The 2008 Financial Crisis & How to Prevent It from Happening Again

Topics: Credit default swap, Subprime mortgage crisis, Debt Pages: 3 (993 words) Published: September 5, 2012
The 2008 Financial Crisis & how to prevent it from happening again

The 2008 financial crisis originated from the USA, where large growth of the subprime mortgage market resulted in a housing price bubble. However, agency problems started arising that resulted in households to take on mortgages they could not afford. Eventually, the bubble burst led to rising mortgage defaults. Ultimately, investment banks like Lehmann Brothers and Merrill Lynch filed for bankruptcy, citing heavy losses in the subprime market. To prevent this from occurring again, 3 different policy measures have been suggested. Policy 1: System restructuring

The current regulatory system can be restructured by allocating financial regulation and supervision to three different agencies, each responsible for only one of the three principal goals of financial-system regulation. The 1st agency would be in charge of price stability through the conducting of traditional monetary policy. The 2nd agency will be charged with tackling systemic considerations and solvency issues. The 3rd agency would focus on protecting investors and borrowers from experiencing fraud and abuse while undertaking financial activities i.e. stock-investing, taking loans etc. This policy has 2 advantages. Firstly, each of the three agencies would have a very simple and easily measurable goal, thus eliminating any coordination or communication problems. The price-stability agency’s goal would be to control inflation, the effectiveness of which can be easily measured by inflation expectations. The system-stability agency's goal would be to minimize the risk of systemic collapse. Its accomplishments can be measured using the credit-default swap (CDS) prices of major financial institutions, an indicator of an institution’s probability of failing. The investor-protection agency's success can be measured through trust surveys administered to bank customers. Secondly, any major trade-offs among these goals would...
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