Publication Date

2-6-2009

Description

Global financial meltdown that started in August 2007 had its origin in the United States. A combination of easy monetary policy, rapid economic growth, rising asset prices, low interest rates and financial innovation created conditions whereby the American dream of a home for everyone became almost a reality. As the creditworthy and deserving borrowers had saturated the mortgage market the lenders took excessive risks by moving down the curve to provide subprime mortgages to otherwise suspect borrowers. The banks themselves originated the loans but did not keep them on their balance sheets as they bundled them and sold them to other financial institutions or kept as off-balance sheet items such as Special Investment Vehicles. In a rising asset price scenario there was hardly any problem either for the borrowers or the lenders but when the housing prices started dropping the same mortgage backed securities began to lose their values. International accounting standards demanded the assets to be marked to market and the banks were hit first. But the damage was controlled as the banks were able to offset their write downs by raising capital from Sovereign Wealth Funds which were flush with liquid funds collected from the windfall gains of oil and commodity price hikes. But the loss in values was not limited to the banks alone but had a cascading effect throughout the financial markets across the globe that have all, by now, gotten interconnected through the forces of financial integration. As financial innovation accelerated and became more sophisticated the opacity also became more pronounced and it became difficult to know where the ultimate risk was residing. Financial institutions of all sorts were holding assets with complex risks characteristics which they could not fully comprehend.

Notes

Chief guest’s key note addressed at the Seminar organized by Institute of Cost and Management Accountants (ICMAP) held at Karachi on Feb. 6, 2009

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