Title of the Reviewed Article

The Current Financial Crisis: Causes and Policy Issues

I. Full Bibliographic Reference

Adrian Blundell-Wignall, Paul Atkinson and Se Hoon Lee *
1. Adrian Blundell-Wignall is Deputy Director of the OECD Directorate for Financial and
Enterprise Affairs,
2. Paul Atkinson is a Senior Research Fellow at Groupe d’Economie Mondiale de Sciences Po ,
Paris, and
3. Se Hoon Lee is Financial Markets Analyst in the Financial Affairs Division of the OECD
Directorate for Financial and Enterprise Affairs.

II. Introduction:

This article is based on major research presented on Organization for economic co-
operation and development (OECD) conference hosted at Reserve Bank of Australia /2008/
regarding the Financial turmoil at that time. It also includes the views arise from research
presented to non-OECD conferences, and the discussion it generated.

The purpose of this article is Describe the Financial crises that happened manly in western
countries 2004-2008 , the underline causes and policy issues.

III. Statement of the problem

The 2004 2008 financial crisis as being caused at two levels by by global macro policies
affecting liquidity and by a very poor regulatory framework that, far from acting as a
second line of defense, actually contributed to the crisis in important ways.

“The policies affecting liquidity created a situation like a dam overfilled with flooding
water. Interest rates at one per cent in the United States and zero per cent in Japan,
China's fixed exchange rate, the accumulation of reserves in Sovereign Wealth Funds, all
helped to fill the liquidity reservoir to overflowing. The overflow got the asset bubbles and
excess leverage under way. But the faults in the dam – namely the regulatory system –
started from about 2004 to direct the water more forcefully into some very specific areas:
mortgage securitization and off-balance sheet activity. The pressure became so great that
that the dam finally broke, and the damage has already been enormous. “

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The Current Financial Crisis: Causes and Policy Issues

“relatively independent factors changed and caused endogenous things to happen – in this
case the biggest financial crisis since the Great Depression.”

IV. Specific objectives

1. Describes Origins and causes of the crisis1
2. Describe the measures taken by the governments in solving bank insolvency
3. Describe the Exit strategy & long-term reform
V. Qualitative data are used in the article

VI. Study design- setting - data collection

A descriptive type of study is conducted by using data’s collected from Historical economic
events in the subject matter. The research used convenience sampling method where by Banks
and Firms found in Europe and United states of America are purposive selected.

There were two distinct phases to the study as mentioned in the Article; preliminary research
phase and the research phase. The initial phase “original” research by the Authors are presented
at the OECD Conference at Australia /2008/, reflections and professional viewpoints at that
conference and other Non-OECD presentations are considered to enhance the document.

VII. Confirmatory Data Analysis (CDA) Method is used to analyze facts and information
collected from the sample Banks and business firms.

VIII. Findings

To researchers organized the findings of this descriptive research under the identified three
broad categories

VIII.1 The crisis originated from the distortions and incentives created by past
policy actions
“ For example, rating agency practices would be causal if in 2004 agencies developed
new inferior practices that triggered events; in fact they were only accommodating
banks’ drive for profit as the banking system responded to other exogenous factors.”

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The Current Financial Crisis: Causes and Policy Issues

VIII.2 The Four time specific factors came into play in 2004 in 2004 caused banks to
accelerate of f balance sheet mortgage securitization
A. The Bush Administration ‘American Dream’ zero equity mortgage proposals
became operative, helping low-income families to obtain mortgages;
B. Office of Federal Housing Enterprise Oversight (OFHEO), imposed greater
capital requirements and balance sheet controls on those two government
sponsored mortgage securitization monoliths, opening the way for banks to move
in on their ``patch'' with plenty of low income mortgages coming on stream;
C. the Basel II accord on international bank regulation was published and opened an
arbitrage opportunity for banks that caused them to accelerate off-balance-sheet
activity;
D. the SEC agreed to allow investment banks (IB’s) voluntarily to benefit from
regulation changes to manage their risk using capital calculations
- The combination of these four changes in 2004 caused the banks to accelerate off-
balance sheet mortgage securitization as a key avenue to drive the revenue and the
share price of banks.
VIII.3 Greater capital requirements and balance sheet controls on Fannie and
Freddie imposed by OFHEO, banks that had been selling mortgages faced revenue
gaps and an interruption to their earnings.
- Their solution was to create their own Fannie and Freddie look-alikes: The
Structured Investment Vehicles (SIVs) and Collateralized debt obligation (CDOs).
VIII.4 Banking began to mix its traditional credit culture with an equity culture.
The previous model, based on balance sheets and old fashioned spreads on loans, was
not conducive to banks becoming “growth stocks”. So, the strategy switched more
towards activity based on trading income and fees via securitization which enabled
banks to grow earnings while at the same time economizing on capital by gaming the
Basel system.
VIII.5 Basel II published in 2004 make Mortgages more attractive
During this time banks operate based on the “portfolio invariance” - the riskiness of an
asset like a mortgage is independent of how much of the asset is added to the portfolio.

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The Current Financial Crisis: Causes and Policy Issues

VIII.6 The aggregate results on the sudden acceleration of subprime leverage

The period in which Basel II was anticipated and arbitraged and the Fannie and Freddie
controls were in play, banks were able to accelerate RMBS using lower quality mortgages.
Much of the problems now known as the subprime crisis can be traced to these securities.
According to the authors of this article , Mortgage securitization in subprime was more
pronounced in the USA,
VIII.7 Poor Corporate governance played a role in the crisis.
However, Banks without IB's perform relatively better because; the culture of investment
banking is much harder to control from the board room

IX. Conclusions

In thinking about policy, the Reserve Bank conference discussion focused on addressing bank
solvency in a crisis and the longer-term requirements of reform.

The Article have identified three basic stapeses to deal with a banking system solvency crisis:

1. Guarantee liabilities…
2. Separate good from bad assets /Asset Relief Program (TARP) program/
3. Recapitalize the asset-cleansed banks by finding new equity holders.
4. Removing the bad loans from the banks as a precondition for recapitalization
- Lessons of the Japan banking crisis /The Japan banking crisis led to repeated policy
rescue packages from 1996 to 2004/
Recapitalization becomes a moving target; if loan problems worsen, leading to more write-downs
of asset values, further injections are required to avoid a credit crunch.

X. Recommendation

The Authors of this Article recommended the Policy considerations that stake holders that stake
holders need to emplement for as an exit strategy and long-term reform

There are 3 interrelated areas that will need attention as emergency measures need to be
relaxed and removed.

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The Current Financial Crisis: Causes and Policy Issues

1. Reforming the incentive systems that gave rise to the crisis in the first place.
2. Matching the regulatory influence on the cost of capital to the risks that institutions
actually take.
3. Exiting from government bank ownership and insurance commitments through asset
sales and debt management techniques.

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