Question

3. During the 2008 Financial Crisis, the US government and the Federal Reserve had three options in dealing with failing financial institutions. Using the concepts covered in our lectures, discuss the advantages and disadvantages of each option.

A. Arranging an acquisition of a failing financial institution (e.g. Bear Stearns)

B. Bailing out a failing financial institution (e.g. AIG, Fannie and Freddie)

C. Letting a failing financial institution declare bankruptcy (e.g. Lehman)

Answer 1

Below, I have listed advantages and Disadvantages of each 3 options while dealing with failing financial institutions :-

(1) Arranging an acquisition of a failing financial institutions as Bear Sterns :-

It's Advantage :- Economic Stability- It help in minimizing the adverse effects of an institutions failure on a community by maintaining access to it's full service.

It's disadvantage :- Compliance and risk Consistency as Acquisition of a failing financial institutions is a very complex process and when two mismatched risk cultures clashed, it may negatively affects the profitability down the road.

(2). Bailing out a Failing Financial Institutions as AIG, Fannie and Freddie :-

It's Advantages :- It will restore Liquidity, It will avert another major Financial institution collapse and it may not end up being as costly as feared.

It's Disadvantages :- It is hugely expensive & this deal is a nationalisation on a grand scale.

(3). Letting a failing financial institution declare bankruptcy as Lehman :-

It's Advantages :- Outstanding debts are written off, Legal Action is halted, Leases can be cancelled and relatively low costs are involved.

It's Disadvantages :- Most debt from taxes will not be discarded. Declaring bankruptcy now may make it harder to declare it later, if something worse happens down the road. Also there are too many negative perceptions surrounding bankruptcy.

So, these are some advantages and disadvantages of each three options (referred above) in dealing with failing financial institutions.