So in case my previous entries proved to be a little bit too complex to read I will summarize everything I said into a few paragraphs.
The worldwide economic crisis occurred because consumers borrowed to fund their spending. On average in the US (numbers in NZ are also quite similar) individuals spent more than 130% of their income. The spending was finance by the wealth effect; relying on house prices to finance spending. But as the housing market became oversupplied with houses, price of houses plunged, individuals were unable to sustain the lifestyle they were accustomed to and unable to pay off the debt that they have accrued.
The financial industry- this is made out of commercial banks (i.e Citigroup or ASB), investment banks (consultants i.e. Merill Lynch) and insurance companies (i.e. AIG).
So Commercial banks were the ones that provide loans to businesses and individuals. Commercial banks are at fault because they were lending money without properly assessing the borrowers ability to pay back. They are also at fault for vastly expanding their lending activities without raising any additional capital.
Investment banks were the ones which packaged these high risk bonds for commercial banks to issue. So when the housing market crashed, investment banks were still in possession of these bonds that were completely worthless causing investment banks to lose a major revenue source. Investment banks are at fault for packaging the sub-prime bonds and exposing banks to a great deal of risk.
Being aware of the possibility of these sub-prime bonds may falter, banks took out insurance. Insurance companies stay in business by diversify their risk, however in the case of insurance companies and sub-prime mortgage bonds, insurance companies wrote multiple policy covering different banks for exactly the same risk. So companies like AIG were protecting companies from systemic risk. So as the sub-prime bonds began to lose its value, banks simultaneously made claims with their insurers. The insurance companies simply did not have reserve needed to pay for all the claims.
Therefore if it wasn't of government assistance, insurers like AIG would not have been able to pay claimants like Citigroup bank and in turn Citigroup would not have been able to pay its depositors and bond holders. Deposits and bonds is a banks' promise to pay and if that promise is broken then the whole financial system becomes a total sham.
GENERAL OVERVIEW
The worldwide economic crisis occurred because consumers borrowed to fund their spending. On average in the US (numbers in NZ are also quite similar) individuals spent more than 130% of their income. The spending was finance by the wealth effect; relying on house prices to finance spending. But as the housing market became oversupplied with houses, price of houses plunged, individuals were unable to sustain the lifestyle they were accustomed to and unable to pay off the debt that they have accrued.
HOW THE FINANCIAL SYSTEM CONTRIBUTED TO CRISIS
The financial industry- this is made out of commercial banks (i.e Citigroup or ASB), investment banks (consultants i.e. Merill Lynch) and insurance companies (i.e. AIG).
So Commercial banks were the ones that provide loans to businesses and individuals. Commercial banks are at fault because they were lending money without properly assessing the borrowers ability to pay back. They are also at fault for vastly expanding their lending activities without raising any additional capital.
Investment banks were the ones which packaged these high risk bonds for commercial banks to issue. So when the housing market crashed, investment banks were still in possession of these bonds that were completely worthless causing investment banks to lose a major revenue source. Investment banks are at fault for packaging the sub-prime bonds and exposing banks to a great deal of risk.
Being aware of the possibility of these sub-prime bonds may falter, banks took out insurance. Insurance companies stay in business by diversify their risk, however in the case of insurance companies and sub-prime mortgage bonds, insurance companies wrote multiple policy covering different banks for exactly the same risk. So companies like AIG were protecting companies from systemic risk. So as the sub-prime bonds began to lose its value, banks simultaneously made claims with their insurers. The insurance companies simply did not have reserve needed to pay for all the claims.
Therefore if it wasn't of government assistance, insurers like AIG would not have been able to pay claimants like Citigroup bank and in turn Citigroup would not have been able to pay its depositors and bond holders. Deposits and bonds is a banks' promise to pay and if that promise is broken then the whole financial system becomes a total sham.
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