4.4.2 Market Failure in the Financial Markets Flashcards
LS16
1
Q
Fractional-reserve banking?
A
- Banks accepting deposits (savings) and making loans to borrowers while only holding a fraction of deposit liabilities in reserve
- Minimum amount of liquid assets required = reserve ratio (determined by central bank)
2
Q
Run-down of financial crisis background?
A
- Mortgages common form of contractual debt securitised in US - MBS
- CRAs rate MBSs (safe = AAA, lowest = CCC)
- Leading up to GFC, trillions of dollars worth of MBS issued
- Mortgage issues earned commission, investors able to profit, easiers for borrowers to obtain mortgages, CRA earning profit from rating MBSs
- Credit-worthy people harder to find so banks issued more subprime mortgages
3
Q
Misselling definition?
A
- Deliberate, reckless, or negligent sale of products or services where contract is either misrepresented or product or service is unsuitable for customer’s needs
4
Q
Explain the role of asymmetric info in the PPI scandal (UK)
A
- Sellers told customers they need PPI when they didn’t (bc they got commission)
5
Q
Explain the role of asymmetric info in the financial crisis
A
- Mortgage issuers credit-rated C categories higher - investors thought they were safe assets when they were risky
6
Q
Market-rigging/Market manipulation?
A
- Type of market abuse in which there is a deliberate attempt to interfere with market forces
Can be seen as market failure as leads to less efficient allocation of resources + undermines trust in financial system
7
Q
Moral hazard definition?
A
- Occurs when someone increases their exposure to risk when insured, especially when someone else bears the cost of the risk
8
Q
“Bubble”?
A
- Refers to situation where price of asset > fundamental value by a large margin
- Speculative demand fuels inflated price so bubble pops = massive sell-offs = prices decline
9
Q
Negative externalities in financial sector?
A
- Decreases in GDP
- Falling wages
- Rises in unemployment
Caused by mismanagement of risk
