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The High Frequency Game Changer: How Automated Trading Strategies Have Revolutionized the Markets by Sang Lee, Paul Zubulake

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Chapter 8

Credit Crisis of 2008

The Blame Game

The financial crisis of 2008 was a perfect storm, with much finger-pointing toward responsible parties. While no one contributor was solely responsible, all participants—the U.S. Federal Reserve (Fed), regulatory agencies, credit agencies, politicians, and the end-users and institutions that brokered such deals—need to reflect and make changes to decrease the likelihood of another economic collapse.

U.S. FEDERAL RESERVE

The Fed's monetary policy over the last 20 years has never been described as tight. The Goldilocks economy pursued by the Fed in the mid- to late- 1990s tried to produce consistent growth with little inflation. This, of course is a logical goal, but the reality is the hardest decision a central bank needs to make is to raise interest rates in the anticipation of an economic crisis or a market bubble.

The New York Federal Reserve's bailout of Long Term Capital in 1998 set a terrible precedent, creating a mind-set that any fund or a firm deemed by the market as “too big too fail” would be backed by the Fed, despite any bad loans or investments. This mentality inspired additional risk-taking by hedge funds and Wall Street firms. Counterparty risk—which should be to investors the number one priority—was perceived as less of an issue, so long as the investor and the trading partner fell into the systemic risk category.

REGULATORY AGENCIES

Underfunded and fragmented, regulatory agencies failed in their role of protecting ...

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