Money and Capital Markets Essay

Ryan Reynolds

FIN 3244

Essay 4

A) Due to the recession, banks have been observed much more closely over the past few years and their return and profitability have been tracked and measured much more than in depth. Specifically their return on assets which have been a key component of the bank failures. Return on assets (ROA) can best be measured by dividing net income after taxes by assets. When reviewing the quarterly banking profile found on FDIC website, ROA remained relatively constant from 2003 up until 2006 and then decreased from 2006 to 2008. It increased slightly from 2008 to 2009. This decrease in ROA had a lot to do with toxic assets, which I will discuss in the following paragraph.

A bank’s assets consist of reserves, securities, loans and other assets. Reserves and securities are relatively liquid and low risk while loans are associated with high risk and low liquidity for a bank. The recession has showed us that many banks have been issuing loans to high-risk creditors that have turned into toxic assets. When a loan becomes a bad asset also referred to as a toxic asset, the bank is unable to gain income off it, causing the net income after taxes to decrease. When net income decreases, ROA decreases. Real estate loans are a good example of a toxic asset and were a key factor in the recession and the closing of banks. The housing boom started in the mid decade causing everyone to become caught up in the act of flipping houses. Flipping houses means that someone could buy a house and then turn around and sell it at a higher price for a profit. As with any booming industry, profits that are easy to make will not last long. Borrowers who should not have received loans received them because they were convinced they could flip a house and make a profit. Bankers were caught up in the real estate boom and were putting the majority of their loans into real estate. These bankers were also giving loans out to bad creditors with no collateral because they...