The Financial Crisis of 2008 Analysis

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The lack of official oversight and supervision, the widespread but undervaluation of risk, the complexity of the new markets, and the rarely understood of the risk from the investors caused the financial crisis in 2008.

- What reforms should be made to ensure it does not happen again?

There is an inherent risk in the financial market, which is matching of borrower and lender. On the one hand, there are people who need reliable and long-term funds to invest and build their business. On the other hand, there are available funds looking for safe, highly liquid outlets.

In the past, it was commercial banks, insurance companies and savings institutions that absorb the risk. But now, the financial system became much opener and the risk is shifted to those most willing and capable of absorbing them.

So the reform needed to prevent the similar crisis would be enhancing the supervision and oversight on the lenders. They should judge the credit worthiness of a loan in a right way and make reasonable disclosure to the borrowers. For example, the modeling system used by the rating agencies needs to be updated. The old modeling system was based on the past and can’t accurately anticipate in the more complex market. With the updated rating system and results, the lenders will better recognize and determine the value worthiness of a loan.

Also, the reform should make investors aware that they need to be equipped with ability of measuring the nature and value of the credits in their own way. Some regulations should help reduce the amount of investors who concern on short-term gains without reasonable analysis based on the financial statements. In this way, when another wave of irrational investment acts appear on the market, fewer investors would follow without appropriate and critical analysis.

Furthermore, another reform should call people’s attention to the potential risks in the market. When the house price went up quickly before 2006, not even one of the financial authorities pointed out the subprime problem. So in the future, we need to concern more about the risks. For example, the off balance sheet operations of the commercial and investment banks may exist great risks and need more oversight and disclosure.