The financial crisis has been a topic of great interest to many due to the impact of the crisis to both developed and developing countries. The local origins of the crisis were subprime mortgages and credit crises in the U.S. and Western Europe but the effect spread to the rest of the world.
The effects of the crisis have been both severe and long term. The Wall Street in New York is currently under siege by protestors and the credit rating for some European countries has been downgraded. We have also seen the financial sector for some countries heavily impacted by the crisis to the brink of collapse.
Due to the impact of the financial crisis, I embarked on a visit of the United States for the 2010 Women’s Leadership Programme under the Eisenhower Fellowship for a seven week study of the financial crisis which provided an opportunity to interact with leaders in the private and public sector and discuss the cause of the financial crisis, the response to the crisis, and crucial lessons that can be shared with African countries.
Under the Fellowship, we had developed a structured programme which covered visits to key stakeholders in the financial crisis which includes regulators, accountancy bodies, investment banks, universities, researchers, economists and government officials in different states. In a series of articles over the next few weeks, I will share my journey through the financial crisis as well as discuss the lessons that we can learn from the crisis.
My first visit was to two Federal Reserve Banks in Philadelphia and Texas where I met senior officials in bank supervision. The financial crisis had been building up for several years and was pushed by a focus on home ownership which increased the demand for mortgages. At the same time, there was excess availability of funds as a result of the surplus balance of payment and increase in savings in foreign markets. This coupled with the low long term interest rates by Federal Reserve Banks mainly to stimulate investment resulted in excess availability of funds for investment and a demand for higher interest rates.
Mortgage backed securities and other derivates were developed by the investment banks as a solution for investors looking for higher interest rates and to provide banks with additional funds or capital for on lending. This resulted in the development of complex financial instruments and subprime loans without a proper regulatory environment.
The subprime loans eventually resulted in borrowers defaulting in repayment. The default by borrowers made it difficult for banks to repay their obligations to investors and the housing bubble made it difficult for the banks to recover their funds through sale of property resulting in the financial crisis which spread to the rest of the world. Africa too was not spared and has been indirectly affected by the crisis. What are the lessons that we can learn from the crisis?
For regulators, who may include central banks and capital market authorities, the main lesson is that there should be adequate regulation in place for loans and financial innovations. An early warning sign would be the aggressive growth of mortgage, loan products and financial innovations at a pace much faster that we can regulate. There are also lessons that can be learnt by other stakeholders including credit rating agencies, accountants, investment banks and commercial banks. In the coming weeks, we shall explore the role played by each of these stakeholders in the financial crisis and the lessons we can learn.
The author is a Senior Manager PwC Rwanda