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Risk Management in Securities Companies Post Financial Crisis

In August 2007, the outbreak of the subprime mortgage crisis in the United States dealt a severe blow to investor confidence in the value of mortgage-backed securities, which in turn triggered a liquidity crisis. The crisis then spread to the common credit market, which has little to do with the real estate industry, and directly affected large securities-holding financial institutions. Bear Stearns went bankrupt, Lehman Brothers shut down, and Morgan Stanley and Goldman Sachs were converted to bank holding companies.

Lehman Brothers was a 158-year-old Wall Street company. It was the fourth-largest investment bank in the United States, a leader in the fixed-income product market, and the top-ranking company in the mortgage-backed securities business in the United States for 40 years in a row. On September 15, 2008, the world's consummate player in the fixed-income product market applied for bankruptcy.

In contrast, with its acute foresight and resolute measures, Goldman Sachs dodged a severe blow from the subprime mortgage crisis, which testifies to the effectiveness of its risk-management system. Of the USD 1 trillion on Goldman Sachs' balance sheet, only USD 28 billion was illiquid assets. Of this, only USD 1.7 billion was subprime mortgage-related assets. Goldman Sachs was the first financial institution to foresee the subprime mortgage crisis and actively took preventive measures. It had a very advanced risk-monitoring system in place that had been conducting risk tests based on 25,000 data entries each day collected from major transaction markets and business activities around the world. Goldman Sachs foresaw the high risk of subprime mortgage. The system had issued warnings before the risks of subprime mortgage loans were fully exposed. Goldman Sachs held a meeting to discuss the topic of mortgage risks, and decided to reduce its holdings of mortgage-backed securities. It instead purchased expensive insurance policies. While its rivals were busy expanding their mortgage bond business,

Goldman Sachs started short selling mortgage-backed securities and going long on crude oil, in a bid to protect itself against possible losses.

 
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