Lack of Regulation in Banking Industry

4801 Words Oct 25th, 2010 20 Pages
What case can be made that it was the lack of regulation of the banking sector that led to the financial crisis of 2008-9? What are the new regulatory structures that are being proposed in the US and UK?

The preconditions of the 2008-9 crisis were high unemployment, high growth which was stimulated partially by foreign investment caused by imbalance of current accounts on the international arena (ie. Huge debt of US and the UK and surplus of China, Korea, Japan). Large part of the problem was caused by low inflation – in healthy economy house prices oscilate around the inflation rate. In this recession prices were raising faster than inflation. Finally, interest rates which were kept low after the dot com bubble (2004) in order to
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The level of defauls in the sub-prime market was over 10% whilst the prime market was around 2%. The price decrease in real estate lead to banks not being able even to recover the amount they invested.

When the speculative subprime market went into crisis it only began much bigger recession. Behind the sub-prime there was another crisis - the financial innovation products: CDO 's, CDS 's, derivatives, futures market, which were directly interlocked with sub-prime loans. Creation of a secondary «shadow market» with no transparency and lack of government regulation. Banks were continuiously and artificially creating enormous amount of money.

Derivatives which are essentially just bets (on virtually anything: price of commodity, exchange rate, inflation, currency exchange, etc.) have become a huge market worth over $700 trillion. The problem with them is that there is no physical value behind them and if things go wrong one have to face loss of all the money that have been invested.

Shadow banking system has developed further based on the innovation and creation of new over-the-counter financial solutions. The illegal practices were allowed to flourish. It is known now for example that Credit Default Swaps even though they are a type of insurance, were sold as derivatives. Credit Default Swap is the financial solution of sprading the risk of defaulting on repayment of the loan. It is an agreement than one side gets paid for

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