Sample Essay

The financial system was a Pandora’s Box waiting to be opened and when one bank went under other giants followed in a domino effect. The three main flaws in the financial system were market satisfaction, bad regulation and deficiency of transparency. In answer to question one it was mentioned that the leverage ratio of Lehman Brothers was 30 to 1 while the regulation states that banks cannot have a leverage ratio greater than 15 to 1. The instability of the financial system is quite obvious as the banks started failing one after another.

The regulations were so loose that banks not only lent money ignoring the set standards, the prime factors of credit analysis were ignored thus the name subprime mortgages. The worst hit financial sector was the money market. There were also some money market funds which were directly affected by the collapse of Lehman Brothers due to heavy investment in the bank. One such example is of $62 billion Primary Fund, the fund had to suspend redemptions for seven days because of losses suffered on a $785 million investment in Lehman Brothers.  According to Zingales it only cost $2.50 to insure $100 worth of investment in junk bonds but after the crisis the cost has risen over $6 (Zingales).

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