The financial crisis Essay Example | Topics and Well Written Essays - 3750 words

The financial crisis - Essay Example Lehman Brother’s was one of the major victims of this crisis, and its bankruptcy acted as a catalyst in such a situation. The decline of Lehman Brothers started with the abolition of the Glass-Steagall Act. This is considered as one of the legislative acts which influenced the financial institutional structure of US. This was a seminal event that intensified the financial crisis of 2008. About $10 trillion eroded away from the equity market in 2008 after the bankruptcy event of Lehman Brothers, which was recorded to be the biggest decline of all times. Answer a: Financial Crisis of 2007-2010 The financial crisis of 2007-2010 is considered as one of the worst financial crisis after the Great Depression of 1930s (Coggan, 2007; Minsky, 1992). In this section, the discussion would be specifically on such causes that led to financial crunch Right from lax regulation, housing bubble, credit rating given by the agencies, to subprime mortgage lending, pay structure of the management a nd board, and easy credit facilities, are considered to be the major causes of financial crisis. In this study each aspect will be identified, and flaws in every situation would be evaluated, so as to discuss the grounds for the downfall major financial institutions in the second section. ... However, Gramm-Leach Bliley Act of 1999, also known as Financial Modernization Act, was an abolished part of Glass-Steagall Act of 1993 acted as a force in minimizing the gap between the traditional commercial banking institutions and the modern risky investment banks. It allowed the banks to associate with each other and engage into underwriting activities and security deals (Baily, and Elliott, 2009; The Financial Crisis Inquiry Commission, 2011). The Commodity Future Modernization Act which was passed in 2000, allowed over the counter derivatives to become self-regulating. Derivative was designed to be a tool that hedged risk associated with investment in securities market. However, this soon turned into a speculative tool (Federal Reserve Bank of San Francisco, 2012; (Duhigg, 2008). The banks sell the loans to the investment banks, which combine different types of loans such as home loan, car loan, education loan, etc into a complex derivative instrument, called Collateralized De bt Obligations (CDOs), and further sell them in the market to the investors. The borrower of the loans when paid the loan back, the money went straight to the investors. The Sub-prime loans were also popular because it was a high interest loan taken by those who could not afford it. The return and risk of any CDO investor was dependent on the various tranches. The securitization food chain is stated below. Figure 1: Securitisation Food Chain The Credit Default Swaps (CDS) allowed the investors to invest in certain corporations without feeling the heat of direct equity exposure, as can be seen in Figure 1. By 2008 it was found that the outstanding associated with CDS was around $40 trillion, and the over the counter derivative outstanding amount was