Information Asymmetry and the Recent Financial Crisis

Abstract

The financial crisis of 2008 was preceded by smaller crises that also produced substantial levels of systemic risk. In addition to their impact on global markets, these lesser events shared several symptoms with the ones that later caused the Great Recession. If regulators and supervisors of the financial industry are to avoid future predicaments, they must monitor indicators beyond the traditional economic parameters. The goal of this paper is to discuss factors that prevented financial regulators from acting on deficiencies found in the financial sector before and during the most recent global financial crisis of 2008. In retrospect, we found that behavioral trends observed during the liquidation of Long-Term Capital Management, a massive hedge fund that failed in 1998 should have warned the regulators about potential risks that were clearly detected in 2008. The inquiry questions on this paper are answered through the analyses of three cases, Long-Term characterizing the crisis of 1998, and Bear Stearns and Lehman Brothers, investment banks that epitomized the global crisis of 2008. The result of this investigative study shows that several behaviors portrayed by regulators and financial executives throughout the period enabled the chain of events that culminated with the global crisis. This paper analyzes one of them: information asymmetry.