It is an indisputable fact that the present financial and economical tsunami is one of the worst slowdowns just close to the previous one, being the economic collapse in 1929. Indeed each semester previsions a particular percentage of growth. However, this foresight is depleting in terms of the growth scenario deteriorating and getting worse from time to time. This impact is adverse as the plummeting vision states that the world economy might even endure recession. Then a chain of reactions led to a major crisis and final losses could stand between one and two trillions of dollars. Well established banks such as Lehman Brothers, Bear Stearns or Northern Rock have reached a stage of bankruptcy and the governments of most of the developed countries have had to set up rescue operations. While encountering such a severe turmoil, the next step is to infer the possible causes for this kind of an economic slump. Identifying the factors that has led to the crisis is necessary to implement reforms and avoid future disasters. Many explanations have been provided and several of them have been condemned as derivative products. To quote more precisely, the concept focuses on credit derivative products. Warren Buffet who is the greatest investor of all times, and has proved in ever so many situations that his time tested strategy in the investment area is a success has critically declared the derivative products as 'financial weapons of mass destruction' in 2003. The hypothesis based on which Warren declared this statement was insignificant as the statement was made without having the forethought of something like the actual crisis.
[...] Thus this crisis should be tackled like the dot-com crisis or the one post 9/11 and at the end everything should come back to normal. In this steadier world banks can operate with higher leverage than what was previously tolerated and that explain credit growth over years. Nevertheless none of the last two crises were of the same size. Presently it is the whole financial system which is at stake. This fact brought to light the work of Hyman P. Minsky. According to Minsky during stable periods, margins of safety decline and progressively lead to a crisis. [...]
[...] This launched the “credit crunch”. With the credit crunch also began a decrease in real estate value. There were fewer buyers because they could not get a loan and prices were going down, the default rate increased. Indeed some buyers had almost paid no principal and with the value of their house declining it was more interesting for them to lose what they had already paid rather than paying a high price for a house with a declining value. This induced new losses for financial institutions and sustained the crisis. [...]
[...] The remaining question is whether the present crisis will turn into a real depression. Conclusion Credit derivative products and their exaggerated development clearly launched the crisis and thus there are responsible for the current problems in the financial sector. Nevertheless a precise analysis of the spreading crisis shows that other parameters were involved. Without loose regulations concerning over-the-counter trading, accounting standards or risk evaluation the crisis could have been more limited. The general climate of “greediness” of the last decade, as L. [...]
[...] A Lack of transparency and information Credit derivative products had become more and more complicated, for example with the soaring of synthetic CDOs. Synthetic CDOs are CDOs with other CDOs as underlier thus it is very difficult to know what an investor in a synthetic CDO is exactly buying. More generally speaking CDOs are products difficult to understand and many investors just had a look on the yield but did not really know what they were buying. More regulations concerning prospectus of emissions (such as a standardization of the prospectus) could have helped. [...]
[...] B Hidden exposure to high risks Many investors such as hedge funds had bought CDOs with a high leverage and the required funds were provided by banks (the same who originated the CDOs) with the bought assets used as collateral. This led banks to be indirectly exposed to the products they had sold. Moreover banks themselves were buying CDOs through Structured Investment Vehicles which were off balance sheet. This mean that most institutional or alternative investors were exposed to credit derivative products but this exposure was often hidden, it did not appear directly on the balance-sheet and this contributed to the panic when losses started to generalize. Another problem came upon these: credit default swaps. [...]
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