Theme 4 - The Global Financial Crisis

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  • Created by: becky.65
  • Created on: 09-03-18 12:55
What is the sub-prime market?
When banks made good profits from mortgage loans to people with low incomes and weak credit histories who would be unable to make the payments if they lost their jobs
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How did banks spread the risks of sub-prime mortgages?
They bundled together mortgages with a variety of risks and sold them as securities with triple-A credit ratings so there would not be widespread defaults
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How did the house market collapse in the US?
Inflation and interest rates were rising so unemployment rose and this meant people could not repay their mortgages so house prices fell and many people fell into debt
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Which bank failed in the UK in 2008?
Northern Rock
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How did Northern Rock fail?
It had bought new financial products that they thought were profitable and when depositors realised they were short of money they began withdrawing savings
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Why is it critical that depositors get their money back if a bank fails?
It avoids people and businesses being made bankrupt and depressing the economy further
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What is moral hazard?
The fact that banks can borrow from their central bank can encourage them to take risks and behave irresponsibly because they do not pay for their mistakes
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What does it mean when a bank is 'too big to fail'?
The cost to the whole economy of a big bank failing is so great that the government cannot allow it to happen so the bank will have to be bailed out with huge loans
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What would be the effect on the economy if a bank that was 'too big to fail', failed?
Businesses would lose their deposits and be forced to cut output, employment or close down, individuals will have lower disposable income and AD will collapse
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Why was the US government allowing Lehman bank to fail a mistake?
Instead of making an example to other banks about moral hazard it destabilised the whole global banking system as it destroyed banks' trust so they did not lend to each other
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What did the failure of Lehman bank result in?
Most banks not lending to anyone for weeks as any lending was risky thus businesses that needed to borrow to pay wages could not and the damage was serious
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What is speculation?
Buying or selling something in the expectation of a price change that generates profit
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How did a housing market bubble help cause the financial crisis?
House prices began to rise as it was easier to get a mortgage, more people bought homes, so house prices rose; the base rate went up, contractionary policies caused redundancies, house prices fell and banks that bought financial products lost profit
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How did speculation make the housing market bubble worse?
Speculators can buy houses and push up the price; the bubble bursts when some of them sell to get the profit
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Why were bankers pressing forward with more risky transactions?
Banking cultures were all about making a profit. Bankers received bonuses in proportion to the profits they made on their deals, giving them big incentives to press forward with more risky transactions as the focus was on short-term profit
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How did bankers maximise their profits?
They developed complex models that devised new ways of spreading risks. For a while this worked, but when the economic growth turned down, the risks reappeared
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What happened to banking regulations from 1987 onwards?
It was made lighter to encourage innovation and competition, reduce bank charges and make the financial system more efficient
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How did the financial crisis make regulations more tight again?
It revealed that banks were allowed to operate with levels of reserves that were insufficient to keep them safe
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What is the purpose of the Financial Conduct Authority?
It covers the entire financial sector and ensures that financial institutions' customers are not misled.
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What is the objective of the Prudential Regulation Authority?
It's charged with the supervision of banks, building societies, credit unions, insurers and major investment firms. It ensures no financial institution engages in reckless activity that will affect customers or threaten the stability of the financial
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How does the Prudential Regulation Authority regulate insurance companies?
It monitors them to ensure that policy-holders are adequately protected and aims to promote competition
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Why are financial services immensely important for individuals, businesses and governments?
Banks create a safe place for savings, investment is the lifeblood of the economy, lending makes it possible for businesses to thrive and individuals to buy homes, it funds loans for government projects
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If the economy is in an unstable state, what might happen to the financial sector?
Confidence may evaporate and then loans become very hard to get
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What happened as a result of low trust in the banks during the financial crisis?
The banks became wary about lending; businesses closed and there were widespread redundancies. Incomes fell and economic growth went into reverse
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How did banks take advantage of their asymmetric information?
They tried to sell profitable products without fully explaining the way they would work to their customers
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What happened when it was found out about the banks asymmetric information?
It was stopped and the banks paid big fines
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Why does the UK still have very low levels of investment?
Because of uncertainty; banks continue to encourage the creation of very complex products with small print that is hard for the customers to take in, further damaging trust in the system
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What is shadow banking?
Organisations that lend finance for investment, but are much more lightly regulated than the banks
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Why could shadow banks destabilise the financial system in the future?
They are not as regulated because they are set up by small groups of very wealthy people and financial businesses that deal in financial assets which they buy and sell anytime they can see a possible profit to be made
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Other cards in this set

Card 2

Front

How did banks spread the risks of sub-prime mortgages?

Back

They bundled together mortgages with a variety of risks and sold them as securities with triple-A credit ratings so there would not be widespread defaults

Card 3

Front

How did the house market collapse in the US?

Back

Preview of the front of card 3

Card 4

Front

Which bank failed in the UK in 2008?

Back

Preview of the front of card 4

Card 5

Front

How did Northern Rock fail?

Back

Preview of the front of card 5
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