| When do Financial Crisis usually Happen? | -The Ways that can Trigger a Financial Crisis is Myriad
-But it usually Happens after a Long Period of Economic Prosperity as Interest Rates are Low, Credit is Abundant, Speculation is High, and Overconfident Markets. This leads to a Recession like 2008 |
| How can Financial Crisis make a normal Recession more Harmful | -Not only it takes Longer for the Economy to Recover, the Systematic Risk creeps back up again
-One Bank acting faulty can lead to the Breakup of the Banking System and quickly Spread. Confidence and Spending can cease to Exist which can affect the International World |
| What does Speculation mean? | -Refers to when Individuals try to make Profits by buying Assets quite Cheaply, and selling them at a High Price |
| What are Market Bubbles? | -When the level of Speculation is High, then:
-Investors will keep Expecting the Price to rise to Unrealistic Realms - like Internet Stocks in the Late 1990s
-When the Confidence goes down, even by a bit, the Bubble can 'pop' and make the Prices of these Assets crash down. This can be a cause of a Financial Crisis. |
| Why can 2008 be an Example of a Market Bubble? What happened? | -2008 saw a Speculative Bubble in the US Housing Market crashing down. The Growth in the 'Sub Prime' Mortgage Market (Risky Mortgage Lending) led to House Prices Rising
-As they got more Expensive, people started to Default on their Mortgages as it got too Expensive
-Eventually, in 2008, the Bubble had been too big and Popped, when too many people had Defaulted, leading to House Prices Crashing
-Bank's Assets Sheet had reduced Severely and had to Cut Lending creating a Credit Crunch
-This lent itself to a Loss in Confidence overall in the US and Europe, leading to a Deep Recession |
| What are the Negative Externalities that Financial Markets can Bring | -The Mismanagement of Risk can be a Cause of an Externalities. 2008 saw Huge Taxpayers spent because of not Balancing Risk with Security
-Large Drops in GDP, Falling Salaries and Unemployment Rising are other, Acute Externalities |
| What is the Idea behind the 'Too Big to Fail' saying? | -The Bailout for Banks had been a Large Need for the Banking Industry, as their Size was too Big for the Economy.
-If a Large Bank had Collapsed, the Panic and Fear would lead to an overall Meltdown in the Financial System
-The UK, USA and Europe had to deploy Large Bailout Schemes in 2008, even if it costed Billions of $$$$$ |
| Why can Asymmetrical Information find its way in the Financial Market? | -When one Party has Less Information than the Other, then Asymmetrical Information Exists
-Borrowers will know Better than Lenders how Likely they will Pay back a Loan |
| What is Adverse Selection? | -This occurs when the Most Likely of Buyers of a Product are those that the Seller would Prefer NOT to sell to.
-This leads to Firms making Unknowingly Riskier Decisions than that was Thought out |
| In an Insurance Markets, how can Adverse Selection affect it? | -If a Firm engages with Medical Insurance, it will Calculate the Insurance Premiums (Cost of Obtaining the Policy_ based on People it will think will Buy it
-The Premiums may be too High for the People that would want to Pay it - like Healthy People (who are Ideal)
-But it would be good for Poor Health People, who will be a Drain on the Firm's Liabilities
-The Insurance Firm will thus be making a more Unprofitable and Riskier Balance Sheet, which was Unexpected |
| What is the Idea behind Moral Hazard? | -This refers to when an Individual engages with Riskier Behaviour as they know someone else will Pay for their Consequences
-Banks may be more Risky, as they know the Government will Bail them out |
