4.4.2: Market Failure In The Financial Sector Flashcards
What are the markets failures in the financial sector?
-Asymmetric information.
-Externalities.
-Moral hazard.
-Speculation & Market Bubbles.
-Market Rigging.
How is asymmetric information a market failure?
Financial institutions often have more knowledge compared to their consumers and other institutions.
This means they can sell them products that are riskier than the buyer realises.
How was asymmetric information a market failure in the 2008 Financial Crisis?
The 2008 Financial Crisis was partially caused by banks selling packages of prime & subprime mortgages, but advertising them all as prime mortgages.
How is externalities a market failure?
There are costs placed on economic agents that the financial market doesn’t pay.
How was externalities a market failure in the 2008 Financial Crisis?
The taxpayer bailed out the banks after the 2008 Financial Crisis.
The long-term effects on economic demand & growth.
How is moral hazard a market failure?
It will occur when individual workers take adverse risk in order to increase their salary.
How was moral hazard a market failure in the 2008 Financial Crisis?
The 2008 Financial Crisis was caused by moral hazard, when employees sold mortgages to those who may be unable to pay them back.
By selling more mortgages, they would see higher salaries & bonuses, but would not see the negative effects if the loan was not repaid.
How is speculation & market bubbles a market failure?
A market bubble occurs when the price of an asset is predicted to rise significantly.
This causes it to be traded more, and demand exceeds supply so the price rises beyond the expected value.
The bubble then ‘bursts’ when the price suddenly falls, causing panic sales.
What are examples of market bubbles?
-Dot com (1990s).
-Wall Street Crash (1929).
How is market rigging a market failure?
This is where a group of institutions collude to fix prices or exchange information that will lead to self-gains at the expense of other participants.
How was market rigging a market failure in the 2008 Financial Crisis?
in the 2008 LIBOR scandal, financial institutions were accused of fixing LIBOR.
