...The financial crisis which began in July 1997 in the East Asian countries, Thailand, Indonesia, Malaysia and Korea, has had devastating effects on their economies. Growth rates in these countries which were in excess of five percent before 1997, turned sharply negative in 1998 and, at the time of this writing it is not yet clear when these economies will turn the corner and resume positive rates of growth. This paper examines why these countries, which were part of what has been termed "the Asian miracle" and were able to eradicate so much poverty, are now undergoing severe economic contractions, with such harmful effects on their populations. A breakdown of information in financial markets is the key factor that has driven this crisis. After laying out an asymmetric information view of the Asian financial crisis, this paper goes on to use this framework to explore lessons from this crisis. 1. An Asymmetric Information View of the Asian Crisis The financial system plays a critical role in the economy because, when it operates properly, it channels funds from those who have saved surplus funds to those who need these funds to engage in productive investment opportunities. The major barrier to the financial system performing this job properly is asymmetric information, the fact that one party to a financial contract does not have the same information as the other party, which results in moral hazard and adverse selection problems. An asymmetric information view of financial...
Words: 7371 - Pages: 30
...securities volatility during the financial crisis In Group with Mr Duchemin and Mr Melloul Benjamin CNUDDE Introduction: The world of finance is from now global and has huge repercussions all over the planet as we could see during those last years of the recent recession. The subprime crisis triggered in the United States during the second half of 2006 has quickly turned into an international financial crisis with huge repercussions on the European financial markets. Banks and financial intermediaries were particularly affected by it because of the fair value accounting for financial instruments. As we all know, the real estate crisis in the United States has been the triggering element of the financial crisis which has initiated the international financial crisis we are facing now. Credit rarefaction and an obvious rise of market volatility were the fundamental consequences of the crisis. And to stop the proliferation of the crisis worldwide (especially provoked by the “toxic” assets owned by banks) comes the International Accounting Standards Board (IASB) intervention. We will discuss if such an intervention has managed to prevent a rise of the French banks securities volatility. In the financial crisis we are passing through, many personalities criticized the installation of IFRS (International Financial Reporting Standards), and notably concerning the impact on fair value. According to Christine Lagarde (French Minister of Economy, Industry and Employment during its audition by...
Words: 2351 - Pages: 10
...The financial crisis which began in July 1997 in the East Asian countries, Thailand, Indonesia, Malaysia and Korea, has had devastating effects on their economies. Growth rates in these countries which were in excess of five percent before 1997, turned sharply negative in 1998 and, at the time of this writing it is not yet clear when these economies will turn the corner and resume positive rates of growth. This paper examines why these countries, which were part of what has been termed "the Asian miracle" and were able to eradicate so much poverty, are now undergoing severe economic contractions, with such harmful effects on their populations. A breakdown of information in financial markets is the key factor that has driven this crisis. After laying out an asymmetric information view of the Asian financial crisis, this paper goes on to use this framework to explore lessons from this crisis. 1. An Asymmetric Information View of the Asian Crisis The financial system plays a critical role in the economy because, when it operates properly, it channels funds from those who have saved surplus funds to those who need these funds to engage in productive investment opportunities. The major barrier to the financial system performing this job properly is asymmetric information, the fact that one party to a financial contract does not have the same information as the other party, which results in moral hazard and adverse selection problems. An asymmetric information view of financial...
Words: 7371 - Pages: 30
...The Mortgage and Financial Crises: The Role of Credit Risk Management and Corporate Governance William W. Lang Federal Reserve Bank of Philadelphia Ten Independence Mall, Philadelphia, PA 19106 Phone: 215-574-7225 E-mail: William.Lang@phil.frb.org Julapa Jagtiani Federal Reserve Bank of Philadelphia Ten Independence Mall, Philadelphia, PA 19106 Phone: 215-574-7284 E-mail: Julapa.Jagtiani@phil.frb.org February 9, 2010 Abstract This paper discusses the role of risk management and corporate governance as causal factors in the onset of the financial crisis. The downturn in the housing and mortgage markets precipitated the first phase of the financial crisis in August 2007 when the solvency of a number of large financial firms was threatened by huge losses in complex structured financial securities. Why did these firms have such high concentrations in mortgage-related securities? Given the information available to firms at the time, these high concentrations in mortgage-related securities violated basic principles of modern risk management. We argue that this failure was a result of principal-agent problems internal to the firms and to breakdowns of corporate governance systems designed to overcome these principal-agent problems. Forthcoming in Atlantic Economic Journal (2010) JEL Classification Numbers: G01, G18, G21, G28 Keywords: Financial Crisis, Risk Management, Corporate Governance, Subprime Crisis _________________________ The opinions expressed in this paper...
Words: 9804 - Pages: 40
...The Russian financial crisis occurred on August 17, 1998, exacerbated by the global recession caused by the Asian financial crisis in 1997. Russia was highly dependent on exports of raw materials, with petroleum, natural gas, metals and timber accounting for more than 80% of its exports. With the drop in global demand, prices of those commodities began to decline. This resulted in an impact on its foreign exchange reserves since Russia had a fixed exchange rate regime during this period of time, where the ruble was only allowed to move within a narrow band. With the speculative attacks caused by the Asian financial crisis along with the decline in global demand, the Central Bank of Russia stepped in to defend the ruble in the markets. Russia was also experiencing fiscal deficits and declining productivity in its economy. Foreign capital was initially attracted to the Russian market due to the high interest rates, which was then used to provide internal loans in the country. The Gosudarstvennoe Kratkosrochnoe Obyazatelstvo (GKO) bond interest rates soared to 150% in an effort to prop up the currency and to stop capital flight. Internally, debt on wages continued to grow and financing for major big budget items were impacted as debt grew. The Chechnya War from several years earlier further compounded these problems. Russia also suffered from a political crisis where the entire government was fired in 1998, causing for investor confidence to be further eroded. ...
Words: 2376 - Pages: 10
...Case 5: Research Affiliates International Portfolio Management 31.03.2014 Executive Summary Tower Watson, an investment consultant company, has for main objective toward its pension clients to increase their return as high as possible while keeping as low as possible the risk taken by their investments. We are asked to analyze the pertinence for TW to recommend to its clients the Research Affiliate Financial Index (RAFI) strategy over traditional indexing and over a more actively managed strategy. The RAFI is presented to Tower Watson as a new efficient B2B tool to invest, to help investment advisory firms to better establish their strategy. Indeed this index is based on fundamental criteria instead of market capitalization criteria (and thus it has an economic-centric view instead of a market-centric view). It has been proved through studies that portfolio weights decided by fundamentals are more reliable than by price. This interesting strategy, halfway between active and passive, has shown some significant higher returns over the past years, a fact that many pension funds have already noticed since the trend today for these funds is to invest more and more in passively traded funds. Even if such strategies seem to increase the investment exposure to market fluctuation they can still be considered as “smart-beta” strategies. In the end we will have understood that TW should follow that investment tendency and purchase RAFI’s license to offer a better performing...
Words: 3129 - Pages: 13
...Final Project Part One: Impact of Global Financial Crisis on Air Transport in the U.S Embry-Riddle Aeronautical University MBAA 522 – Business Research Methods For: Dr. Barry Bauer March 15, 2015 Introduction This research paper examines the origins of the 2008/2009 world financial crisis and the impact that the crisis had on air transport in the United States of America. Although the crisis originated in the economies of North America and Europe, its effects were global with particular serious implications for economies of the developing countries including my country, Zambia. The maximum blame of the crisis is pointed at the money lenders who created such problems as it is believed that it was the lenders in the developed nations who lent funds to people with poor credit and a high risk of default. Therefore, in an effort to address the crisis, the American Federal Reserve flooded the markets with increasing capital liquidity in order not only to lower interest rates but to also broadly depress risk premiums as investors sought riskier opportunities to bolster their investment returns (Craig, 2013). As we all know that aviation is one of the most important pillars of the global economy as it provides millions of jobs globally and contributes heavily in the global gross domestic products of a number of countries. To this effect, the aviation sector which is one of the fastest growing industries had to face negative growth rate while some aviation companies were...
Words: 1965 - Pages: 8
...The Role of Financial Institutions & Risk Management in Subprime Crisis Vikrant Joshi The Role of Financial Institutions & Risk Management in The Subprime Crisis This paper discusses the role of financial institutions & their risk management strategies in the subprime mortgage crisis. The downturn in the housing and mortgage markets precipitated the first phase of the financial crisis in August 2007 when the solvency of a number of large financial firms was threatened by huge losses in complex structured financial securities. Why did these firms have such high concentrations in mortgage-related securities? Given the information available to firms at the time, these high concentrations in mortgage-related securities violated basic principles of modern risk management. Introduction: This paper analyzes the role of financial institutions in the light of risk management and corporate governance in the events leading to the subprime crisis. This paper explores the following question: Given the tremendous advances in financial risk measurement and management, why was the solvency of large and complex financial firms threatened by large losses in the mortgage market? First, the subprime mortgage market was about $1.3 trillion. Even a very high percentage loss in this market seemed manageable, given the overall size of U.S. and world debt markets. Commonly cited reasons such as high mortgage defaults in 2006 and 2007 do not provide a sufficient...
Words: 3836 - Pages: 16
...Contribute to the Financial Crisis? Christian Laux and Christian Leuz I n its pure form, fair-value accounting involves reporting assets and liabilities on the balance sheet at fair value and recognizing changes in fair value as gains and losses in the income statement. When market prices are used to determine fair value, fair-value accounting is also called mark-to-market accounting. Some critics argue that fair-value accounting exacerbated the severity of the 2008 financial crisis. The main allegations are that fair-value accounting contributes to excessive leverage in boom periods and leads to excessive write-downs in busts. The write-downs due to falling market prices deplete bank capital and set off a downward spiral, as banks are forced to sell assets at “fire sale” prices, which in turn can lead to contagion as prices from asset fire sales of one bank become relevant for other banks. These arguments are often taken at face value, but evidence on problems created by fair-value accounting is rarely provided. We discuss these arguments and examine descriptive and empirical evidence that sheds light on the role of fair-value accounting for U.S. banks in the crisis. While large losses can clearly cause problems for banks and other financial institutions, the relevant question for our article is whether reporting these losses under fair-value accounting created additional problems. Similarly, it is clear that determining fair values for illiquid assets in a crisis is very difficult...
Words: 14541 - Pages: 59
...October 28, 2011 The Efficient-Market Hypothesis and the Financial Crisis Burton G. Malkiel* Abstract The world-wide financial crisis of 2008-2009 has left in its wake severely damaged economies in the United States and Europe. The crisis has also shaken the foundations of modern-day financial theory, which rested on the proposition that our financial markets were basically efficient. Critics have even suggested that the efficient--market–hypotheses (EMH) was in large part, responsible for the crises. This paper argues that the critics of EMH are using a far too restrictive interpretation of what EMH means. EMH does not imply that asset prices are always “correct.” Prices are always wrong, but no one knows for sure if they are too high or too low. EMH does not imply that bubbles in asset prices are impossible nor does it deny that environmental and behavioral factors cannot have profound influences on required rates of return and risk premiums. At its core, EMH implies that arbitrage opportunities for riskless gains do not exist in an *Princeton University. I am indebted to Alan Blinder and to the participants in the Russell Sage Conference on Economic Lessons From the Financial Crisis for extremely helpful comments. 2 efficiently functioning market and if they do appear from time to time that they do not persist. The evidence is clear that this version of EMH is strongly supported by the data. EMH can comfortably coexist with behavior finance, and the insights of Hyman...
Words: 11209 - Pages: 45
...the Financial Crisis? Christian Laux and Christian Leuz I n its pure form, fair-value accounting involves reporting assets and liabilities on the balance sheet at fair value and recognizing changes in fair value as gains and losses in the income statement. When market prices are used to determine fair value, fair-value accounting is also called mark-to-market accounting. Some critics argue that fair-value accounting exacerbated the severity of the 2008 financial crisis. The main allegations are that fair-value accounting contributes to excessive leverage in boom periods and leads to excessive write-downs in busts. The write-downs due to falling market prices deplete bank capital and set off a downward spiral, as banks are forced to sell assets at “fire sale” prices, which in turn can lead to contagion as prices from asset fire sales of one bank become relevant for other banks. These arguments are often taken at face value, but evidence on problems created by fair-value accounting is rarely provided. We discuss these arguments and examine descriptive and empirical evidence that sheds light on the role of fair-value accounting for U.S. banks in the crisis. While large losses can clearly cause problems for banks and other financial institutions, the relevant question for our article is whether reporting these losses under fair-value accounting created additional problems. Similarly, it is clear that determining fair values for illiquid assets in a crisis is very...
Words: 15964 - Pages: 64
...June 2010, Vol.6, No.6 (Serial No.61) Journal of Modern Accounting and Auditing, ISSN 1548-6583, USA Fair value accounting under financial crisis HE Cai-xia1, ZHANG Chi2 (1. School of Accounting, Zhongnan University of Economics and Law, Wuhan 430073, China; 2. School of Management, Huazhong University of Science and Technology, Wuhan 430073, China) Abstract: The recent financial crisis has led to a vigorous debate about the pros and cons of fair-value accounting (FVA). This debate presents a major challenge for FVA going forward and standard setters’ push to extend FVA into other areas. In this article, we highlight three important issues as an attempt to make sense of the debate. First, much of the controversy results from confusion about what is new and different about FVA. Second, while there are legitimate concerns about marking to market (or pure FVA) in times of financial crisis, it is less clear that these problems apply to FVA as stipulated by the accounting standards, be it IFRS or U.S. GAAP. Third, historical cost accounting (HCA) is unlikely to be the remedy. There are a number of concerns about HCA as well and these problems could be larger than those with FVA. Key words: fair value accounting; historical cost accounting; financial crisis 1. Introduction The recent financial crisis has turned the spotlight on fair-value accounting (FVA) and led to a major policy debate involving among others the U.S. Congress, the European Commission as well banking...
Words: 2462 - Pages: 10
...NBER WORKING PAPER SERIES THE FINANCIAL CRISIS AND THE POLICY RESPONSES: AN EMPIRICAL ANALYSIS OF WHAT WENT WRONG John B. Taylor Working Paper 14631 http://www.nber.org/papers/w14631 NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 January 2009 I am grateful to John Cogan, Angelo Melino, John Murray, George Shultz and participants in the Global Markets Working Group for helpful comments and suggestions. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications. © 2009 by John B. Taylor. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source. The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong John B. Taylor NBER Working Paper No. 14631 January 2009 JEL No. E0,G01 ABSTRACT This paper is an empirical investigation of the role of government actions and interventions in the financial crisis that flared up in August 2007. It integrates and summarizes several ongoing empirical research projects with the aim of learning from past policy. The evidence is presented in a series of charts which are...
Words: 7455 - Pages: 30
...about new ways of doing business with different outcomes, risk and how to manage it has become a critical issue. The recent global financial crisis served as a reminder that risk management and how the same is practiced is fundamental if performance objectives are to be consistentlyachieved. It has emerged that as business owners and managers strive to improve and sustain performance they are now also required to consider what risk management practices their organizations have adopted to avoid falling short of their strategic objectives. This is even more so in the financial services sector which was the most affected during the recent financial crisis. The objectives of this study were to analyze the risk management practices undertaken by Commercial Banks in Kenya and to determine and assess the effect of these risk management practices on their financial performance. The risks facing financial institutions are mainly classified into; strategic, operational, credit and market risks. In managing these risks, the risk management approach adopted by the owners and/or management was influenced by the organizational culture and support, whether or not risk management is integrated in the setting of organizational objectives, whether there is a documented risk management policy or framework, how the risk identification process is conducted, the risk analysis process, evaluation and treatment of risk; risk monitoring and review; and last but not least ensuring that there is effective risk...
Words: 541 - Pages: 3
...and the aftermath of the 2008 financial crisis During the periods the 2008 financial crisis, zero equity lending to homebuyers immensely flourished through the development of financial instruments known as Mortgage Backed Securities(MBS). There are many possible explanation how mortgage securitisation in subprime was effectively encouraged. First of all, a major policy set by the Bush Administration to fuel home ownership to lower income groups by providing easier access to loans for borrowers with zero equity lending. In addition, the crisis was triggered by overvalued subprime mortgages based on the idea of continuous increases in housing prices. Hamilton and Schwab (1985) find that house price changes are positively correlated...
Words: 932 - Pages: 4
