Uniform Bank Performance Report - Anderson School of Management

een lost. The investment banking model is gone, short‐term T‐Bills are returning close to 0%, and the
national debt is approaching $12 Trillion. It is clear to see that the financial system of yesteryear was
doing a few things wrong.
To understand the state of the current financial system, it is useful to examine some of the major forces
that have inspired these changes to occur. The most extreme changes to the banking system have
occurred as a result of the financial crisis that began in October of 2008. The following section examines
two of the main causes of the crisis, and shows how weaknesses in the system have affected, and will
continue to affect the modern banking environment.
Examining the Past
Mortgage Backed Securities
The first main factor is the securitization of mortgages to create Mortgage Backed Securities (MBS).
Securitization, in theory, is an ingenious system whereby risky assets can be rearranged to enable more
efficient risk distribution. However, recent history has shown that even in the highly calculated world of
finance, sound theories do not always translate into sound practices. The problem with securitizing
mortgages was that it changed the way risk was distributed among parties involved in the process.
Turning mortgages into MBS is a complicated process that requires the cooperation of many different
parties (i.e. Mortgage originator, investment bank, Ratings Agency). The more complicated a process,
the more likely it is that people will find ways to exploit it. This leads to the root of the problem with
MBS. Due to a lack of planning, oversight, and regulation, inefficiencies in the process of mortgage
securitization allowed individuals and groups to exploit the system for personal gain.
The advent of mortgage securitization turned the mortgage market into a game of hot‐potato. It was no
longer standard practice for loan originators (lenders) to hold loans on their books. Instead, the loans
they made could be sold to banks, which securitized them and sold the MBS to raise large amounts of
capital. This was a great deal for lenders as they were able to reap the cash flows from lending, yet pass
all of the risks on to banks. However, this also created a fundamental risk‐management problem. The
lenders did not have to carry the risk on the loans they made. Therefore, there was no incentive for
them to ensure the creditworthiness of the borrowers. In the years leading up to the crisis, the