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    • Join Date: Dec 2007
    • Posts: 25

    Unhappy Summary of an Economic Article

    "Financial markets need more than a patch-up"(page 1 and 2) - Financial markets need more than a patch-up

    This is an economic article posted on Financial Times.
    I want to understand the article, but it is too difficult.
    Could you please tell me the rough summary or the writer's conclusion?

    • Join Date: Oct 2006
    • Posts: 19,434

    Re: Summary of an Economic Article

    Briefly, and without going into too much detail:

    The author presents a series of examples of poor financial management, discusses the reasons for this, and concludes that these are over-free innovation in banking practice, too much risk-taking, and the effects of new Federal procedures. What is needed is a change in how the financial markets are managed.

    • Join Date: Dec 2007
    • Posts: 25

    Smile Re: Summary of an Economic Article

    Dear Anglika:

    Thank you for your excellent summary. I almost understand.
    If possible, could you explain in more simple words about "over-free innovation in banking practice" and "too much risk-taking"?
    Thank you once more.

    • Join Date: Nov 2007
    • Posts: 5,409

    Re: Summary of an Economic Article

    The US is in the grip of a financial meltdown.
    Barack Obama and Hillary Clinton both blame deregulation of the money market, and say action needs to be taken with regard to mortgages: Clinton says the Federal Housing Administration may have to step in and write off bad mortgages.
    John McCain said it is not the job of government to bail out the banks or the money borrowers. He says what’s needed is for banks to have more capital so they have more to lend, which can be achieved by removing “accounting and tax impediments". ALL of them consider that there needs to be more regulation of their business practices such as closer supervision of those financial institutions offering mortgages to people.

    However, all the presidential candidates seem to be proposing ‘let’s just muddle through the present emergency’ and have no real solutions for the future. Even the Treasury has not come up with anything better - though it is about to release a "blueprint" for future financial regulation.
    So, at the moment, all anybody is really suggesting is to try to mend the situation with a patch (just like, if the door on a car won’t stay closed, you tie it closed with some rope: it fixes the problem in the short term but is not the long term solution). In fact, there is hesitancy, if not resistance, to thinking in larger and wider terms about just how we should fix the meltdown situation. The Fed, Housing Assoc. and the Treasury won’t commit to injecting money to support stressed financial companies, nor to using public tax money to buy up mortgages. But the Bear Stearns (NYSE:BSC) operation has caused the Fed Housing Assoc to take decisive action. (Bear Stearns was bailed out of its difficulties by the Fed Housing Assoc. in that it paid off its creditors, but did not assist its sharehoulders); so now, like it or not, the Fed. Housing Assoc is the owner of $29bn (£15bn) of mortgage-backed securities: this means, if any of these securities are sold at a loss, it bears all the loss.
    The big fear of stepping in and assisting people who get into trouble financially, as with mortgages, is what they term ‘moral hazard’. If you are there, ready to step in and protect banks if they get into such financial difficulties, then there are no consequences if things do go wrong – in effect, you encourage them to be reckless in their financial undertakings because ‘they will bail me out if it goes belly-up’ The debate about future financial regulation is framed around this concept: that Government safety nets would mean there has to be supervision to guard against any recklessness on the part of financial institutions.
    But the example of Bear Stearns and what happened to that bank hardly encourages others to be reckless. In fact, in bailing out the creditors but not the bank and its shareholders, it is a cautionary lession: do what Bear did in its financial management of its affairs, and you pay the same price (share prices plummeted).
    The point is though, did Bear Stearns act recklessly or was it just part of the risk taken with adventurous investments?
    Whichever, running repairs (patching things up as with Bear Stearns) is not the answer. We need an entirely new model.

    • Join Date: Dec 2007
    • Posts: 25

    Re: Summary of an Economic Article

    Dear David:

    Thank you very much for your summary, which made me understand far more clearly. Now I understand most of the article, thanks to you.
    But only these phrases are difficult to understand.
    "innovation run amok"and "privately rational but socially harmful risk-taking"

    Thank you once again.

    • Join Date: Nov 2007
    • Posts: 5,409

    Re: Summary of an Economic Article

    The right answer may well be it is all of the above: innovation run amok; privately rational but socially harmful risk-taking;...

    This is the writer's summing up of the situation. The meltdown needs 'a new model'. So, let's come up with new ideas about how to solve the problem (innovation) even if it means going a bit wild and turning the present system upside down and on its head with changes(amok= behave wildly, even 'out of control', and in so doing, cause disruption and a bit of chaos).

    We shouldn't fear the bogey of the 'moral hazard'. It is logical and rational to regulate institutions and be prepared to step in and bail them out if need be, even though it seems to be giving a message to society that it is OK to take huge risks with the hope of huge profits because the good-ol' Government or Fed. Housing Assoc will always come to our rescue and bail us out if it goes belly-up. It's like encouraging institutions to take potentially harmful risks - harmful because both creditors and shareholders in the institution suffer if things go wrong.

    SO - even if it does seem like encouraging 'socially harmful risk-taking', we need to bite the bullet because we need to protect the individuals affected in the event of a collapse of a financial institution - it is indeed rational (= sensible, reasonable and logical) to do so!
    Last edited by David L.; 25-Jul-2008 at 10:23.

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