I need help with the following assignment: Please discuss the business decisions which ultimately lead to the economic crisis which precipitated...
I need help with the following assignment:
Please discuss the business decisions which ultimately lead to the economic crisis which precipitated the Great Recession, and explain whom you believe to be the “villains” and the “heroes” of the crisis. Please use your text, the lectures, the documentary “Inside the Meltdown” and the article on credit default swaps to support your argument.
There are many different ways of interpreting what actually gave rise to the financial crisis. Personally, I'm not sure that terms such as "heroes" and "villains" really help us understand what happens. Rather, the major lesson seems to be that complexity of financial instruments, and the way in which they become detached from actual measures of labor and goods, is itself a problem.
One point made in both the articles is that financial instruments by 2008 had become so complex that they were almost impossible to regulate effectively. This meant that regulation complexity and financial instrument complexity both kept increasing in a vicious circle, diverting the financial industry from the productive task of matching borrowers and lenders to trying to creating increasingly complex financial instruments to finesse regulators. The two most immediate problems precipitating the crisis were credit default swaps and securitized mortgages. Both of these were essentially sleights of hand intended to remove the risk from inherently risky investments. The reality though is that the underlying risks, such as subprime mortgages and junk bonds remained, but complex instruments made the risks harder to understand and evaluate, actually worsening the underlying problems. Exacerbating this was the overconfidence engendered by the "great moderation".
The next problem is that the promotion of home ownership and implicit government backing of US mortgages created moral hazard, in which the actual risks were not priced into mortgages themselves or securitized derivatives. Next, there was a problem of excessive use of leverage which contributed to systematic instability.