Theme 4: Market failure in the Financial Sector Flashcards
What is a subprime mortgage?
A mortgage that the borrower is unlikely to be able to pay back.
Why did bankers sell subprime mortgages?
They believed they would make a profit either way.
- If they repaid the bank would be repaid plus interest.
- If the borrower couldn’t they could make a profit by selling the house when they defaulted.
What is the housing bubble?
Banks offer subprime mortgages
Demand for houses increase
House prices increase
Banks make more profits from selling houses
What are the 5 types of financial market failure?
- Asymmetric information
- Speculation and market bubbles
- Negative externalities
- Moral hazard
- Market rigging
What is asymmetric information?
When one party knows more or less than another in a transaction.
What is speculation and market bubbles?
As the price of an asset increases, demand for that asset increases. This increases the price of the asset further and the cycle continues until the asset become hugely overvalued.
What are negative externalities?
Impacts which effect third parties outside the price mechanism.
What are moral hazard?
Moral hazard occurs when you take more risks because somebody else is bearing the cost of that risk.
How much money was spent after the 2008 financial crisis to bail out banks?
$700bn
What is market rigging?
This is where firms unfairly try to control prices which distorts the price mechanism . One of the most famous examples of market rigging is LIBOR or London Interbank Offered Rate .
