Hedge funds have received a lot of criticism for betting on things going badly. In the recent crisis they were criticized for shorting on banks, driving down their prices. Some countries temporarily banned shorting on banks. In some regards, hedge funds may have been signaling an underlying weakness with banks, which were encouraging borrowing beyond peoples means. On the other hand the more it continued the more they could profit. The market for credit default swaps market (a derivative on insurance on when a business defaults for example, was enormous, exceeding the entire world economic output of 50 trillion by summer 2008. It was also poorly regulated.
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A whole new market in risk was born. Combined with the growth of telecoms and computing, the derivatives market exploded making buying and selling of risk on the open market possible in ways never seen before. As people became successful quickly, they used derivatives not to reduce their risk, but to take on more risk to make more money. Greed started to kick. Businesses started to go into areas that was not necessarily part of their underlying business. In effect, people were making more bets — speculating. Hedge points funds, credit default swaps, can be legitimate instruments when trying to insure against whether someone will default or not, but the problem came about when the market became more speculative in nature. Some institutions were paying for risk on margin so you didnt have to lay down the actual full values in advance, allowing people to make big profits (and big losses) with little capital. As Nick leeson (of the famous Barings Bank collapse) explained in the same documentary, each loss resulted in more betting and more risk taking hoping to recoup the earlier losses, much like gambling. Derivatives caused the destruction of that bank.
In a follow-up documentary, davis interviewed Naseem Taleb, once an options trader himself, who argued that many hedge fund managers and bankers fool themselves into thinking they are safe and on high ground. It was a result of a system heavily grounded in bad theories, bad statistics, misunderstanding of probability and, ultimately, greed, he said write What allowed this to happen? As davis explained, a look for way to manage, or insure against, risk actually led to the rise of instruments that accelerated problems: Derivatives, financial futures, credit default swaps, and related instruments came out of the turmoil from the 1970s. The oil shock, the double-digit inflation in the us, and a drop of 50 in the us stock market made businesses look harder for ways to manage risk and insure themselves more effectively. The finance industry flourished as more people started looking into how to insure against the downsides when investing in something. To find out how to price this insurance, economists came up with options, a derivative that gives you the right to buy something in the future at a price agreed now. Mathematical and economic geniuses believed they had come up with a formula of how to price an option, the Black-Scholes model. This was a hit; once options could be priced, it became easier to trade.
As evan davies described it, banks had somehow taken what seemed to be a magic bullet of securitization and fired it on themselves. Creating more risk by trying to manage risk securitization was an attempt at managing risk. There have essay been a number of attempts to mitigate risk, or insure against problems. While these are legitimate things to do, the instruments that allowed this to happen helped cause the current problems, too. In essence, what had happened was that banks, hedge funds and others had become over-confident as they all thought they had figured out how to take on risk and make money more effectively. As they initially made more money taking more risks, they reinforced their own view that they had it figured out. They thought they had spread all their risks effectively and yet when it really went wrong, it all went wrong.
Assets were plummeting in value so lenders wanted to take their money back. But some investment banks had little in deposits; no secure retail funding, so some collapsed quickly and dramatically. The problem was so large, banks even with large capital reserves ran out, so they had to turn to governments for bail out. New capital was injected into banks to, in effect, allow them to lose more money without going bust. That still wasnt enough and confidence was not restored. (Some think it may take years for confidence to return.) Shrinking banks suck money out of the economy as they try to build their capital and are nervous about loaning. Meanwhile businesses and individuals that rely on credit find it harder to get. A spiral of problems result.
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Rising house prices led lenders to think it wasnt too risky; bad loans meant repossessing high-valued property. Subprime and self-certified loans (sometimes dubbed liars loans) became popular, especially in the. Some banks evens started to buy securities from others. Collateralized Debt Obligations, or cdos, (even more complex forms of securitization) spread the risk but were mandela very complicated and often hid the bad loans. While things were good, no-one wanted bad news. Side note When asked what if someone raised concerns, peter Harn, one of the innovators of cdos, an even more complex version of securitization, told the bbc such people would likely lose their job; anyone trying to slow down would have seen a decline. High street banks got into a form of investment banking, buying, selling and trading risk.
Investment banks, not content with buying, selling and trading risk, got into home loans, mortgages, etc without the right controls and management. Many banks were taking on huge risks increasing their exposure to problems. Perhaps it was ironic, as evan davies observed, that a financial instrument to reduce risk and help lend more—securities—would backfire so much. When people did eventually start to see problems, confidence fell quickly. Lending slowed, in some cases ceased for a while and even now, there is a crisis of confidence. Some investment banks were sitting on the riskiest loans that other investors did not want.
However, as former us presidential speech writer, mark lange, notes, because derivatives are entirely unregulated and trade on no public exchanges, their originators can deliberately hide their vulnerabilities. Jonathan Jarvis explains the causes of the credit crisis in a short, engaging video: The Crisis of Credit Visualized, jonathan Jarvis If you are unable to see the video, or, for further details, the next two sections go into this further. Securitization and the subprime crisis The subprime crisis came about in large part because of financial instruments such as securitization where banks would pool their various loans into sellable assets, thus off-loading risky loans onto others. (For banks, millions can be made in money-earning loans, but they are tied up for decades. So they were turned into securities.
The security buyer gets regular payments from all those mortgages; the banker off loads the risk. Securitization was seen as perhaps the greatest financial innovation in the 20th century.) As bbcs former economic editor and presenter, evan davies noted in a documentary called The city Uncovered with evan davis: Banks and How to Break them (January 14, 2008 rating agencies were. Starting in Wall Street, others followed quickly. With soaring profits, all wanted in, even if it went beyond their area of expertise. For example, banks borrowed even more money to lend out so they could create more securitization. Some banks didnt need to rely on savers as much then, as long as they could borrow from other banks and sell those loans on as securities; bad loans would be the problem of whoever bought the securities. Some investment banks like lehman Brothers got into mortgages, buying them in order to securitize them and then sell them. Some banks loaned even more to have an excuse to securitize those loans. Running out of who to loan to, banks turned to the poor; the subprime, the riskier loans.
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A crisis so severe, the world financial system is affected. Following a period of economic boom, a financial bubble—global in scope—has now burst. A collapse of the us sub-prime mortgage market and the reversal of the housing boom in other industrialized economies have had a ripple effect around the world. Furthermore, other weaknesses in the global financial system have surfaced. Some financial products and instruments have become so complex and twisted, that as things start to unravel, trust in the whole system started to fail. John Bird, john Fortune, subprime Crisis, february 14, 2008, while there are many technical explanations of how the sub-prime mortgage crisis came about, the mainstream British comedians, john Bird and John Fortune, describe the mind set of the investment banking community in this satirical interview. Together with impressionist Rory Bremner, derivatives (securities derived from other securities) are also explained: Bremner, bird, and Fortune, silly money: book Where did all the money go?, part 3, november 10, 2008Bremner, bird, and Fortune, silly money: Where did all the money go?, part 4, november.
A crisis that need not have happened. Dealing with recession, developing world saving the west? Rethinking the international financial system? Reforming international banking and finance? Reforming International Trade and the wto. Reforming the Bretton woods Institutions (imf and World Bank)? Reform opinion and Resistance, rich countries resist meaningful reform, rethinking economics?
and the financial crisis, latin America and the financial crisis. A crisis in context, a crisis of poverty for much of humanity. A global food crisis affecting the poorest the most. Human rights conditions made worse by the crisis. Poor nations will get less financing for development. Odious third world debt has remained for decades; Banks and military get money easily.
The problem could have been avoided, if ideologues supporting the current economics models werent so vocal, influential and inconsiderate of others viewpoints and concerns. This article provides an overview of the crisis with links for further, more detailed, coverage at the end. On this page: A crisis so severe, the world financial system is affected. Securitization and the subprime crisis, creating more risk by trying to manage risk. The scale of the crisis: trillions in taxpayer bailouts. A crisis so severe, those responsible are bailed out. A crisis so severe, the rest suffer too. The financial crisis and wealthy countries. A crisis signaling plan the decline of USs superpower status?
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Develop High Performing teams, develop High Performing teams, understand hr procedures and Legal Requirements. Understand hr procedures and Legal Requirements. Performance management Methods, performance management Methods, delegate Effectively. Delegate Effectively, recruiting people, recruiting people, end of course quiz. End of course quiz. The global financial crisis, brewing for a while, really started to show its effects in the middle of 2007 and into 2008. Around the world stock markets have fallen, large financial institutions have collapsed or been bought out, and governments in even the wealthiest nations have had to come up with rescue packages to bail out their financial systems. On the one hand many people are concerned that those responsible for the financial problems are the ones being bailed out, while pdf on the other hand, a global financial meltdown will affect the livelihoods of almost everyone in an increasingly inter-connected world.