{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

financial crisis - ECON 104Financial Crisis 1 What is the...

Info icon This preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
ECON 104---Financial Crisis 1. What is the nature of the current crisis?  There are 3 big proximate causes: a bunch of new  and unregulated assets emerged, and people traded them without knowing their value; there  was a bubble in asset prices, but now it is popping---asset prices (such as house prices)  have fallen, so that people feel poorer and don't want to spend;  credit markets have  tightened so that banks are less willing to lend and charge higher interest rates, pushing  down investment by people and firms;  2. Recall that if the conditions of the First Fundamental Theorem hold, credit markets defined  as the markets for borrowing and saving money, will be efficient.   2.1. This means, roughly, that good investments will be made and bad investments will not  be made because people will be able to borrow money to fund investments that pay off  in the long run.  2.2. However, if the conditions don't hold, some good investments may not get made, and  some bad investments may get made.   2.3. What conditions might not hold?  Two important ones are: perfect competition and  perfect information.  Banks may have power in the market, driven by their bigness;  People with investment projects may have more and better information than bankers.  Both of these features drive credit markets away from efficiency. 2.4. If bankers have market power, they will charge more for their services, meaning they  will charge more to borrow money.  This means that some good investments will not get  made: only the super high-value investments will be made, and the ones that are  somewhat high-value, but not super-high-value, will be judged unaffordable by the  people trying to borrow the money. 2.5. If people trying to borrow have private information about the value of their projects, they  will consistently lie in the direction of over-valuing their projects when they are talking to  bankers.  So, bankers will only fund projects that seem to be super-high-value.  Similar  effect as banker market power. 2.5.1. There are some ways out of this problem:  people develop reputations, they put  up collateral or bonds, they find credible ways to convince the banker that they are  a good risk.
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
2.6. These market failures (lack of perfect competition, lack of perfect information) make  credit markets inefficient in general. 2.7. Right now , credit markets are facing extreme information problems, because they have  'discovered' that they can't trust anybody, and so they are being  extremely  careful about  who they lend to, and charging  extremely  high interest rates on new loans that go out.
Image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern