Role of Securitized Lending and Shadow Banking in the 2008 Financial Crisis

THE ROLE OF SECURITISED LENDING AND SHADOW BANKING IN THE 2008 FINANCIAL CRISIS
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An economic crash has significant effects because its impacts extend beyond the financial sector. It harms both the economy and its citizens. One lesson of the 2008 scandal was that shadow banking outside the conventional banking system poses a risk to the financial instability of a country (Huang, 2018). The failure of several shadow financial institutions aggravated the crisis, such as the insurance company American International Group, investment bank Lehman Brothers, and the General Electric Capital finance company. Shadow banks fuelled the global financial crisis by developing subprime mortgages, organising them into Mortgage-Backed Securities (MBS), and distributing them in the financial market (Nijs, 2020). In essence, "too big to fail" is a perceived problem that could lead to systemic risks regarding complex financial bonds, regardless of traditional or shadow financial institutions. This write-up will explore the global financial crisis, shadow banking concerning the 2008 financial crisis, the collapse of AIG, and the failure of the Lehman Brothers. The paper will also discuss securitised banking and the repo market. Lastly, the write-up will explore the FBS recommendations and the responses to curb the reoccurrence of a future financial crisis.
The Global Financial Crisis of 2007-2008
Since the Great Depression of 1929, the financial crisis of 2008 recorded the second most severe global economic crash. Financial institutions incurred severe damages leading to the bankruptcy of some firms, such as the Lehman Brothers, and a subsequent global crisis. The crisis resulted in other economic breakdowns, including the Icelandic financial crisis of 2008-2011 and the 2009 European debt crisis (Gilreath, 2017). While the causes of the global economic crash are not clear, the main contribution was the crush of the U.S. housing bubble and the subsequent turmoil resulting from missed payments and the repurchase of mortgages by investors. According to the Financial Crisis Inquiry Commission report, the crisis was avoidable were it not for various factors that came into play (Cecchetti, 2018). They include inconsistent action and ill preparation of crucial policymakers and government regarding the financial system, deregulation of credit default swaps, widespread failures in financial regulation and supervision, and systemic breakdown in ethics and accountability.
Other factors include the collapsing mortgage securitising pipeline and mortgage lending standards, failures of credit agencies to correctly price risks, dramatic failures of risk management and corporate governance, and a combination of risky investment, risky borrowing, and lack of transparency. Securitisation contributed to the growth of subprime mortgage lending. Banks came together, took thousands of subprime mortgages, and sold them in capital markets as securities to pension and hedge funds (Hament, 2009). The securities consisted of Mortgage-backed bonds that entitled the purchasers to a share of principal payments and interest on the loan borrowed. In this essence, sell...