Small Complex Financial Institutions Found Themselves Of Liquidity At The Beginning Of The Crisis

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Zhong Zheng Mark Sniderman, Ph.D. Econ 376 8th Nov 2014 Short Paper #3 Many large complex financial institutions found themselves of liquidity at the beginning of the crisis and as it progressed. I think they were surprised. The trigger for the liquidity crisis was an increase in subprime mortgage defaults, which was first noted in February 2007. The bank centered nature of the crisis made it harder than in the past for banks to attract deposits and provide liquidity to borrowers shut out of securities markets. Banks may not be able to provide liquidity in a financial crisis. The reason for this is that a bank-centered crisis may lead investors to concern about the safety of bank deposits, even with deposit insurance. Therefore,…show more content…
On the other hand, AIG has been increasingly active in the credit derivatives business, including credit default swaps. AIG’s stock price fell more than 90 percent, capping off a large decline from the previous days in September 16, 2008. The AIG bailout was extended by a further 37 million in October and another 40 billion in November. An originate-to-distribute model of lending, where the originator of a loan sells it to various third parties, was a popular method of mortgage lending before the onset of the subprime mortgage crisis. This originate to distribute model had advantages over the old originate to hold model, where a bank originated a loan to the borrower and retained the credit risk. People believe that originate to distribute model of banking played a key role in the development of the financial crisis because instead of holding loans on banks’ balance sheets, banks moved to an “originate and distribute” model. Banks repackaged loans and passed them on to various other financial investors, thereby off-loading risk. Next, banks increasingly financed their asset holdings with shorter maturity instruments. This change left banks particularly exposed to a dry-up in funding liquidity. However, Gary Gorton has a different perspective. He believes that originate to distribute model claims that securitizations should not end up on bank balance sheets. There is no basis for his idea. In fact, there is an important

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