The Subprime Crisis of 2008 occurred because of the excessive number of credits that were provided to individuals who could not affirm their solvency. The mortgage-backed securities were massively sold to third parties, investment banks in particular. Lehman Brothers were one of the largest investment banks in the US, but mortgage-backed securities exhausted their capital and led to bankruptcy. Meanwhile, Goldman Sachs and Morgan Stanley decided to continue their operations as commercial banks, “suggesting that such business model is more resistant to the crisis than that of investment banks” (Fang et al. 595). The Subprime Crisis affected the performance of most financial institutions within the US and outside the country.
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The lack of proper risk assessment was among the major reasons that caused this crisis. The events of 2007 and 2008 have revealed crucial deficiencies in the risk models of many corporations. In some cases, risk models fail because of the known unknowns. During the crisis, the collapse of risk models occurred because of unknown unknowns, including regulatory and structural changes in the capital markets. Apparently, the risk was primarily assessed within the theoretical perspectives, while practical scenarios should have been tested. Insufficiency of stress tests resulted in a poor understanding of the outcomes when numerous credits were issued. Nevertheless, the flawless risk models cannot guarantee major losses.
The collapse of many financial institutions in the US caused the global financial crisis in 2008. American investment banks’ failure also resulted in the outflow of money from the developing markets in the rest of the world. Such events encouraged to overview of the efficiency of the unipolar monetary system within the global financial market. Furthermore, events of 2008 depicted that the risk management models must be more sophisticated and include stress tests.
Fang, Hao, et al. “Impact of the Subprime Crisis on Commercial Banks’ Financial Performance.” Panoeconomicus, vol. 60, no. 5, 2013, pp. 593-614.