Essay on Money and Banking

Words: 881
Pages: 4

1. Briefly explain the rise and fall of LTCM. What was the moral hazard issue the fed was worried about? How did they try and get around the moral hazard issue? What specifically was the Fed's role in the bailout? What roles specifically did Bear play and not play in the LTCM's life and death?
LTCM’s board of directors included many geniuses in from the financial world, who collectively created complex models allowed them to calculate risk of securities much more accurately than others. LTCM’s trading strategy was featured by the divergence in price between long-term U.S. Treasury bonds. It shorted the more expensive “on-the-run” bond and purchased the “off-the-run” security at the same time to exploit the price divergence. In order
…show more content…
Even in the case of a collapse of such businesses, it would not have the same contagion effect as in the case of a collapse of a large investment bank that has interconnection with a large part of the financial system. This could actually cause bankruptcy.

3. Compare and contrast Bear's demise to a traditional bank run. How did a "run on the bank" cause the demise of Bear?
Bear’s demise differs from a traditional bank run in terms of two aspects. First of all, the major participants are different. While unsophisticated investors like us tend to be the ones demanding our deposits in a traditional bank run, institutions like hedge funds and firms are the ones asking back money from Bear. Secondly, the deposits in the bank are now insured up to $250,000 by FDIC but the funds invested in Bear is not. Thus, this makes a “bank run” on Bear more likely to erupt, even to the slightest rumor. Furthermore, the investors are more concerned about how much Bear takes, opposing to a common depositor.

The rumor about Bears having a liquidity problem set off the series of bank run and later pushed Bear into demise. First, it were the major banks that started the explosion of “novation requests,” acting as a bad signal and support for the rumor. Then live interview from Bear’s annual media conference triggered the run from hedge funds. Hedge funds were pulling money out from their accounts. Furthermore, repo lenders started to refuse to renew borrowings, which