Lessons learned from the collapse of bear stearns Essay

Lessons learned from the collapse of bear stearns - Essay Example All the major cause will be expansively presented in this paper. The valuable lessons learnt from the crisis will also be thrown light upon in this paper. Bear Stearns, AIG, Lehmann Brothers, Northern Rock, Goldman Sachs are some elite names that suffered the most because of the economic crisis also known as recession. Lehmann brothers filed for bankruptcy while AIG and a few other elites just hung in there with the skin of their teeth. This economic crisis is still having repercussions on countries like Greece and Spain; the whole of Euro Zone is facing a financial turmoil. There are a few other countries that have been not so severely affected by the same. The crisis triggered off because of unchecked debt, banks kept issuing loans to people who invested heavily in buying assets, several things were taken for granted but when proved otherwise there was hardly a place in the world to hide. Overvaluation in real estate is perhaps the biggest cause of the current economic crisis, it i s better known as the subprime crisis in the US. The likes of Lehmann Brothers and other financial services went bust because they kept issuing credit to the people who thought the property price would increase and they would be easily able to pay off the debt that they are borrowing. It did not turn out that way and there was a short of equity, this is exactly why the financial institutions went bankrupt. The overvaluation is the biggest factor that caused the current economic crisis. Factors like bad income tax practices have added insult to injury, bad mortgage lending also contributed heavily to this current economic crisis. â€Å"The way to address the root cause is to let house prices drop to where an average house is within the means of an average household.   (Or, alternatively, boost the income of the average household to the point that they can afford an average house.   But that's very hard.   Letting houses prices go on falling, although painful for everyone who o wns a house or who has lent money to someone who owns a house, is very easy.)† (Root Cause of the Financial Crisis) Role of Monetary Policy Some of the main plausible reasons that caused the recent financial crisis have been identified in the above sections. According to Brunnermeie (2009), cheap mortgage financing to sub-standard borrowers fuelled the boom in the U.S. housing market. Three factors were primarily responsible for the fall of the housing market in the U.S. (which in essence, constituted a very small segment of the financial market in the country) transforming into a global contagion. First, the â€Å"originate and distribute† banking model, together with the high rate of securitization, led to declining lending standards and made it impossible to re-price the complex structured products. This significantly eroded the confidence level of banks, thereby disrupting the inter-bank markets and credit flow. Second, banks relied heavily on short-term funding sou rces, hence raising the risk of funding. Finally, the ever-growing integration of global financial systems and the increasing interest towards structured financial instruments quickly transmitted the crisis to all the major regions of the world. Gourinchas (2010) focused on the role of monetary policy in the recent financial contagion as well as the role played by exogenous influences, particularly the rising external deficits referred to as ‘Global Imbalances’. According to Gourinchas, both explanations are not satisfactory as the sole