6. Global Financial Crisis

Question 1

What are the remote causes of the financial crisis?

Answer 1

5 remote causes

1. Savings glut in Asia
2. Optimism about the future
3. The dot-com bubble recovery: The FED keep interest rate at 1%
4. American dream of owning a house
5. Banks are easy to lend and investors have $$

Question 2

What are the direct causes?

Answer 2

(1) Debt was given to people who couldn’t pay
(2) Housing prices dropped
(3) Banks couldn’t pay their debt

Question 3

What are the take-aways from the financial crisis?

Answer 3

Dodd-Frank Act
Misalignment of incentives (brokers, investors, borrowers, banks)
- Inaccurate assessment of risk: incorrect model + conflict of interest between credit rating agencies and issuer of the securities