The financial crisis started in the USA because of subprime mortgage crisis in 2007. As a consequence of it, a credit crunch was originated and it quickly spread from the real state sector to other sectors, and furthermore, from USA to other countries. This caused a series of financial and economic crises like the collapse of housing markets in Europe, the global stock markets, global financial systems and markets, along with a lot of large banks and financial institutions, as (Sun, et al., 2011) explained.
The financial crisis from 2007 has caused the greatest global economy recession since the Great Depression and also the European sovereign debt crisis. The consequences and cost are enormous. Due to this fact, explanations and responsibilities for financial crisis are searched so that the role of corporate governance and financial engineering is set on the spotlight.
The financial crisis has been said to be a case of financial engineering and corporate governance gone wrong. In this paper I will discuss this statement and demonstrate that wrong financial engineering practice and corporate governance effectively caused, or at least in part, the financial crisis.
2. The role of Financial Engineering in the Crisis
The origins of the crisis have been discussed and a number of different causes have been pointed out. According to (Sun, et al., 2011), the roots of the crisis have been identified to be in the preference for deregulating financial institutions and markets, which resulted in the prompt growth of securitization.
Financial engineering allowed a great burst of global derivatives setting the context in which major financial institutions thoughtlessly disregarded risk management and corporate governance. In this context, the rating agencies such as Standard & Poor’s, Moody’s or Fitch in an exercise of irresponsibility encouraged risks instead of managing them. Executive incentives also took part in boosting risk, which illustrates as well the irresponsibility of the companies.
However, the causes of the global financial crisis are rather complicated. On 15 November 2008, (Leaders of G20, 2008) declared that the financial crisis was caused by:
• Market participants seeking higher yields without an adequate appreciation of the risks and failing to exercise proper due diligence.
• Weak underwriting standards, unsound risk management practices, increasingly complex and opaque financial products, and consequent excessive leverage combined to create vulnerabilities in the system.
• Policy-makers, regulators and supervisors, in some advanced countries, did not adequately appreciate and address the risks building up in financial markets, keep pace with financial innovation, or take into account the systemic ramifications of domestic regulatory actions.
• Underlying factors such as inconsistent and insufficiently coordinated macroeconomic policies and inadequate structural reforms which led to unsustainable global macroeconomic...