Unit 7 Part 1 Please write an essay based on the following questions: l Why are financial intermediaries so crucial to well-functioning financial markets? l Why do they extend credit to one party but not to another? l Why do they usually write complicated legal documents when they extend loans? l Why are they the most heavily regulated businesses in the economy? Case study: The Enron Implosion Until 2001, Enron Corporation, a firm that specialized in trading in the energy market, appeared to be spectacularly successful. It controlled a quarter of the energy-trading market and was valued as high as $77 billion in August 2000 (just a little over a year before its collapse), making it the seventh-largest corporation in the United States at that time. However, toward the end of 2001, Enron came crashing down. In October 2001, Enron announced a third-quarter loss of $618 million and disclosed accounting “mistakes.” The SEC then engaged in a formal investigation of Enron’s financial dealings with partnerships led by its former finance chief. It became clear that Enron was engaged in a complex set of transactions by which it was keeping substantial amounts of debt and financial contracts off its balance sheet. These transactions enabled Enron to hide its financial difficulties. Despite securing as much as $1.5 billion of new financing from J. P. Morgan Chase and Citigroup, the company was forced to declare bankruptcy in December 2001, up to that point the largest bankruptcy declaration in U.S. history. The Enron collapse illustrates that government regulation can lessen asymmetric information problems but cannot eliminate them. Managers have tremendous incentives to hide their companies’ problems, making it hard for investors to know the true value of firms. The Enron bankruptcy not only increased concerns in financial markets about the quality of accounting information supplied by corporations, but also led to hardship for many of the firm’s former employees, who found that their pensions had become worthless. Outrage against the duplicity of executives at Enron was high, and several of them were convicted and sent to jail. Please answer the following questions: How can asymmetric information problems lead to a bank panic? “ The more collateral there is backing a loan, the less the lender has to worry about adverse selection.” Is this statement true, false, or uncertain? Explain your answer