Readers Question: Assuming that corporate executives are to blame for the current financial crisis, what would be some of the reasons why they are to blame?
The main reasons for the financial crisis include:
- Mortgage companies ignoring ability to pay and taking unreasonable risks in lending high income multiples to subprime customers. Some examples of subprime mortgage lending was definitely wrong. For example, lending people a mortgage where after 2 years the amount to pay back was greater than their total income (see: dangers of subprime mortgages)
- Mortgage brokers even joked about lending to the “ninjas” to whom they lent money – Ninja’s means No Income, No Job, no Assets
- Rise in personal debt before crash. During boom years, high confidence encouraged people to reduce their savings and increase their level of debt. This led to an unbalanced economy based on consumption rather than saving and investment.
- Banks hiding or Being Unaware of the risk inherent in their balance sheets. By getting involved in buying collateralised subprime mortgage bundles, banks took great risks with their balance sheets. They were either unaware of the risk involved in their decisions or ignored the risk assuming the boom would continue.
- Banks reduced their reserve ratios. During boom years, banks reduced their reserve ratios. In many cases, banks borrowed money on money markets to be able to lend profitable loans to firms and consumers. However, when financial system found itself short of money, they struggled to gain sufficient liquidity.
- Gambling other peoples money. The derivatives market was supposed to be a way to help insure the smooth running of financial markets. But, in the hope of making quick profits (and pay bonuses) many dealer took long or short positions on stocks and shares, which magnified their exposure to fluctuations in the market.
How Financial Crisis spread to become European Debt Crisis