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Finance - Essay Example

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FINANCIAL CRISIS 1- After reviewing the case and our discussion in class, what events led to the 2008-2010 financial crises? The origin of the financial crisis was the set of government policies that encouraged ownerships for new homes, easy access to sub-prime lending, faulty trading practices on behalf of buyer as well as sellers, prioritization of short term lending over long term lending, and most importantly the lack of adequate capital base in banks that made their solvency vulnerable…
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Download file to see previous pages There were already reports of rising default on subprime mortgages that further fuelled quickly thereafter. Such mortgages are usually given to borrowers with below average credit ratings which are mainly due to their higher average risk of evasion in loan repayment. The financial institutions often charge higher interest on subprime mortgages in order to compensate for the risk taken. Thus, as the banks began clear out more loans to home owners, the housing prices rose. The easy accessibility of credit in U.S. in addition to large foreign inflows led to the boom in construction and increased consumer spending that was mostly financed by debt. The falling prices of houses resulted in more homes less worthy than mortgaged loans which provided a financial incentive to financial institution to take possession of mortgaged property when the mortgagor failed redeem loans leading to financial crisis in banking sector (Brunnermeier, pp.78-81). 2- What would a commercial bank's balance sheet have looked like in 1973? What would an investment bank's balance sheet have looked like in 1973? Considering Bear Stearns in 2007, was it closer to a commercial bank or an investment bank? During the period of 1973, the commercial bank operations involved both issuing loans as well as taking deposits. The loans and deposits were shown in the lenders’ balance sheet. On the other hand the investment banking operations involved underwriting activities such as underwriting equity and debt. In addition to underwriting activities, the investment banking operations also included buying and selling of securities. The investment bankers would buy securities such as debt and equities from a syndicate bank and then sell such security to investors. Thus, the investment bank would act like a market maker and their functions were similar to that of a broker or a dealer. Historically, the financial companies could slot in both investment and the commercial banking activities. It was only after the Great Depression Era that the congress realized the intrinsic risk of underwriting securities and hence decided to separate the commercial banking activities from the investment banking activities. Such a step was taken to protect the depositors from the risk of defaulting from underwriting activities. The Congress issued Glass-Steagall Act to separately identify the commercial and investment banking activities of the banks. The distinction between the investment banks and commercial banks narrowed during the mid 80s. In the late 80s, Fed started removing the Glass-Steagall Act that restricted the interference of investment activities from commercial activities. This Act was ratified by the Congress in the year 1999 with passing of Gramm-Leach-Bliley Act. After the issue of this new act many investment and commercial banks were consolidated that resulted into renowned conglomerates like UBS group, Citi group, JP Morgan Chase, and so on. But other exclusive investment banks like Bear Sterns decided not to enter the commercial banking activities and take deposits. 3- Bear Stearns fell quickly. On March 10th, SEC Chairman Christopher Cox described Bear as being "well-capitalized". Do you agree with this assessment? Why or why not? Bear Sterns & Co. also known as Bear was the fifth-largest investment bank ...Download file to see next pagesRead More
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