Summary
The 2007 credit crisis that originated from the subprime mortgage in the USA led to far flung effects to the financial institutions in the country and other markets abroad. The bubble that grew through periods staring from 2000 in the housing market as investors pumped in money expecting good returns fast enough. It is the returns that motivated investors to pump large sums of money in expectation of profits reap offs.
The desire for martgage providers to sell the houses overrode need for assessing ability of requestors to repay the loans. Securitization of these mortgages were done using advanced credit instruments and derivatives, some of which were erroneously rated. Procedures of assessing the loans were ignored and all that mattered was for investors to provide loans into the mortgage market to finance the loans for home buyers. Even the property assessors were at times pressured by lenders to “overvalue” property, which they did, meaning more money for the property. The reality was that the houses in most cases of poor conditions but the money lent had to be repaid by borrowers who were also not able to pay.
To avoid such risks in future, there is need to improve ratings of mortgage loans and assessing borrowers before advancing loans to them. The author suggests use of models that have stood test of time rather than using risky derivatives. But of even more importance is use of risk assessments tools and accounting procedures that comply with international standards.
Implications of the credit crisis to financial risk managers in international business
Securitization is essential when it is done with the right procedures that are approved and tested through time. One of the main reasons that contributed to the crisis is failure to regulate the accounting and risk assessment procedures. There is need to assess booms and bursts cycles and learn lessons to avert possible repeats of the same.
International financial managers need to assess loans that are provided to borrowers are backed with the right securities. This includes correct valuation of assets and ability of borrowers to meet repayment obligations. Procedures used in the assessment need to conform to internationally accepted standards, and if not, they need to be harmonized for consistency and credibility. Such regulations need to include regulations that control liquidity level in financial institutions.
International risk managers should also use enterprise risk management to identify the source as early as possible before the risk spirals to irrevocable levels. Each company should use this tool and obtain facts about overseas institutions before partnering with companies using unorthodox risk and accounting measures. With this information, it is possible to warn other companies of the risk. Even with models, the managers should have enough information regarding liquidity of the institutions, accounting and all underlying assumptions considered while compiling reports.
Conclusion
Financial risk is contagious and has deleterious effects to world economy. This is because world economies are interconnected and dependant in several ways. The deeper the integration gets, the greater the need for risk managers to use advanced models of assessment to avert possible risks in future. A historical check on history of bubbles and bursts reveal almost similar trends that should provide invaluable lessons in risk management. More stringent risk measurement tools should be developed and applied to identify nationally and even more assessment before investing across borders.