. These MBS delivered high rate of return for the traders increasing their bonus but were not sound investments for the bank. This careless disregard of the compan...
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... to guarantee these banks & their debts, economies & Countries would collapse. Society as a whole could have collapsed. The situation was a loaded gun and the pulling of the trigger started by bankers being greedy by trying to get the biggest bonus and not being regulated when making investments that went bad. See Fig 6 Bank Run Northern Rock
References
1. http://www.un.org/esa/desa/papers/2012/wp115_2012.pdf
2. http://www.theguardian.com/business/2013/feb/28/bonuses-the-essential-guide.
3. http://en.wikipedia.org/wiki/Subprime_lending#Subprime_crisis.
4. http://www.theguardian.com/business/2013/feb/28/european-union-cap-bankers-bonuses.
5. http://www.davidmcwilliams.ie/2013/06/27/how-the-banking-collapse-turned-into-a-dramatic-hostage-crisis.
6. Philippon and Reshef (2009)
7. Crotty (2009)
8. Bebchuk, Cohen and Spamann (2010)
9. (Acharya, 2009).
The Savings and Loans Crisis of the 1980’s and early 90’s created the greatest banking collapse since the Great Depression in 1929. Over half the S & L’s failed, along with the FSLIC fund that was created to insure their deposits.
Leading up to the crisis of the housing market, borrowers got mortgages without understanding the terms. Banks were giving out loans to people the banks weren't sure could pay the money back. The closer to the crisis, the higher the frequency of illegitimate loans and mortgages. Because there were so many mortgages on houses that could not be paid back, millions of mortgages were foreclosed on, and the houses we...
But this time would be different. Henry Paulson stepped in to let Lehman Brothers know there would be no bailout for them. Someone had to fail to set an example for the rest of the banking industry and Lehman Brothers would be that someone. In Paulson’s view Lehman Brothers was guilty of moral hazardous decisions and would not be paid for mistakes made. I find it interesting that Richard Fuld the CEO at Lehman Brothers at this time was Paulson’s chief competitor before becoming Treasury Secretary. Why was Lehman Brothers by the way of Paulson’s moral hazard decision making? They were a large bank and posed greater systemic risk to the overall industry than Bear Stearns. Paulson told Fold to make a deal with another bank or risk bankruptcy. When no deal could be made Paulson told the Wall Street banks to solve the problem collectively since they created the problems collectively. With no end in sight Paulson eventually shelved his moral hazard standing and was forced to make loans to the largest banks in America. Two of the largest companies in the world were United States banks and had lost almost 60 percent of their value. United States banks held nearly 5 trillion in mortgages. AIG alone held billions in credit default swaps and would eventually need nearly 185 billion in government loans to remain in business. AIG famously was deemed too big to fail. The government now controlled the largest insurance company along with Fannie Mae and Freddie Mac the largest mortgage banks on
A majority of mortgage defaults that Americans used were on subprime mortgage loans, which were high-interest-rate loans lent to people with high risk credit rates (Brue). Despite knowing the risks, the Federal government encouraged major banks to lend out these loans to buyers, in hopes, of broadening ho...
Increasing global connectivity and integration in today’s world ensures that almost any serious problem has worldwide ramifications. The global financial system can serve as a key example of this phenomenon. Very recently, Britain’s fifth-largest mortgage lender Northern Rock was rescued by emergency funding from the Bank of England. This made the Newcastle-based firm the highest profile UK victim of the global credit crunch that had been triggered by the sub-prime mortgage crisis in the US. The bank run on Northern Rock that followed was unprecedented in recent UK monetary history. The Overend Guerney crash of 1866 was the last recorded bank run in the UK, before Northern Rock lost over £2 billion, starting on the 14th of September 2007.
The book The Banker’s New Clothes: What’s Wrong with Banking and What to Do About It was wriiten out of necessity after the worst economic downturn in the United States in more than eighty years. The massive breakdown of the United States housing market in 2006 and 2007 had overwhelming consequences on domestic and global economies and devastated the global banking systems. Between 2001 and 2006, many large financial institutions had accumulated large positions in the subprime mortgage market that gave out superb returns. Asset prices in this market inflated to unreasonable levels due to the quality of the loans being packaged and sold by commercial bankers and would soon create a major asset bubble in the markets. The bursting of the housing
Mortgage loans are a substantial form of revenue for the financial industry. Mortgage loans generate billions of dollars in the financial industry. It is no secret that companies have the ability to make a lot of money by offering a variety of mortgage loan products. The problem was not mortgage loans but that mortgage companies were using unethical behavior to get consumer mortgage loans approved. Unfortunately, the Countrywide Financial case was not an isolated case. Many top name mortgage companies have been guilty of unethical behavior. Just as the American housing market was starting to recover from its worst battering since the Great Depression, a new scandal, an epidemic of flawed or fraudulent mortgage documents, threatens to send not just the housing market but the entire economy back into a tailspin (Nation, 2010).
In the article Predatory Lending and the Devouring of the American Dream, the article talks about how subprime mortgages were a booming success in the mid- nineties to the early two-thousands. It was a success because subprime mortgages offered an opportunity for people with bad credit history or people from the lower class of society to actually be able to purchase a home. The only consequences of doing subprime mortgages is that there is a high interest rate which makes paying off the home in a reasonable time impossible. More and more people started to apply for subprime mortgages, therefore, causing a crisis. The crisis was because people could not keep paying on their homes, so foreclosures happened. The percent of people applying and getting approved for subprime loans went up anywhere from seven to eight percent every year which also was a contributing factor in the crisis. The fact that the perfect home went up nine hundred square feet in four years, and eighteen years later was up by eighty-five hundred square feet is just an example of how the American Dream was going up in size but down in value.
•Merrill Lynch, a massive investment back on Wall Street was the starter of the biggest mortgage companies to go wild. Merrill plan was to do a subprime mortgages that would get people to fail on their own toxic products. He knew those debts would stack up and then people would not afford to pay off that mortgage. His plan was to secretly bet against or insuring themselves to fail. Merrill only focused on making more money by doing subprime mortgages. Therefore, the plan was to get mortgages that would not be sustained and redo it into a subprime mortgages. Indeed he would sell them off other corporation that would not question the investment and would more likely not be able to understand the possible risk of buying it. Merrill was doing
In the early 1980’s Wall Street firms recognized that home mortgages could be used to create bond-like products, functioning similarly to bonds issued by governments and corporations. The “mortgage bond” bundled many individual home mortgages purchased from lenders and the income streams from monthly mortgage payments. The bundle was later termed a Collateralized Debt Obligation (CDO) and was sold by investment banks including Goldman Sachs, Merrill Lynch, Bear Sterns, JP Morgan, and Morgan Stanley on the bond market. In later years, banks generated larger profits by creating mortgage bonds for subprime mortgages, those mortgages with substantially higher credit default risk. A dangerous cycle was established as Wall Street banks bought more subprime mortgages, lenders placed more subprime loans, and individuals, enticed by artificially low interest rates during an initial fixed-term interest period, accepted mortgages that they could not
Generally, one can say that there is no single cause that led to the increase in the failed financial institutions in the USA during the period between 1980s and early 1990s. Preceding to the beginning of the crisis, the laws and rules governing the financial markets were changing. The 1980 Depository Institutions Deregulation and Monetary Control Act took out many limitations and restrictions governing the economy and credit unions.
The subprime mortgage crisis is an ongoing event that is affecting buyers who purchased homes in the early 2000s. The term subprime mortgage refers to the many home loans taken out during a housing bubble occurring on the US coast, from 2000-2005. The home loans were given at a subprime rate, and have now lead to extensive foreclosures on home loans, and people having to leave their homes because they can not afford the payments. (Chote) The cause and effect of this crisis can be broken down into five major reasons.
Individuals like the two young and rambunctious mortgage consultants portrayed in the film gave loans to anyone and everyone that could sign the paper, regardless of the recipient’s ability to pay the loan in full. It is doubtful that all consultants fully understood the ramifications of their actions, but undoubtedly the overall disregard for consequence was the start of the collapse. Mortgage consultants mislead and tricked people into loans they could never afford by playing on their desire to live the American dream. Distributing adjustable rate loans to individuals without jobs, without collateral is unconscionable. Unfortunately, from their perspective they were helping these individuals. In a twisted way, these consultants were acting ethically from a utilitarian point of view. The consultants won because they received utility in the form of a bonus for distributing the loans, and the loanee won because they could now afford the home of their dreams. What the consultants didn’t consider in their calculations were the long term results and utility of their actions, unethically building the flawed foundation of the housing
In 2007, the housing market in the United States was booming. Banks were giving out subprime mortgages to buy new houses. “A subprime mortgage is a housing loan that’s granted to borrowers with impaired credit history. Often,
The large banking businesses are in many ways at blame for the current recession. They lobbied for, and got, the relaxation of rules limiting how much debt they could have. By going into greater debt, they could increase their profits. However, this also greatly increases their risks. When the economy began to decline, these companies suddenly were not able to pay back their debts, which made a huge impact upon the economy. This trickled down throughout the entire economy, which relies upon loans and investments to keep working. The government had to step in and passed a “bailout” for these large companies in order to keep the economy from getting worse, but the damage was already done (Labaton).