Essay on Financial Crisis Cause

831 Words Nov 22nd, 2014 4 Pages
The full story behind the financial crisis will take decades to develop. If the Great Depression is any guide, studies of what really caused this crisis will occupy economists’ minds for a long time to come. The crisis started in the US and spread through financial and real economic channels to the rest of the world but countries with weak initial economic position were hit the worst. Some causes of the crisis can thus be found in the macroeconomic policies of the past years. However, failures in the financial system, particularly in the US, were at the root of the problem. In the following we try to explain some of the most important causes of the crisis. 1. Financial market causes a. Financial Innovation:
The term financial
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The increasing use of the originate and distribute model of lending also meant that lenders have had less incentive to apply strict credit controls since the loans were expected to only stay on lenders’ balance sheets for a short time. b. System-wide risks underestimated
Developments in financial markets over the last twenty years have in certain aspects made the financial system more vulnerable to market shocks. Financial institutions have become increasingly more dependent on continued liquidity in securitization and other wholesale funding markets for their financing. On their own, market participants cannot identify or manage systemic risk.
In disrupted markets, banks’ actions are motivated by self-preservation and make the financial system as a whole less stable. Regulatory standards have largely been set on the basis that if each financial institution remained sound, then the system overall would also be sound. But this approach underestimated the implications for system-wide risk of innovations in financial markets.
The extension of diversification, for example through expansion in the use of securitization markets and derivatives products, increased systemic risk by creating an increasingly complex network of interconnections between banks and other market participants.
Because financial market participants were highly interconnected, a full assessment of the risks of investing in or lending to a bank

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