The country of Utopia is experiencing a full blown financial crisis Use the labe
ID: 1208042 • Letter: T
Question
The country of Utopia is experiencing a full blown financial crisis Use the labels to identify the various aspects of the situation. The Crisis The Investment Bank of Utopia (IBU) has invested heavily in gold because its price had been rising sharply However, extensive new gold deposits have been found in nearby Paradise, and the price of gold now falls precipitously The IBU finds that the price of gold has fallen so low. the bank actually owes more on the loans it took on to buy the gold than the gold is worth. The IBU's level of debt needs to be reduced, and it has no choice but to sell as many assets as possible to come up with the funds. The IBU asks the Utopian Central Bank, the government banking authority, to help IBU by loaning it funds to pay off the debts. The Central Bank officials do not make the loans believing it better to allow market forces to control the banking sector So many banks are selling assets to pay off gold debts, the prices of other assets have fallen as well Even though the Utopian National Bank did not buy gold, it finds itself also facing lower asset values, leaving it also short of funds.Explanation / Answer
1. debt overhang: The IBU finds that the price of gold has fallen so low, the bank actually owes more on the loans it took on to buy the gold than the gold is worth
2. deleveraging: The IBU'S level of debt needs to be reduced, and it has no choice but to sell as many assets as possible to come up with the funds
3. Lender of Last Resort: The IBU asks the Utopian Central Bank, the government banking authority, to help IBU by loaning it funds to pay off the debts.
4. Laissez-Faire: The Central Bank officials do not make the loans believing it better to allow market forces to control the banking sector
5. Financial contagion: So many banks are selling assets to pay off gold debts, the prices of assets have fallen as well. Even though the Utopian National Bank did not buy gold, it finds itself also facing lower asset values, leaving it also short of funds
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