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The inside job

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2008 market crisis

Publicada em: Negócios
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The inside job

  1. 1. Assignment on Movie-The Inside Job Submitted To Prof S Veena Iyer SubmittedBy :- Swraj Kumar Dhar 29NMP87
  2. 2. Q1 The movie demonstratesmultiple waysin which misuse of derivativesledtoor contributedto the 2008 global financial crisis. Pick up any one of those instances/ storiesand explaininnot more than 200 words and how it contributed to the crisis. One of the derivatives extensively used before the crisis was credit default swap. These derivativeswere derivative issued by AIG, Security Insurance Company to the investor who purchased CDO. In other world the company insured CDO, due to this investor felt more secure, and however the AIG also issued these derivatives to those who did not own CDO. Those financial institutionswhichwereselling CDO were also betting against them because they knew that they will be unable to pay them back. So the CDOs were actually a fraud to the real investors and these CDO were shown as safe investment, whereas in actual, they were very risky. The rating agencies like Moody’s, Standard & Poors and Fitch were paid to rate CDO AAA rating, the highest possible rating, and the investor invested huge fund on these CDO because of their highest ratings. Q2 List four gaps that you saw in regulationsand/or designand/or practices around the financial servicesindustryor derivative instrumentsthat you think were most responsible inprecipitating the crisis.(8points) 1) Deregulation in 1980s of Financial Institutions which include Banks, Insurance Companies, CreditRatingAgenciesetc.Asaresultof this deregulation,the Financial Institutions started playing in their own ways to get maximum personnel benefits. 2) The financial lobbies and economists captured political system. By late 1990s the Financial Institutions consolidated into few gigantic firms, as a result the economic system was correlated with the decision of these large firms. 1999 CiticorpandTravelersmergedtogethertoformCitigroup,thismergerviolatedthe Glass-Steagal act,whichprohibitmakingriskyinvestmentwithcustomerdeposits.Inthe same year the congresspassedGramm-Leach-Bliley-Act,thisactwas passedtofacilitate the saidmerger,buton the basisof thisnew act manyother mergerstookplace,whichlater became the cause of Financial Crisis 3) Before the Financial crisisof 2008, therefore short-termfinancialcrisisin2001, whichwas bubble createdbyFinancial InstitutionsinInternet Companies,whichlatterburstin2003, but US Govt. did not learnfrom this crisis and did not put the regulationon these institutions. 4) US Govt and SecurityandExchange Commissionof USdidnot monitor the banks closely. Andbank alsoheavilyborrowedinthisperiod,the ratioof loanversusactual depositwas 33 to 01.
  3. 3. Q3 Besidesthe above,human and behavioural tendenciesplayeda keyrole inprecipitatingthe crisis. Mentionany two such tendencieswithat least one example of each to substantiate your point. Do not have limitlessknowledge andinformation:Overconfident Since we face an informationoverloadinthe world(aggravatedbythe internet),we become veryselectivewiththe informationwe acquire.Andgiventhe confidence we have inour ownability,we are more likelytoselectivelyseekinformationthatconfirmsourownview. InvestorpurchasedCDObasedonthe rating agencywithoutseeingthe underline valuation of derivative. Nature over Optimisticand Greedy Those financial institutionswhichweresellingCDOwere alsobettingagainstthembecause theyknewthattheywill be unable topaythemback. So the CDOs were actuallyafraud to the real investorsandthese CDOwere shownassafe investmentbythe ratingagency, whereasinactual,theywere veryrisky. Q4 What isthe first thing you woulddo if you were in a positionto change/influence regulations and rules governingthisspace? How would this helppreventsuch a recurrence? 1) Firstthingi needto create a financial systems stabilitycommission to take an overview of the entire financialsystem, recognizingthe interrelationsamongthe various parts, and to preventthe excessive systemicleveraging thatwe have experiencedin2008. 2) We needtoimpose other regulationstoimprove the safetyand soundnessofour financial system,such as "speedbumps"to limitborrowing.Historically,rapidexpansionof lendinghas beenresponsible fora large fraction of crisisand thiscrisisisno exception. Strict regulation on disbursals of subprime loans 3) We needbetterconsumerprotectionlaws,includinglawsthatpreventpredatorylending. 4) We need bettercompetitionlaws.Competitioncommissionshouldtake strictactionand avoidthe creationof financial institutionswhichare toobig to fail. If it isthat big,it should be brokenup.Hence inorganicformationof suchgiantsthroughmergersand acquisitions shouldnotbe allowed. 5) We needcorrect incentivesforexecutives,reducingthe scope for conflictsof interest and improvingshareholderinformation aboutdilutioninshare value asa resultof stock options