The crisis and the future

1654.jpgDecember 2009 | By Manuel Romero, Professor at IE Business School

The subprime mortgages unexpectedly sparked the financial crisis, but the resulting raging fire took hold because there was so much more fuel lying around to add to it. How can we rise from the ashes?

The first thing to be considered is the background to the crisis and the essential causes of it. Perhaps the best example has been the strong sensation of liquidity experienced by all the players on the market, which has led to excessive leverage and a significant undervaluation of the risk associated with excess debt and a significant overvaluation of assets that has given rise to clear consequences that include a lack of coherence and macroeconomic consequences such as negative saving rates in the USA and investment records in China in excess of the GDP. All the market analysts expected the system to break down as a result of macrospeculators such as the hedge funds and the CDS (Credit Default Swaps), but neither of the two originated the crisis.

The origin of the crisis actually came from an unexpected trigger, more specifically, the heavy default produced by ´sub-prime´ mortgages, which were none other than loans awarded to the so-called ´NINJAs´, i.e. people in the USA with no income, no job, and no assets, that had been securitised, which means that those who awarded the loans just sold them on the market, in many cases leaving nothing showing in their balances. One of the surprising aspects is that a market as small as the sub-prime mortgage market was the detonator of this entire situation.