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Bernanke - Econ 423 Homework

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1.) The biggest trigger was subprime borrowers’ large (in absolute terms) losses of residential mortgage loans. IKB’s Rhineland off-balance-sheet vehicle was also no longer rolling over the ABCP it issued in U.S, markets to fund its asset-backed securities. Commercial paper investors feared risk of default on these securities because of IKB’s difficulty in meeting its funding obligation. This led to runs on key institutions which had a detrimental effect on the financial system as a whole. This “Run on Commercial Paper” occurred because it is easier and safer for lenders to withdraw their money in this type of situation even if the vehicles had no exposure to subprime mortgages. Thus, this financial strain also spread to the bigger banks that were funding these vehicles. This caused short-term funding in interbank market to freeze up. This, with the growing instability in global money, hurt the flow of lending to nonfinancial borrowers and ended up being more damaging than the subprime losses.
Another trigger was a “sudden stop” in syndicated lending to large risky corporate borrowers because funding for these loans had recently transitioned from banks to special purpose vehicles that funded themselves through CLOs that were purchased by a variety of investors, including ABCP vehicles. This sudden stop was viewed negatively by investors and contributed to triggering the crisis.

2.) One of the vulnerabilities was the dependence on unstable short-term funding. Shadow banks, which are intermediaries not subject to regulation, had become dependent on short-term wholesale funding leading up to the crisis, which were growing rapidly and insured and made the shadow banks susceptible to runs (similar to the freeze up in secondary markets for ABCP). Since runs tend to blur the lines between insolvent and illiquid firms, the increase in perceived risk leads to financial...

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...A UTH-WE ST MBA series N's CEN G SO ER GE in E conomics Managerial Economics A Problem Solving Approach SECOND EDITION LUKE M. FROEB Vanderbilt University BRIAN T. MC CANN Vanderbilt University Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Kingdom • United States Managerial Economics: A Problem Solving Approach, Second Edition Luke M. Froeb, Brian T. McCann Vice President of Editorial, Business: Jack W. Calhoun Vice President/Editor-in-Chief: Joe Sabatino Acquisitions Editor: Michael Worls Developmental Editor: Jean Buttrom Associate Marketing Manager: Betty Jung Content Project Manager: Lindsay Bethoney Media Editor: Deepak Kumar © 2010, 2008 South-Western, Cengage Learning ALL RIGHTS RESERVED. No part of this work covered by the copyright hereon may be reproduced or used in any form or by any means—graphic, electronic, or mechanical, including photocopying, recording, taping, Web distribution, information storage and retrieval systems, or in any other manner—except as may be permitted by the license terms herein. For product information and technology assistance, contact us at Cengage Learning Customer & Sales Support, 1-800-354-9706 For permission to use material from this text or product, submit all requests online at www.cengage.com/permissions Further permissions questions can be emailed to permissionrequest@cengage.com Print Buyer: Sandee Milewski Production......

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