Examining Major Banks Involvement In Sub-Prime Securities

In times of roar the attractive force of high returns being offered on the subprime related securities induced the investing Bankss to put to a great extent in extremely rated subprime securities through investing financess such as “ Structured Investment Vehicles ” and Hedge Funds. In the effect of an addition in the default hazard of the mortgage related assets and the early symptoms of the crisis, the investors started to deliver their capital to such an extent that the establishments such as BNP Paribas and Bear Stearns who originated these financess had to halt backdowns and disallowed salvations from their investing financess. These establishments justified their move by reasoning that they could n’t “ reasonably ” value their retentions after the U.S subprime mortgage losingss roiled the recognition markets. BNP Paribas while holding backdowns from three of its investing financess stated that “ the complete vaporization of liquidness in certain market sections of the U.S securitization market has made it impossible to value certain assets just irrespective of their recognition evaluation ” – ( Boyd,2007 ) . In my sentiment there is no justification of halting backdowns or salvations simply on the land that in the absence of liquidness they can non “ reasonably ” value the assets of their investing financess. As discussed in the old subdivisions, the just value accounting regulations define a three degree hierarchy and in the absence of liquidness the coverage entities are non bound to follow the market monetary values. In a state of affairs where there is no liquidness the coverage entities can value their assets based on their ain premises and theoretical accounts known as level-3 ( grade to pattern attack ) .Brunnermier ( 2009 ) observes that the Bankss ‘ plus retentions were progressively being financed with short term adulthood instruments. As the Bankss were funding their investings with short term adulthood instruments one has a valid ground to believe that the halt in backdowns and salvations was chiefly due to the fact that the ill-liquid markets and these backdowns and salvations posed serious fiscal troubles for these really establishments instead than holding jobs in just rating of their assets.

Reacting to the jobs faced by the investing financess their conceivers tried to bail them out by supplying warrants and secured loans. However, by making so the conceivers efficaciously assumed the hazard and assets of their investing financess. ( Laux and Leuz 2010 ) . This action program can merely turn out to be utile in a state of affairs where it is believed that assets are being traded at discounted monetary values, may be due to some market deformations, and the bailing party is financially self sufficient plenty to retain the assets until the clip the monetary values lift up to their cardinal values. But in a state of affairs where the conceivers of the investing fund themselves are mostly reliant on short-run financess, there is a great opportunity that these conceivers may besides set down in similar problems as their originated investing financess.

In response to rapid impairment of the creditworthiness of the structured finance merchandises such as the “ ABS CDOs ” the evaluation bureaus started to badly down grade the recognition evaluations of these merchandises on a monolithic graduated table. It is deserving adverting here that more than eleven thousand of the downgrades affected the securities that were antecedently rated as “ AAA ” -the highest evaluation awarded to any security ( Benmelec and Dlugoze 2009 ) . Following monolithic downgrades by the evaluation bureaus the uncertainness among the investors started to increase. For case in June 2007, following the evaluation downgrades two of the hedge financess originated by Bear Stearns faced jobs run intoing the border calls which led Bear Stearns itself to shoot $ 3.2 billion in secured loans in order to keep its repute ( Brunnermier ) , but on 17th July Bear Stearns disclosed that two of its hedge financess are about valueless and later these financess filed for bankruptcy. Furthermore there were turning concerns among the investors that Bear Stearns someway misrepresented the information when they asked that whether they should remain in or go forth the fund ( Gasparino, 2007 ) . It would be deserving adverting here that Bear Stearns was besides sued by Barclays for fraud and misrepresentation by consistently concealing losingss in one of its financess ( Clark 2007 ) .

To look into the function of just value accounting it is deserving to analyze as to what happened with the outstanding investing Bankss Lehman Brothers, Bear Stearns and Merrill Lynch who could non keep their being during the crisis and were either sold to other Bankss or filed for bankruptcy. All the three investing Bankss became the victims of bank tallies and faced liquidness jobs. They were unable to procure support through different channels for illustration the repo market and they had to fight with increased collateral demands but unluckily they could non last at the terminal. They besides tried to sell their assets and besides raised new capital but ended with losing their being. It is deserving adverting here that Bear Stearns and Lehman brothers were unable to last in malice of run intoing their regulative capital demands. ( Morris and Shin 2008 ; Brunnermeier 2008 ; Amel-Zadeh and Meeks 2010 ) .

It is hard to believe that a different set of accounting regulations would hold helped the investing Bankss to keep their being or their jobs would hold been less in this crisis. Although describing assets utilizing a different set of accounting regulations for illustration historical cost accounting, the fiscal statements of the Bankss would hold been insulated from the predominating market conditions and the subprime losingss but at the same clip the anxiousness and uncertainness among the investors would hold been much more. The investors cognizing the bank ‘s exposure to the subprime related securities and the subprime mortgage default rates would hold been left to their ain premises and theoretical accounts to gauge the possible losingss being incurred by the Bankss on subprime related securities and their trust on information provided in the Bankss ‘ fiscal statements would hold been really less which would hold resulted in more backdowns and salvations therefore making more liquidness jobs for them. In add-on to this the investing Bankss and the investing financess being mostly funded by short-run debt, redeemable financess and holding a large ball of collateralized understandings in their plus portfolios have to regularly find the predominating market or “ just ” values of the assets they hold ; hence for these really entities, the finding of just or market values of their assets is more of import than merely following with the accounting regulations. Therefore in nutshell it is hard to believe that the write offs or fair-value accounting played a major portion in the ruin of the investing Bankss or the investing financess holding significant exposure in subprime related securities.

It is deserving to look into another possible issue which might be raised as an statement proposing that just value accounting contributed to the jobs of the investing Bankss keeping a large ball of subprime related securities in their plus portfolios. It can be argued that the losingss reported by the investing Bankss under just value accounting model were abnormally immense and were merely a consequence of distorted or frozen markets. In other words this statement suggests that the values of the assets reported on the Bankss ‘ balance sheets under just value accounting model were much less than their cardinal value. In order to look into as to what extent this statement is justified it is deserving to hold a expression on the events which took topographic point during the crisis. Probe of the events during the crisis clearly rebut this statement and convey us to the decision that the values of the assets reported on the Bankss ‘ balance sheet were overstated when compared with their market worth and the losingss recorded by the Bankss were significantly understated. For case David Einhorn ( a hedge fund director who had a stake on Lehman Brother ‘s portions ) while knocking Lehman ‘s accounting techniques in a address said that losingss reported on the house ‘s mortgage portfolio were non realistic. He argued that in malice of the fact that the mortgage backed bond index has fallen by 10 per centum in the first one-fourth, Lehman has merely recorded a loss of three per centum on its $ 39 billion commercial mortgage-backed securities portfolio ( Onram, 2008 ) . Another of import event that occurred during the fiscal crisis was when Merrill Lynch sold its $ 30 billion of Collateralized Debt Obligations ( CDOs ) to Lone Star financess for merely $ 6.7 billion dollars. The trade resulted in a pretax loss of $ 4.4billion and the sale monetary value of the CDOs was merely 20 two per centum of their book value ( Keon and Harper,2008 ) . This really event may hold farther shaken the investors ‘ assurance and contributed in increasing the terror in the fiscal markets.