Causes and Consequences of the Credit Crisis Flashcards
(43 cards)
What is mark-to-market?
A way of valuing assets by their most recent market price
Mark-to-market during the GFC?
During the GFC valuing assets by their most recent market price became very difficult for many bank-held securities as the market for the broke down
What are reserves?
Reserves are part of a bank’s assets, being a certain % of the deposits that are not lent out
What is capital?
Capital is the share holdings of the banks owners
What are the 4 types of financial crisis?
- Banking Crisis
- Banking crisis 2
- External debt crisis
- Domestic debt crisis
What is a banking crisis?
Systematic failure of the baking system - there is a run on at least one major bank leading to take over by the public sector
What is a 2nd form of banking crisis?
There is financial distress but no bank runs - e.g., western banks in the 1980s following the sovereign debt crisis
What is an external debt crisis?
Sovreign default is when the government fails to meet repayment on its debts, e.g., Argentina 2001
What is a domestic debt crisis?
The government fails to meet payments on its domestic debts
What are the leading indicators of a banking crisis according to Reinhart and Rogoff?
- Sharp rise in asset prices, especially house prices
- Sharp rise in domestic credit
- Capital flows from abroad increase
- Public borrowing increases before the crisis, much of which is hidden
- Sovereign debt rises sharply both during and after the crisis
Why did people think that this time was different and a banking crisis would not happen?
“Everything is fine because of globalisation, the technology boom, our superior financial system, our better understanding of monetary policy, and the phenomenon of securitized debt
What caused the GFC according to Bernanke?
Failure of financial regulators
What caused the GFC according to Taylor?
Failure of monetary policy, Alan Greenspan was the chair of the Fed
What are other reasons for the GFC?
- Credit rating agencies giving inappropriate ratings to sub-prime agencies
- Current account imbalances leading to excessive capital flows between economies
- Political failure
What are CDOs?
A collaterised debt obligation is a mortgage-backed security, which involves securitisation, where security purchasers are divided into different groups with different risks. Payments are firstly to the most risk-averse investors, then to more risk-loving investors
What are CDSs?
Credit default swaps are forms of insurance taken out against holders of bonds, in which the bond holder receives payment in the event of the bond issuer defaulting. The payment is made by the writer of the CDS, usually an insurance company or bank
Why did the housing market cause the GFC?
- Housing market in US and UK along with other economies grew rapidly from early to mid 2000s
- This led to a speculative bubble, whereby house prices were substantially above long-run equilibrium levels
- Much of the lending to the housing market was through MBSs, which were held by the banks off-balance sheet
- Much lending was to sub-prime borrowers
- As long as house prices were rising, the sub-prime sector could pay the interest by withdrawing equity
What do banks require as a buffer which can be used to write off losses?
Capital
How can a bank be safer?
By having more risk-adjusted capital relative to laons
What controls capital requirements for banks?
The Basel Accords
Why do banks not like high capital requirements?
Capital is expensive to raise, is often taken as a sign of weakness
How can banks escape high capital requirements?
By moving their business to a low regulatory environment or off its balance sheet
What are banks allowed to hold off their balance sheet?
Allowed to hold any fee income off their balance sheet, so it does not require the same level of capital or regulation as on balance sheet items
What were rates cut to in 2002 after the end of the dotcom speculative bubble?
1%
