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Reccession of 2008 and Great depression - Essay Example

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The principle significance of losses on mortgage-backed securities in the recent financial crisis led to losses on the balance sheets of financial institutions. The housing bubble resulted to financing of home ownership using low interest rates. Consumer spending was facilitated…
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Reccession of 2008 and Great depression
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Reccession of 2008 and Great depression

Download file to see previous pages... HSBC which is the global largest bank wrote down its holdings of subprime mortgage backed securities by $ 10.5 billion while more than other 100 mortgages companies were either shut down or suspended their operations.US and European Banks lost more than $ 1 trillion on toxic assets during the financial crisis. Northern Rock which was a British bank, was highly leveraged could not obtain credit in the financial markets. Bear Stearns collapsed in March 2008. Other financial institutions made bad losses and were subject to government take over. Lehman Brothers, Fannie Mae, Freddie Mac and AIG made a lot of losses during the crisis (Halm-Addo 4).
Various limits to arbitrage can help explain why assets were selling below their fundamental level at the height of the financial crisis. Constrains to short selling does not account for the assets selling below their fundamental prices. Short selling was evident since investors made speculative short sale bets against the financial assets which made the prices to decline. For instance, short selling led to drop in the value of Lehman Brothers stocks. US Securities and Exchange Commission imposed at temporary ban on short selling since it this method of trading reduced the market confidence and the stability of financial assets (Halm-Addo 40).
The “too big to fail” notion led to moral hazards, bail outs and increased the Fed’s balance sheet. Adverse selection was not caused by the notion of “too big to fail”. The notion created moral hazard since the financial institutions engaged in predatory lending like Countrywide Financial which advertised low interest rate loans for home refinancing. The notion made banks to borrow short term in liquid markets and purchase long term illiquid assets which were risky. The notion led to the bail out where $ 700 billion Troubled Assets Relief Program was created to rescue the ...Download file to see next pagesRead More
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