US Financial Crisis: US Banking Sector at Crossroads?



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Code : ECC0023

Year :
2008

Industry : Banking, Insurance and Financial Services

Region : US

Teaching Note: Available

Structured Assignment : Available

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Investment Banking: Is the Road Closed? Looking into the roots of the problem, the drop-off inmortgage-backed securities and asset erosion led to troublesome situation within the I-banks. These banks, which had broughtmortgage-backed loans fromother US financial institutions, majorly banks, converted them into Collateralised Debt Obligations (CDOs) and sold them to investors. I-banks also invested some part of their own capital to hold CDOs. These CDOs were insured withAmerican International Group Inc. (AIG), a leading US insurance company, and were called Credit Default Swaps (CDSs). Things were running smoothly for I-banks until the value of the houses kept rising (The rise in the value of securities enables I-banks to sell them and provide additional debt tomortgage lenders to issue freshmortgages).

Universal Banking Universal banks provide different services under one roof, hence referred to as one-stop shop. They hold claims on other companies' equity and debt and also engage in corporate governancematters of the firms that depend on these banks for funds or for insurance under-writing. This bankingmodel gainedmomentumafter theGlass-SteagallAct was repealed in 1999.

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US Financial Crisis: Involvement of Universal Banks However, the big banksmisused the new liberty to certain extent and attracted criticism from many quarters. Robert Kuttner, an economics journalist opined, "Since repeal of Glass-Steagall in 1999, after more than a decade of de facto inroads, super-banks have been able to re-enact the same kinds of structural conflicts of interest that were endemic in the 1920s lending to speculators, packaging and securitising credits and then selling themoff,wholesale or retail, and extracting fees at every step along the way.Andmuch of this paper is evenmore opaque to bank examiners than its counterpartswere in the 1920s."


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