Before the global financial crisis of 2007
Most of the financial institutions in the U.S. heavily relied on increased lending rates and mortgages as a source of revenues. The building of assets on the mortgages was risky, though none of the companies were willing to hear such information. There were very many beneficiaries of the high lending rates and subprime mortgages. Some financial analysts, on the other hand, argued that asset investments at the Wall Street were a bubble that was waiting to burst in the future. In 2006, homeowners started defaulting on their mortgage payments and this is when it started dawning on financial organizations such as Lehman Brothers that the credit crush was a reality (Lewis 56).
Driving factors to Steve Eisman
Steve Eisman was an analyst at the Oppenheimer and Company and was one of the first persons to be involved in mortgage bond securities. Mortgage bonds were debts that were owed by the ordinary Americans and were packaged by financial organizations and sold to various investors. He was initially optimistic about the potential of the industry and would help most companies to get into the market. However, he was alarmed by the poor quality of the bonds and the fact that most of the homeowners had started defaulting on their mortgage payments (Lewis 63). Eisman’s desire to gain high returns in the short-run drove him to take steps to short mortgage-backed securities. Despite the fact that he had predicted about future challenges in the industry, he went ahead with the move.
Role of credit rating agencies
Credit rating agencies are mandated with the role of assessing relative credit risks for various specified debt securities and financial institutions. They tend to serve as intermediaries through the reduction of information costs and the promotion of the liquid markets. Credit rating agencies also provide ratings to the sovereign borrowers and this is essential in that it helps in the mitigation of financial and credit risks. The agencies also monitor the operations of financial organizations with the aim of ensuring that they operate within set regulations.
Reasons for default of the actual mortgages
There are various reasons that led to the default of the actual mortgages. Firstly, financial institutions inflated the rates with the aim of maximizing profits. However, this made it hard for the borrowers to pay back the mortgage debts. Another reason for the high default rates was the penetration of brokers into the market that worked as intermediaries by introducing Credit Default Swaps. With confusion setting in the financial sector, most of the homeowners that were paying their debts started defaulting (Lewis 70). From a bigger picture, the events leading default of the actual mortgages marked the beginning of the global financial crisis of 2007 to 2009.
Impact on assets during the default of mortgages
With the increase in the mortgage default rates, assets were also affected directly. Most of the investors started investing in the Collateralized Debt Obligations but this was only for the short while. As financial crisis set in, asset performance of various organizations around the U.S. was on the decline and this was an indication that things were headed in the wrong directions. Some of the homeowners that defaulted on the mortgage payments were forced to surrender their homes and other assets. Firms such as JP Morgan and Bear Stearns were wallowing in debts by the time the crisis started in 2007. Another reason that led to high default rates was the information that started circulating that some of the financial institutions were offering subprime mortgages (poor quality) to the clients. Subsequently, over 43% of the homeowners, gripped with fears of dealing with poor quality mortgages stopped paying their mortgage debts.
Reasons for lack of predictions
Before the start of the financial crisis, no one had predicted that the housing bubble was about to burst. Most of the investors believed that the future was bright and that they would in the future continue enjoying high returns from their investments. With no indicators in the industry about the possibility of high mortgage default rates as well as a decline in the market performance, most of the investors continued channeling their investments to financial institutions in the form of mortgage bonds (Lewis 72). Subprime mortgages, by then had skyrocketed but financial regulatory bodies such as the Federal Reserve implemented no measures to deal with the situation.
Reasons for taking subprime mortgages
Most people decided to take subprime mortgages because they were offered to individuals with lower credit ratings. Consumers prefer companies that offer affordable products and services. Compared to the actual mortgages, subprime mortgages were cheaper and this attracted several persons to go for them. The financial institutions, in return, increased their lending to the interested parties. Organizations such as Lehman Brothers and Bear Stearns that capitalized on the subprime mortgages initially enjoyed a significant increase in their revenue generation (Tebogo 45). However, with the onset of the credit crash, they were faced with financial challenges to a point of collapse.
Michael Burry driving factors
Michael Burry was driven by the desire to generate profits from the purchase of credit default swaps. Moreover, he wanted to ensure that his investment fund firm, Scion Capital, gained market penetration and enjoyed increased revenue generation. He was an intelligent individual and a former a medical student. However, his passion in finance led him to Wall Street where he owned a successful investment fund. He would bet against the mortgage bonds using the credit default swaps in what are termed to as shorting. By investing in the endeavor, Barry was able to make millions.
Driving factor to Cornwall Capital
Having been founded in 2003, Cornwall Capital had enjoyed market sustainability through investments. The company’s growth was first witnessed when it successfully bet on the capital one financial. Driven by the desire to penetrate the investment industry and at the same time gain a competitive edge in the market over its rivals, the firm incorporated various business frameworks and models (Tebogo 47). Cornwell Capital provided consultancy services to various clients that had doubts on the subprime mortgages that were being supplied by some of the financial institutions. Before the crisis, the company was able to make a fortune of $120 million from the U.S. market (Lewis 65). Cornwell Capital was one of the companies that predicted the 2007 global financial crisis. The different of the company's risks to those of the financial institutions is that it majorly relied on assessing market performance before making an investment.
Credit default swap and asymmetric bet
A credit default swap is form of financial swap agreement where the seller of the CDS is supposed to compensate the buyer in the event of loan default. Usually, the buyer of the swap pays the swap's seller until contract maturity date. An asymmetric bet, on the other hand, happens when the potential upside of a financial or investment bet is higher than its potential downside. Most investors and traders avoid making bearish and bullish bets and instead focus on investing in bets where they will earn high returns both in the short-term and in the long-run.
Discrediting of Wall Street
Events leading to the global financial crisis took place at the Wall Street. The Federal Reserve is a financial regulatory body that was mandated with the role of implementing suitable regulations and measures that were aimed at dealing with all the causes of the mortgage crisis that arose from the Wall Street. However, the regulatory body did little to address the issues. When the financial crisis hit in 2007, the reputation of Wall Street was damaged significantly. Most of the investors pulled out their investments from companies operating in the region fearing that they would end up earning losses (Lewis 80). However, despite being the starting point of the mortgage crisis, Wall Street has never undergone any form of discrediting. The region currently stands tall as one of major America's investment hubs. Most of the financial analysts argue that the global financial crisis would have been avoided had suitable risk management strategies being adopted by companies operating on the Wall Street. Additionally, the Federal Reserve was blamed for its lack of implementing vital strategies that were aimed at thwarting the causes of the mortgage crisis.
Work Cited
Lewis, Michael. The Big Short: Inside The Doomsday Machine. New York: Norton, 2011. Print.
Tebogo, Baitshepi. “The Failure and Collapse of the Lehman Brothers.” SSRN Electronic Journal, 2012, doi:10.2139/ssrn.2060758.
