2. Q1 The movie demonstratesmultiple waysin which misuse of derivativesledtoor contributedto
the 2008 global financial crisis. Pick up any one of those instances/ storiesand explaininnot more
than 200 words and how it contributed to the crisis.
One of the derivatives extensively used before the crisis was credit default swap. These
derivativeswere derivative issued by AIG, Security Insurance Company to the investor who
purchased CDO.
In other world the company insured CDO, due to this investor felt more secure, and
however the AIG also issued these derivatives to those who did not own CDO.
Those financial institutionswhichwereselling CDO were also betting against them because
they knew that they will be unable to pay them back.
So the CDOs were actually a fraud to the real investors and these CDO were shown as safe
investment, whereas in actual, they were very risky.
The rating agencies like Moody’s, Standard & Poors and Fitch were paid to rate CDO AAA
rating, the highest possible rating, and the investor invested huge fund on these CDO
because of their highest ratings.
Q2 List four gaps that you saw in regulationsand/or designand/or practices around the financial
servicesindustryor derivative instrumentsthat you think were most responsible inprecipitating
the crisis.(8points)
1) Deregulation in 1980s of Financial Institutions which include Banks, Insurance Companies,
CreditRatingAgenciesetc.Asaresultof this deregulation,the Financial Institutions started
playing in their own ways to get maximum personnel benefits.
2) The financial lobbies and economists captured political system. By late 1990s the Financial
Institutions consolidated into few gigantic firms, as a result the economic system was
correlated with the decision of these large firms.
1999 CiticorpandTravelersmergedtogethertoformCitigroup,thismergerviolatedthe
Glass-Steagal act,whichprohibitmakingriskyinvestmentwithcustomerdeposits.Inthe
same year the congresspassedGramm-Leach-Bliley-Act,thisactwas passedtofacilitate the
saidmerger,buton the basisof thisnew act manyother mergerstookplace,whichlater
became the cause of Financial Crisis
3) Before the Financial crisisof 2008, therefore short-termfinancialcrisisin2001, whichwas
bubble createdbyFinancial InstitutionsinInternet Companies,whichlatterburstin2003,
but US Govt. did not learnfrom this crisis and did not put the regulationon these
institutions.
4) US Govt and SecurityandExchange Commissionof USdidnot monitor the banks closely.
Andbank alsoheavilyborrowedinthisperiod,the ratioof loanversusactual depositwas 33
to 01.
3. Q3 Besidesthe above,human and behavioural tendenciesplayeda keyrole inprecipitatingthe
crisis. Mentionany two such tendencieswithat least one example of each to substantiate your
point.
Do not have limitlessknowledge andinformation:Overconfident
Since we face an informationoverloadinthe world(aggravatedbythe internet),we become
veryselectivewiththe informationwe acquire.Andgiventhe confidence we have inour
ownability,we are more likelytoselectivelyseekinformationthatconfirmsourownview.
InvestorpurchasedCDObasedonthe rating agencywithoutseeingthe underline valuation
of derivative.
Nature over Optimisticand Greedy
Those financial institutionswhichweresellingCDOwere alsobettingagainstthembecause
theyknewthattheywill be unable topaythemback. So the CDOs were actuallyafraud to
the real investorsandthese CDOwere shownassafe investmentbythe ratingagency,
whereasinactual,theywere veryrisky.
Q4 What isthe first thing you woulddo if you were in a positionto change/influence regulations
and rules governingthisspace? How would this helppreventsuch a recurrence?
1) Firstthingi needto create a financial systems stabilitycommission to take an overview
of the entire financialsystem, recognizingthe interrelationsamongthe various parts, and
to preventthe excessive systemicleveraging thatwe have experiencedin2008.
2) We needtoimpose other regulationstoimprove the safetyand soundnessofour
financial system,such as "speedbumps"to limitborrowing.Historically,rapidexpansionof
lendinghas beenresponsible fora large fraction of crisisand thiscrisisisno exception.
Strict regulation on disbursals of subprime loans
3) We needbetterconsumerprotectionlaws,includinglawsthatpreventpredatorylending.
4) We need bettercompetitionlaws.Competitioncommissionshouldtake strictactionand
avoidthe creationof financial institutionswhichare toobig to fail. If it isthat big,it should
be brokenup.Hence inorganicformationof suchgiantsthroughmergersand acquisitions
shouldnotbe allowed.
5) We needcorrect incentivesforexecutives,reducingthe scope for conflictsof interest
and improvingshareholderinformation aboutdilutioninshare value asa resultof stock
options
