Explain how the EU and the US coped with the recent financial crisis.
During the last several months we have witnessed one of the most trying times for financial markets in several decades, perhaps since the 1930's Great Depression. The originators of lower quality mortgages in the United States had strong incentives to meet a constant and, indeed, increasing demand for securitized products of some form or another. There was little incentive to originate good loans or monitor the borrowers' creditworthiness. Additionally, the high demand for other types of structured credit products, such as those formed from commercial real estate, leveraged loans, and some other types of consumer credit, meant that these sectors also witnessed weakened credit standards.
Lessons from the private sector:
Originators need to be "incentivised" to make loans to high-quality borrowers and to monitor loan performance more carefully.
The US federal bank regulators have issued tighter guidance over how riskier mortgage borrowers are to be qualified for loans. As a result, hybrid subprime loans with teaser rates are no longer being made.
The governance structure of the risk management system needs to be improved in financial firms in which the incentives are biased toward returns rather than the risks involved in attaining them.
The incentives to use credit rating agencies and the incentive structures within credit rating agencies themselves need to be re-examined
Investors need to perform their own due diligence and ask the right questions about the riskiness of the securities they are purchasing.
Lessons from the public sector:
There is a need to refine the regulatory framework to avoid distorted incentives.
Supervisors and regulators need to have the incentives and resources to look hard and deep at possible flaws in the risk management systems of the institutions they oversee.
How to cope with the outcomes of crises of this new type?
Bank resolution and deposit-insurance frameworks need to be strengthened and interagency...