Conceptual lessons on financial strategy following the US sub‐prime crisis

Abstract

PurposeOn September 18, 2007, the Federal Reserve Open Market Committee took a major step by cutting the federal funds rate by one‐half a percent (50 basis points). The only time this had happened in the USA was immediately after the September 11, 2001 attacks. Then the sub‐prime derivatives market threatened to engulf the US economy under a dark cloud of uncertainty. The purpose of this paper is an attempt to draw lessons relevant to international financial strategy from the US sub‐prime crisis.Design/methodology/approachThis paper presents reflections upon the sub‐prime derivatives market that had begun to evolve since 1993. Reviewing the situation from then until as late as of October 18, 2007, five key lessons are conceptualized. Where possible, insights on the major lessons to be drawn are rendered through simple diagrams.FindingsFive major lessons may be drawn from the sub‐prime turmoil. For easy citation, these are presented as idioms: “Do not put all bad eggs in one basket,” “Excessive demand outbalances risk and return,” “Robustness of actions for resolving a crisis,” “Banks to stay respectable as banks,” “Outcome of innovation, greed, and politics.” In conclusion, all these lessons are integrated through an overview.Practical implicationsThese lessons are explained in a manner so as to render them useful for both practitioners in the financial industry globally and a broader audience of interested readers. In particular, a thinking approach to learning is emphasized. Financial innovators are reminded of the wisdom of the ancients (eggs in a basket), and the applications of artificially intelligent forecasts of financial futures; specifically, US$ exchange rates are brought into the discussion.Originality/valueThis is an original piece of thinking on what lessons may be drawn from a major highly turbulent event: the sub‐prime crisis. It is an event that is a direct consequence of innovation in the financial markets.