Tuesday, March 24, 2009

Credit Crunch, Who Is To Blame?


Posted By Yi-Xin Jin (Lily)


Though, many people blame the excessive greed of investors that created today’s crisis, however the investors’ argument is that “they did what their incentive structures were designed to do: focusing on short-term profits and encouraging excessive risk-taking”. For the reason that these incentives did not aligned well with the needs of our economy but more in favor of the shareholders, this has caused the amount of leverage in our financial system to increase significantly. Executives were encouraged to take aggressive risks and they were also rewarded with bonuses regardless of their performance. These incentives should be corrected, individuals should be held responsible for their reckless behaviors. The government should also place limits on personal and corporate leverage.


Bank’s capital ratios has decline drastically in the past few years, due to the excessive amount of leverage in the financial system. This has made banks very vulnerable because high level of leverage indicates shortage of capital cushion. According to the article “Taming the Beast”, “That is why regulators are now rethinking the rules on banks’ capital ratios to encourage greater prudence during booms and cushion deleveraging during a bust”. The Federal Reserve should increase the demand for capital cushion which can lower bank’s leverage and improve market stability.


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