Shivansh Khattri (MBA06, IIM Amritsar

Shivansh Khattri

MBA 06 IIM Amritsar

The Financial Crisis of 2008

"Money in the bank is like toothpaste in the tube. Easy to take out, hard to put back." This quotation by Earl Wilson highlights one of the most pervasive issues around the globe inundating even the smartest individual with the inevitable debt.

Banking Sector is devoted to holding and investing of financial assets. Commercial Banks engage themselves in loan-making and deposit-taking providing services to individuals and businesses. Investment Banks offer services to institutional investors and large companies acting as an intermediary between investors in securities and issuers of securities. There also exists a third category of banks, the infamous Universal Banks which offer services of both, Commercial and Investment Banks. Going back in time to 1933 when The Glass-Steagall Act was passed as a response to the crisis of the 1920's. The purpose of the act was to prevent fraud. The precursor to today's Citibank, The National City Bank failed to reveal negative information pertaining to bad Latin American loans which it sold to investors. There was a widespread condemnation. An act was passed to curb a number of abuses including the investment of their own assets in securities by banks which consequently risked their deposits. However, the act is remembered primarily for forcing banks to choose between commercial banking and investment banking. Fast forward to 1999 when the increasingly competitive financial environment led to relaxations in the provision of the act that inhibited the mingling of commercial and investment banks. A midnight deal was struck to promote the soundness of US banks and to ensure the protection of consumers' rights. Consequently, many commercial banks merged with investment banks and many investment banks diversified their financial services. The very purpose of enactment of the Glass-Steagall Act became the purpose of its repeal allowing banks to become "too big to fail".

The financial crisis that occurred in 2008 illustrated the delicate ties that exist between the financial side and the real side of the economy. The collapse of the 'dot-com bubble' in the early years of the century led to macroeconomic threat and emergent recession. The bubble that was created as a result of growing speculation-based investments based on faulty assumptions in Internet-based companies in the late 1990s ultimately burst when the capital dried up. Investors were overlooking the traditional valuation fundamentals. The consequent stock market crash forced many companies to shut down. The Federal Reserve responded by reducing interest rates aggressively. The LIBOR rate fell. The economy was healthy again. This combination of drastically reduced interest rates and a stable economy led to an unprecedented boom in the housing market. The housing prices in the US rose noticeably and accelerated dramatically as rates of interest plummeted. This made investors hungry for higher-yielding alternatives. These hungry investors preyed upon the bright macroeconomic prospects and enhanced their risk tolerance levels.