Response- Fed was createdoNot very well designed- arrangements of banking system disappeared butFed didn’t do well which led to crisis oResponse- Federal deposit insurance- added another layer of interventionthat didn’t solve the fragmentation problemoAdaptation- banks, overtime, increasingly cut their capital- higher leverage, more profitableSNL crisis-oMoral hazard from deposit insurance catches upoRather than erasing two previous problems they add a new adaptation, Capital requirements oAdaptation of capital requirements led to the financial crisisProximal causes:oThe adaptation to capital requirements- Fannie and FreddieAccelerated banks moving out to other markets to avoid regulation (commercial lending,finance companies, commercial paper)Mortgage lending was affected a lotThe first change- Fannie and Freddie (put together mortgage backed securities and marketed them)- could buy at treasury rates and invest in mortgages and they had low capital ratios. Took over mortgage market in 90s oThe Shadow banking System (gov. securities dealers becoming borrowers against repo- bank
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