BFIN 2123 Assignment

The banking industry crisis addressed in the “Bad Bank” podcast was primarily a “balance sheet” problem. In its most basic form, the dilemma that was faced and that served as a catalyst of the crisis was the inability of banks to cover their liabilities with their troubled assets. This led to an imbalance in the balance sheet where liabilities (initial capital and deposits) significantly exceeded assets (loans or foreclosed assets at a diminished market value) resulting, in many cases, in insolvency. The problem arose from unjustified lending practices which led to unqualified consumer mortgages that were defaulted upon, leading to the inability of deposits and capital to match the foreclosed assets which had a diminished value compared with that of when the loan was commissioned. Furthermore, the perception of the banks and federal government that the market was nearing a turnaround led to a cyclical worsening of the crisis since balance sheets sustained an inflated market value of the toxic assets as the government was slow to intervene while allowing the banks to continue this inaccurate accounting practice. Federal initiatives such as TARP would only serve to defer the burden from the banks to the taxpayers, thus contributing to the severe financial crisis faced in 2008. The Citibank and hypothetical “dollhouse” examples both demonstrate the aforementioned erroneous balance sheet issues. The former displays how a major player in the banking industry reported its capital at fifteen times the value set forth by the market according to the value of its outstanding shares, while the latter conveys the issue on a far more simplistic single transaction scale. In both cases, the unwillingness of both the banks and government to recognize current market values, while expecting values to rise towards previous levels, exacerbated the problem