Recent Global Financial Turmoil and Available Financial Regulations/Complaince/Controls and Future

From the past several months, world is watching financial markets, sharpened concerns about credit quality induced a retrenchment by investors, leading in some cases to significant deterioration in market functioning.

It is the sub-prime crisis. I remember one MBA student narrating how one of his friends reacted when he was asked on "sub prime" in a placement interview.

Interviewer: What is "Sub prime"?
Student: Tells every thing about sub prime crisis. Interviewer was patiently listening all his “gyanbhari batein”.
Interviewer: I asked what is "Sub prime"? Not "Sub prime crisis".
Student: Silent for few secs and suddenly show reflection of brilliant idea coming up and says "It is a form of loan".

Then the interviewer said have you heard any about Sub prime lending?

So it obvious that everyone knows about crisis but not about the origin and what is crisis is for?

We say it “near-prime” “non-prime” or “second chance” lending or anything other than Prime…. huh …. This financial term involves financial institutions providing credit to borrowers deemed "sub prime" or "under-banked”.



The culprit goes here.  Sub-prime might also refer to a security for which a return above the "prime" rate is received, sometime also named as C-paper. Sub-prime lending started with the demand in the marketplace for loans to lesser ideal customers, those with imperfect credit. I don’t know for what greed many companies without proper credit value analysis and market / capital projection of assets, entered the market when the prime interest rate was low, allowing modest sub-prime rates to flourish. Many others entered with the relaxation of usury laws. Here Traditional lenders did right thing which these biggies failed to foresee, by becoming more cautious and historically turning away potential borrowers with impaired or limited credit histories. Around 25% of US population was bucketed into this category. In 1998, the Federal Trade Commission estimated that 10% of new-car financing in the U.S. was provided by sub prime loans, and that $125 billion of $859 billion total mortgage dollars were sub-prime.

But forget it; Institutions were over-optimistic on getting return on these sub-prime loans.

Anyways, here I would like to move further with the question when we were having financial regulations like SOX, Basel II then how come this happened? Sarbanes-Oxley Act, is this really followed and worth full considering current Financial Crisis? Is SOX being followed? Many Financial companies are going bankrupt even after they've implemented "SOX", which is intended to put strict guidelines on financial reporting system. How both this are correct at the same time? Where is the latent gap?

I asked these @ linkedin
http://www.linkedin.com/answers/finance-accounting/financial-regulation/FIN_FRG/340221-23986393?searchIdx=0&sik=1224065697723&goback=.asr_1_1224065697723


SOX which is basically designed to ensure accuracy of financial reporting and disclosures and in the current meltdown when collateralized debt obligations (CDO) were bundled and sold to common investors the underlying assets were correctly valued. However, there was subsequent deterioration in the underlying value of the assets which has resulted into meltdown. The scope of work for SOX is on the risks and related controls over a material misstatement, not over everything

Hence, the current meltdown could not have been detected /prevented due to SOX or compliance to relevant accounting standard. This could have been prevented by more stringent regulatory framework which does not allow non prudent leveraging of the bank asset!

But this is not so straight forward, Collateralized debt obligations (CDOs) are an unregulated type of asset-backed security and structured credit product which are constructed from a portfolio of fixed-income assets.

Problem arose when these assets were divided by the ratings firms that assess their value into different trenches: senior trenches (rated AAA) etc with very high value without proper evaluation. Blame it to credit rating Agencies while valuing the product. Few institutions buying CDOs lacked the competency to monitor credit performance and/or estimate expected cash flows. CDO products were held on a mark to market basis later it resulted to the paralysis in the credit markets and the collapse of liquidity in these products. These in line led to substantial write-downs in year 2007. Major loss of confidence occurred in the validity of the process used by ratings agencies to assign credit ratings to CDO trenches and this loss of confidence persists into 2008.

SOX could have never controlled this crisis, but this opens the arena to discuss the fawls in the existing financial regulations and need to either appends some more controls by increasing the scope of SOX or by bringing new regulation / legislation or compliance with checks CDOs, or S&L (Savings and Loan) or SIVs (Structured investment vehicle).