The Global Financial Crisis (GFC) was initially spurred by a bubble of subprime mortgages (mortgages made to those with poor credit ratings) made by the banking sector, with difficulties in repaying these loans causing a high delinquency rate (rate of overdue payments) which ultimately devalued these loans.
In this activity, we will be walking through the steps that lead to a crisis using the example of the ‘Lowman Brothers Bank’.
Lowman Brothers Bank 2008
Assets (millions of $) Liabilities and Equity (millions of $)
Reserves 20 Deposits 340
Securities 20 Equity
Loans 500
TOTAL ASSETS 540 TOTAL LIABILITIES & EQUITY
a) What do each of the items on the balance sheet describe?
b) Fill in the values for ‘Equity’ and ‘Total Liabilities and Equity’
c) It is now revealed that Lowman Brothers has been making loans which will not be repaid and a ‘write down’ occurs where half of the total value of Lowman Brothers’ loans will not be repaid. Depict this change in the balance sheet.
d) The bank is technically insolvent (its liabilities exceed its assets or has negative equity). It now has 3 options to undertake. What are these?
e) If Lowman Brothers Bank is ‘too big to fail’, what are the desired options? Depict how these can restore positive equity to the balance sheet.