Econ Money and Banking

The Evils of

Investment Banking

(ECON 321, Money and Banking)

The Evils of

Investment Banking

(ECON 321, Money and Banking)

Throughout history, there have been major problems involving investment banks. The current economic collapse has brought light upon some of these issues that have been previously ignored by the general public until now. Some of the major problems include, but are not limited to, inability to correctly predict risk, taking unnecessary risks, and inability of properly using risk diversification. Investment bankers are notoriously greedy, but all of these problems could be solved by stopping government bailouts. With the recent issues in our economy, it may be time to look more closely on how to change the financial investing world.

One of the biggest problems recently realized about investment banking is their inability to correctly predict risk. In 2007, the mortgage market began its downward spiral. Before this time, the housing economy was booming. Housing prices hit a peak in early 2006. By December 2008, the Case-Schiller home price index reported the largest price drop in homes in the history of the United States. It seemed as if though, out of thin air, one of the most profitable industries for the past few years had come to a screeching halt.

The housing market was fueled by the perpetual speculation that houses bought now (or in 2006-2007) would always continue to appreciate in value, thus creating a major profit when sold in the future. Nobody stopped to think about what would happen if housing prices actually declined. This caused a massive home buying spree. People who were only making $50,000 a year would be willing to buy a home for $50 million as long as a bank would lend them the money. They never in a million years would have thought that housing prices would decline, so if they could obtain a loan at 7% and their house would presumably appreciate in value by 15%, this was a good investment for the individual...