Bubble Years Finals Penglu

Bubble Years Finals Penglu - 1. The financial crisis of...

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1. The financial crisis of 2009 can be traced back as early as 1994. The concept of contagious risk was first introduced during Mexico Peso crisis in 1994, when Clinton administration was bailing out the Mexico government for its troubled economy. It was believed by Clinton administration that if Mexico defaulted on its government bonds, the whole world, especially North American economy would be affected adversely due to the interconnectedness of the world economy. Again, in 1998, when Long Term Capital Management failed due to a large loss incurred to the company by its highly-risky leveraging strategy in arbitraging business on Russian government bonds, the government again reached out and helped this troubled hedge fund since the government also believed the failure of this large financial institutions would produce a significant repercussions in the financial system that would bring everyone down. In both cases, the government sent a market signal of too big to fail and created a moral hazard in the financial system, which later actually created more interconnectedness and leveraging among financial intermediaries and countries. In 1999 the Congress passed the financial service modernization act, which removed the restrictions on businesses that different financial intermediaries were allowed to engage in. This paved the path for a widespread of toxic CDOs and MBSs in the system and multiplied the financial crisis later in 2007. Furthermore, the Clinton administration started to push the FNM and FRE for creating more housing ownership in the country, as a way to improve American citizens’ standard of living. This push was inherited by Bush Administration. With the bust of internet bubble in 2001, the government carried out relaxed monetary policies and flooded the financial system with abundant easy liquidity. This is because Greenspan, the then Fed Chair was a free market believer. He thought the market would recover in the long run if enough liquidity was injected into the system. Hence, the combined effect of push for more home ownership and easy liquidity promoted the housing market. Prices of houses in the country started to take off the ground. Since the interest rate was low, and investors had a lot of capital, they were trying to find
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This note was uploaded on 04/08/2010 for the course ECON econ050 taught by Professor Neil during the Spring '10 term at Oberlin.

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Bubble Years Finals Penglu - 1. The financial crisis of...

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