Retail Financial Products and the Global Financial Crisis
15 Pages Posted: 20 Jun 2012
Date Written: June 20, 2012
The Global Financial Crisis of 2007-2009 wreaked havoc in world financial markets and almost brought down the global financial system. One of the consequences of the crisis is the large number of borrowers currently struggling to repay loans that were advanced to them largely as a result of irresponsible lending.
In the run-up to the crisis a number of factors, such as flawed monetary policy, excessive liquidity and the misuse of financial innovations led to a deterioration of risk controls and standards for the extension of credit, particularly with regard to sub-prime mortgage loans. Financial innovations such as securitisation, structured finance and credit derivatives provided incentives for irresponsible lending, since they allowed loan originators to transfer the risks associated with their loan portfolios to investors in asset-backed securities throughout the global financial markets. The lowering of standards for the extension of credit led to asset price bubbles in several countries, with the most significant of these being house price bubbles in the US and the UK. This was largely fuelled by sub-prime mortgages advanced to borrowers who could only afford to keep up their mortgage repayments if house prices continued rising, thus allowing them to refinance at lower interest rates in the future. When the house price bubbles burst and house prices stopped rising, these borrowers started defaulting in huge numbers and this caused widespread panic in the global financial markets and almost brought down the global financial system.
In the aftermath of the crisis, much of the discussion on how to prevent, or reduce the effects of, future financial crises, has centred on dealing with the risks to the financial system rather than the protection of vulnerable borrowers and users of financial products. The focus has been on improving the prudential regulation of the banks through such measures as increased capital adequacy requirements and the question of how to tackle the problem of large, systemically important banks that are considered too big to fail. In comparison, very little attention has been paid to addressing the consumer protection issues which were thrown up by the mis-selling of sub-prime mortgages to borrowers who could not afford them. This is despite the fact that the default by these borrowers was one of the key tipping points in the unfolding of the financial crisis.
This paper examines the proliferation of sub-standard retail financial products such as sub-prime mortgages and payday loans. It analyses the factors that contributed to the innovation and diffusion of these products. It looks at some of the patterns in the development and marketing of retail financial products for the less affluent members of society. It also explores the effects that the proliferation of sub-standard retail financial products have on the economy, society, communities and the individual users (consumers) of such products. In doing so, it looks at the economic, political, legal and ethical issues that arise with the diffusion of such financial products. It is only through a good understanding of these products and their effects that we can have a meaningful debate on how best to deal with the consequences of the proliferation of such products.
Keywords: subprime mortgages, financial innovation, securitization
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