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Principles of Banking and Finance - Essay Example

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Principles of Banking and Finance

The attractive mortgage lending was based on a faulty premise that the house prices would continue rising, thus over-lending by the banks, in total disregard of the likelihood of repayment. When the false bubble in the mortgage lending finally burst, the financial crisis began taking its toll, many loans were unrecovered by the banks and the banks become bankrupt. The third force behind the credit crisis was global imbalances; the developing Asian exporting countries had large current account surpluses, a situation that has been defined as “global savings glut”. This situation led to an inevitable influx of capital into the US thus leading to the bubble in share prices in the late 1990s, and the bubble in house prices accordingly; however, the US current account deficits kept going up from the 1990s due to offsetting inflows of capital to the US. In addition, another influential force that was behind the credit crisis was deregulation policies, which had left the exchange rates to be influenced by foreign exchange markets (Evans17); deregulation of the financial sector in response to neo-liberal government policies led to the expansion of the US’s financial sector. In line with the expansions were the emergence of new and riskier financial instruments and accumulated credit; this is what led to the stock market bubble and the housing bubble accordingly. Finally, the credit crisis can be attributed to excess capital in terms of huge sums of capital that had been stashed in the US and Europe at the time (Evans19); this led to stagnation in household incomes, thus constrained purchasing power of the population. This condition led to increased borrowing in households so as to sustain consumption and a built up of debt securities; extensive borrowing to finance consumption spending in turn led to a rise in asset value, but when the rise could not be sustained any further, the growth of consumption stopped suddenly and recession began. Q2 It has been proven beyond any reasonable doubt that indeed, the US government treated some financial institutions differently during the credit crisis. For instance, when the Wall Street Investment bank Lehman Brothers crumpled in response to the crisis, there was a dramatic fall in the global economy; this was a great blow to the financial sector and many people lost faith in the banking system. However, exactly one month after the bank had collapsed and caused a global outcry, the US congress passed a bank bailout scheme that was labeled Troubled Asset Relief Program (TARP) (Fareed). The Troubled Asset Relief Program entailed taking billions of taxpayer money and using it to bail out financial institutions from the deep pits of the credit crisis; ironically, the same financial institutions that were now being bailed out by TARP had caused the credit crisis in question. Questions have been raised with respect to the way the US government reacted at the onset of the credit crisis; one of the most serious questions that arose is with regards to whether the Lehman Brothers could be saved or not. Thus exactly, why ...Show more

Summary

Q 1 The 2007 credit crisis has been attributed to myriad forces: firstly, one of the forces behind the crisis was perverse incentives (Evans13); there are so many instances where incentives played a major role in the making of the crisis. For instance, the sub-prime mortgage sales agents offered low initial repayments in order to attract more clients and be able to earn more incentives; the banks on the other hand were only interested in generating as many mortgages as possible and were not careful to assess likelihood of repayment…
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Principles of Banking and Finance essay example
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