Tuesday, February 10, 2009

Lessons from the sub-prime crisis

On Tuesday, the US senate passed the $819 billion economic stimulus bill, the second of the rescue package for the drowning US economy. Other governments have also come up with/are coming up with such measures to counter the financial crisis.

Even while issuing such packages, neither the US senate nor the other governments across the world can say with certainty that the financial crisis will be harnessed with these. Such is the size of the crisis and one might wonder how can we ensure that a crisis like this won’t happen again? What are the lessons learnt from the financial crisis?

In the case of sub-prime securities, risks were often under-estimated due in part to product complexity and over-reliance on quantitative analysis, including by rating agencies. Thus early detection and cure, which would have reduced the spill over effects of the crisis, didn’t happen in this case. Financial institutions were trying to cover up their losses till the last moment. The failed ones got uprooted in no time.

A major factor that contributed to the crisis is the use of standard risk assessment models used by risk management professionals by which they underestimated the systematic nature of risks. To put it in simple words, if everyone uses the same techniques, every one will be affected by the same issue. Independent assessment of risks using custom developed models would be one of the key lessons to be learnt from the crisis.

Derived from, Financial Risk Management: Lessons from the Current Crisis ... So Far

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- US Sub-prime Crisis

2 comments:

PENNY STOCK INVESTMENTS said...

Theirs always some crisis around very corner.

Disability Insurance for Dentists said...

Interesting story.