Market Failure In Financial Sector Flashcards
Types of market failure in financial sector
Negative externalities
Speculation and housing bubbles
Asymmetric information
Moral hazard
Asymmetric information
Bankers were selling adjustable subprime mortgages to low income people.
Speculation and housing bubbles
Banked speculated houses prices to increase.This led to bankers giving out more subprime mortgages causing demand for houses to increase.This led to prices of house to increase causing people to default on their repayments.This led to increase in profits for bankers as they reclaimed the house and sold more subprime mortgages.This created a housing bubble which later burst as consumers realised that houses were overvalued and starting selling their houses.
Banks across the globe lost $2.8 trillion, which caused a global recession as millions also became unemployed.
Negative externalities
Banks couldn’t led due to shortage of funds (credit crunch) which affected firms and consumers.
Firms costs increased (SRAS SHIFT INWARDS) which led to workers becoming redundant, increasing unemployment.This is a negative externality because these workers were outside of the price mechanism. Consumption decreased causing ad to shift inwards.
US banks were bailed out the gov to prevent no more banks such as Lehman brothers became bankrupt by spending $700 billion (moral hazard)
Moral hazard
Banks take more risks as they know that they will be bailed out by the government.
US Government used $700 billion to bail out US banks to prevent them from becoming bankrupt such as Lehman brothers
Financial regulators
FPC- regulates banks by mitigating systemic risks which are risks that affect the banking system
PRA-regulating financial intermediaries by setting standards which they must follow and supervised by assessing the risks posed by individual intermediaries
FCA- protect consumers by promoting competition to make sure that consumers are not exploited by banks.
Why a bank fails
Become insolvent: a fall in value of assets where it becomes 0
Doesn’t have sufficient liquidity to meet its legitimate demand of its depositors
