How GRC tools can prevent the next financial crisis
The financial crisis that started in 2007 sent the markets into turmoil. People lost homes, jobs, retirement funds, and more. Businesses collapsed or faced losses throughout the world. It remains the worst global financial crisis in the previous few decades. The crisis exposed the vulnerabilities of our economic systems. Once these vulnerabilities were clear governments and businesses around the world started looking at ways to prevent a similar economic crisis in the future.
photo Gerd Altmann via pixabay
The 2008 Financial Crisis was preventable
A little bit of research will reveal a frustrating fact – the crisis which cost so many people their livelihood and bankrupted so many businesses could have easily been avoided. There were even people trying to raise alarm bells about the financial crisis, but no one heard them or took them seriously. The reason? Lack of any GRC tools. It may seem preposterous, that some tools could have prevented a crisis that engulfed the whole world, but that is exactly what happened.
We all know that the housing market caused the economy to collapse. Let’s look at what went wrong. Lenders had a simple assumption – housing prices will keep going up forever. This may seem like a bold presumption, but they did have a good reason to believe that real estate would keep getting more expensive. Housing prices had been going up for almost 80 years. After the great depression in the 1920s real estate values kept going up in America. The same was true for Europe since WW2. The destruction caused by WW2 affected the real estate market but the Marshall Plan and other aid packages which helped rebuild Europe resulted in a stable market.
The costly assumption by lenders that triggered the crisis
Banks and other lenders then realized that they could give housing loans to anyone. Whenever a loan is being given the lender is worried about getting their money back, which is why they make sure that they only give loans to people who could give them back. What bankers realized is that since housing prices kept increasing, they didn’t have to worry about getting their money back. If they gave a loan of $250,000 to someone who stopped making payments after two years the bank really had no issue – it now owned the house that the loan bought, and that house would be worth $300,000 or more now. So even if the loan defaulted the banks would still come out the winners.
The problem is that this ended up creating a dangerous downward spiral. Once banks started giving out loans to almost anyone, even if it seemed like they wouldn’t be able to pay it back, more people started buying houses. People who could never get a loan to buy their own house suddenly had the opportunity of a lifetime. The easy availability of loans meant not just that there were a lot more buyers on the market, which increased demand, but also that people had more money to spend, which increased housing prices.
The prices kept going up, which made the bankers think that their assumption that real estate prices would always go up was correct. The problem is that the prices increased too much and whenever that happens the market adjusts itself. Once the prices increased so much that people weren’t comfortable even with loans, the prices went a bit down. This caused an issue for people who had bought houses in the previous few months – the price of their house was now lower than the loan they got. There were people who had bought houses for $1 million but now their houses cost $900,000. They realized that the smart thing to do was just give up on the house, instead of needlessly paying extra money back now that the value of their houses was lower.
This meant that there were not more houses available in the market which further decreased house values. This meant that people who had bought their houses even years ago were now in the same situation. They too started to opt to default. It went on and on until the whole market had crashed, and the market was full of empty houses that no one wanted to buy anymore. From thereon began the financial crisis since the housing market was the basis of so many economic institutions and products, which resulted in other markets crashing as well.
How GRC tools could have helped
Now, you may be wondering where GRC tools come into the picture. Imagine if the scenario had been detected when it began – if we had realized bank in 2004 or 2005 where we were headed. The problems had already started back then, it’s just that no one was monitoring the issues. If there were GRC systems in place they would have automatically detected the increase in risk being caused by the housing market. The issue could have been fixed and the whole crisis could have been avoided.
The same is true for now. If we employ GRC tools correctly we can prevent a similar crisis from happening again. We can set better controls and have the markets be monitored 24/7 with the help of artificial intelligence. If the risks start going up again we will get a warning a long time before the actual crisis begins.
Author: Fahad Mateen
