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Macro Level Resolution Strategies per the Ongoing Financial Systems Crisis of 2008

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Just a few thoughts and possible resolution strategies (in outline format) to consider per the current financial system crisis from a concerned long-term investor, citizen, and voter.  And from an Independent’s perspective, the political players from both parties don’t seem to be focusing on real solutions, just the problems and the resulting finger-pointing (or “blame game”) that occurs.  Note: In terms of presenting a macro causal analysis for this financial crises, private sector lenders issued risky home loans to buyers who could not afford them, which they then sold to Wall Street financial institutions as bundled, mortgage-backed securities that eventually became worthless with the downturn in the housing market. As a result, the heavily leveraged financial institutions became overly susceptible to the collapsing asset class, leading to a liquidity crisis, a disturbance of bank lending, and an overall global contagion.

I. Short-Term Macro Level Strategies to Mitigate Current Crisis (note that some of these strategies are now being implemented in some fashion) –

1). Continued Implementation of timely “lender-of-last-resort” measures by central banks are needed in order to mitigate the current credit crisis before it spirals completely out of control.      

1a). Immediate, large-scale damage-control measures are needed in order to restore the public’s confidence in financial markets and institutions.            

1b). Organized bailout programs by central banks across the globe are needed in order to reduce the overall amount of help and costs involved (i.e., the quicker the better in terms of lowering costs).

2). Aggressive actions required on the part of central banks and governmental agencies in order to mitigate the seizing global credit crisis include the following:

2a). Continued cutting of short-term interest rates and increasing the amounts of loans made available to banks via auctions in order to maintain fluid liquidity levels.            

2b). Force remaining lenders to extend low “teaser” rates on ARM based loans that have been given to sub-prime borrowers.           

2c). Force remaining lenders to restore partial homeowner equity to sub-prime mortgage holders having negative equity in order to forestall the foreclosure rates.           

2d). Continued swapping of Fed funds (e.g., Treasure bills, etc.) for “Level 3” securities from struggling financial institutions in order to provide them with necessary liquidity.            

2e). Permanent providing of emergency loans to the remaining investment banks, with the resulting increase in regulation that should go with it (i.e., like that required for commercial banks).           

2f). The establishment (ASAP) of an organization similar to the former Resolution Trust Corporation of the S&L days to use taxpayer funds to buy out the worst sub-prime loans.  Note: When the current credit crisis finally does ease up, central banks will then need to expedite reverse monetary actions designed to prevent the reintroduction of market speculation using “cheap” money.  

II. Long-Term Macro Level Strategies & Proactive Regulatory Measures –

1). Implementation of  stricter governmental regulations for securitized mortgage loans.            

1a). SEC directed revamping of underwriting standards to reduce the chances that credit risks will be underestimated, which in turn will reduce the overvaluing of securitized sub-prime loans.            

1b). SEC led mitigation of regulatory capital arbitrage attempts in the securitization process by enforcing the maintenance of minimum capital requirements by financial entities.            

1c). SEC led mitigation of “safety net” and risk transfer abuses in the securitization process.

2). Require that mortgage loan originators hold bigger equity positions in the securitized packages and that banks issue “covered” bonds backed by securitized mortgage loans in order to keep the risks on  their balance sheets.

2a). Increase involvement of criminal investigation agencies in the securities arena to mitigate the misrepresentation of the quality of mortgage loans in securities filings by financial entities. 

2b). Implementation of more stringent licensing requirements for mortgage brokers and tougher mortgage lending standards, including enhanced risk management practices by lenders.

2c). Implementation of more stringent disclosure and write-down requirements for financial institutions, as well as an increase in the monitoring of their “capital adequacy”.

2d). Consolidation of the different governmental finance agencies into a financial oversight “super” agency designed to rate sub-prime mortgages and financial securities per their safety levels.

2e). Establishment of well defined roles for the International Monetary Fund (IMF) in terms of its serving as a bailout agent for emerging market countries experiencing financial difficulties.            

2f). Need to mitigate any moral hazard issues that could arise due to IMF intervention (e.g., an increase in risk-taking activities by the governments of the countries being assisted, etc).            

2g). Complete banning of Alternative-A type mortgage loans, which require little or no documentation on a borrower’s wealth or income, resulting in abuses on the part of mortgage brokers.

3). Establishment of new generally accepted auditing standards (new FAS rulings) designed to force financial entities to start valuating their investment instruments (e.g., CDOs) using market based measures rather than their own pricing models, along with the reform of the credit rating agencies.

3a). Mortgage based securities should be strictly booked as “marked to market” from an accounting standpoint instead of “book” value in order to help mitigate the blatant overvaluation of the underlying collateral assets.

3b). Mortgage securities packages should be categorized and split into different “tranches” based on their differing levels of certified risk for both investing and auditing purposes.

3c). Tighter regulation of credit rating agencies (e.g., Moody’s, S&P, et al.) by the SEC and Congress.

3d). Credit rating agency reform acts are needed to mitigate the overrating of tenuous capital structures being passed as investment grade securities &d to enhance agency quality control measures.

3e). Recourse measures should include the suspending of credit rating agencies that continuously propagate inaccurate (“pumped up”) ratings due to the conflicts of interest involved with the issuers.

3f). The compensation method for credit rating agencies needs to be changed from that of being paid by the issuers of structured debt products to that of being paid by investors to eliminate conflicts of interest.

3g). Credit rating agencies should be required to decline credit rating services for exotic types of securities that have no performance records to track.

3h). Credit rating agencies should also be precluded from having exclusive access to non-public investment information.

Agency Note:  SEC chief Mary Schapiro has now called for sweeping industry changes at a roundtable meeting as credit ratings agencies have been thoroughly blasted for not warning about the risks of subprime mortgage securities. Moody’s, Standard & Poor’s, and Fitch dominate the industry: one proposal calls for a governmental ratings agency that would compete with these three firms.

3i). Central banks should have quickly executable, pre-approved contingency plans “in place” for when unexpectedly large write-downs by financial institutions occur in the future.  The immediate availability of liquidity measures and the continued identification of potential merger partners for failing financial institutions is key here.

3j). Tighter regulation of the corporate auditing function by the SEC & Congress.  If necessary, the corporate auditing function may even need to be “nationalized” to become entirely a governmental function in order to eradicate the inherent conflicts of interest that currently exist between corporations & the private auditing/consulting firms that they employ on a high-fee basis (i.e., need to reduce the risk of over-inflated equity valuations based on creative accounting measures, etc).

Note: These macro strategies were initially conceived of as part of my section of responsibility for a group project/presentation in a graduate level finance course at the University of Houston (i.e., FINA 7340 – Financial Markets & Institutions).

Click on URL to link to a recently published NYU Stern working group paper that provides excellent insights on viable, real-time solutions for financial reform:


Written by Larry Fry, CCP, MBA

August 10, 2015 at 12:47 pm

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