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The Old Days. Mortgage. $. 1930s Principles. Federal government guarantees deposits, to create confidence in the banking system In return, the banks accept federal regulations on what they can do (to prevent “moral hazard”) Size of a bank is limited. The Financial Crisis (a very quick view). - PowerPoint PPT Presentation
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The Old DaysThe Old Days
11
$
Mortgage
1930s Principles1930s Principles
Federal government guarantees Federal government guarantees deposits, to create confidence deposits, to create confidence in the banking systemin the banking system
In return, the banks accept In return, the banks accept federal regulations on what they federal regulations on what they can do (to prevent “moral can do (to prevent “moral hazard”)hazard”)
Size of a bank is limitedSize of a bank is limited22
The Financial Crisis (a The Financial Crisis (a very quick view)very quick view)
I.I.The build up (1980s – 2008)The build up (1980s – 2008)II.II.The end of the party (Sept-Oct The end of the party (Sept-Oct 2008)2008)
III.III.The responses (2008-present)The responses (2008-present)
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The Build-Up (1980s-The Build-Up (1980s-2008)2008)
Deregulation of finance (“free Deregulation of finance (“free market” ideology)market” ideology)
44
Financial DeregulationFinancial Deregulation
Gramm-Leach Bliley replaces Gramm-Leach Bliley replaces Glass Steagall in 1998Glass Steagall in 1998
Commodities Futures Commodities Futures Modernization Act (1999)Modernization Act (1999)
Sarbanes Oxley Rule (2002)Sarbanes Oxley Rule (2002) SEC deregulation of brokers SEC deregulation of brokers (2004)(2004)
The Build-Up (1980s-The Build-Up (1980s-2008)2008)
Deregulation of finance (“free Deregulation of finance (“free market” ideology)market” ideology)
Rise of complex “financial Rise of complex “financial derivatives” and “securitization”derivatives” and “securitization”
66
Mortgage-backed Mortgage-backed Securities MBS Securities MBS
Collateralized Debt Collateralized Debt Obligation, CDOObligation, CDO
A big bunch of mortgages (or A big bunch of mortgages (or other assets) packaged together other assets) packaged together and sold to investorsand sold to investors
77
OriginatorOriginator(e.g. Countrywide)(e.g. Countrywide)
Home BuyerHome Buyer
Investment Bank Investment Bank (e.g. Goldman-Sachs)(e.g. Goldman-Sachs)
Rating agencyRating agencyInstitutionalInstitutional
investorinvestor
End lendersEnd lenders
Insurance company Insurance company (e.g. AIG)(e.g. AIG)
Mortgage Broker Mortgage Broker
ServicerServicer(MERS)(MERS)
Assigns credit rating to Assigns credit rating to issued MBSs and CDOs. Is issued MBSs and CDOs. Is paid by paid by the issuer of the the issuer of the security it is rating. security it is rating.
Creates Creates MBSs and MBSs and CDOsCDOs
Gets a Gets a fee fee for every for every mortgage made!mortgage made!
Manages the Manages the flow of flow of interest and interest and principalprincipal
Specialized Specialized mortgage bankmortgage bank
Mutual funds, Mutual funds, pension funds, pension funds, hedge funds…hedge funds…
Creates Credit Creates Credit Default Swaps Default Swaps
Federal Reserve, Federal Reserve, other regulatory other regulatory
agencies, agencies, administration, administration,
CongressCongress
Deregulates the Deregulates the industryindustry
The Build-Up (1980s-The Build-Up (1980s-2008)2008)
Deregulation of finance (“free market” Deregulation of finance (“free market” ideology)ideology)
Rise of complex “financial derivatives” and Rise of complex “financial derivatives” and “securitization”“securitization”
Increasing concentration of the financial Increasing concentration of the financial industryindustry
Increasingly close government-finance industry Increasingly close government-finance industry tiesties
Enormous profits and bonusesEnormous profits and bonuses Praised by many economists as healthy, Praised by many economists as healthy, contributing to stability, etc.contributing to stability, etc.
99
19991999
1010
ProblemsProblems
Sub-prime loans (predatory Sub-prime loans (predatory lending) fuels housing bubblelending) fuels housing bubble
1111
OriginatorOriginator(e.g. Countrywide)(e.g. Countrywide)
Home BuyerHome Buyer
Investment Bank Investment Bank (e.g. Goldman-Sachs)(e.g. Goldman-Sachs)
Rating agencyRating agencyInstitutionalInstitutional
investorinvestor
End lendersEnd lenders
Insurance company Insurance company (e.g. AIG)(e.g. AIG)
Mortgage Broker Mortgage Broker
ServicerServicer(MERS)(MERS)
Assigns credit rating to Assigns credit rating to issued MBSs and CDOs. Is issued MBSs and CDOs. Is paid by paid by the issuer of the the issuer of the security it is rating. security it is rating.
Creates Creates MBSs and MBSs and CDOsCDOs
Gets a Gets a fee fee for every for every mortgage made!mortgage made!
Manages the Manages the flow of flow of interest and interest and principalprincipal
Specialized Specialized mortgage bankmortgage bank
Mutual funds, Mutual funds, pension funds, pension funds, hedge funds…hedge funds…
Creates Credit Creates Credit Default Swaps Default Swaps
Federal Reserve, Federal Reserve, other regulatory other regulatory
agencies, agencies, administration, administration,
CongressCongress
Deregulates the Deregulates the industryindustry
Housing Housing Price Price
BubbleBubble
ProblemsProblems
Sub-prime loans (predatory Sub-prime loans (predatory lending) fuels housing bubblelending) fuels housing bubble
Rating agencies give CDOs AAA Rating agencies give CDOs AAA ratingsratings
1414
OriginatorOriginator(e.g. Countrywide)(e.g. Countrywide)
Home BuyerHome Buyer
Investment Bank Investment Bank (e.g. Goldman-Sachs)(e.g. Goldman-Sachs)
Rating agencyRating agencyInstitutionalInstitutional
investorinvestor
End lendersEnd lenders
Insurance company Insurance company (e.g. AIG)(e.g. AIG)
Mortgage Broker Mortgage Broker
ServicerServicer(MERS)(MERS)
Assigns credit rating to Assigns credit rating to issued MBSs and CDOs. Is issued MBSs and CDOs. Is paid by paid by the issuer of the the issuer of the security it is rating. security it is rating.
Creates Creates MBSs and MBSs and CDOsCDOs
Gets a Gets a fee fee for every for every mortgage made!mortgage made!
Manages the Manages the flow of flow of interest and interest and principalprincipal
Specialized Specialized mortgage bankmortgage bank
Mutual funds, Mutual funds, pension funds, pension funds, hedge funds…hedge funds…
Creates Credit Creates Credit Default Swaps Default Swaps
Federal Reserve, Federal Reserve, other regulatory other regulatory
agencies, agencies, administration, administration,
CongressCongress
Deregulates the Deregulates the industryindustry
ProblemsProblems
Sub-prime loans (predatory Sub-prime loans (predatory lending) fuels housing bubblelending) fuels housing bubble
Rating agencies give CDOs AAA Rating agencies give CDOs AAA ratingsratings
Credit default swaps become an Credit default swaps become an enormous casinoenormous casino
1616
OriginatorOriginator(e.g. Countrywide)(e.g. Countrywide)
Home BuyerHome Buyer
Investment Bank Investment Bank (e.g. Goldman-Sachs)(e.g. Goldman-Sachs)
Rating agencyRating agencyInstitutionalInstitutional
investorinvestor
End lendersEnd lenders
Insurance company Insurance company (e.g. AIG)(e.g. AIG)
Mortgage Broker Mortgage Broker
ServicerServicer(MERS)(MERS)
Assigns credit rating to Assigns credit rating to issued MBSs and CDOs. Is issued MBSs and CDOs. Is paid by paid by the issuer of the the issuer of the security it is rating. security it is rating.
Creates Creates MBSs and MBSs and CDOsCDOs
Gets a Gets a fee fee for every for every mortgage made!mortgage made!
Manages the Manages the flow of flow of interest and interest and principalprincipal
Specialized Specialized mortgage bankmortgage bank
Mutual funds, Mutual funds, pension funds, pension funds, hedge funds…hedge funds…
Creates Credit Creates Credit Default Swaps Default Swaps
Federal Reserve, Federal Reserve, other regulatory other regulatory
agencies, agencies, administration, administration,
CongressCongress
Deregulates the Deregulates the industryindustry
Credit Default Swap Credit Default Swap (CDS)(CDS)
Like an insurance policy for Like an insurance policy for CDO/MBS. CDO/MBS.
But not called “insurance,” But not called “insurance,” since that would be regulated!since that would be regulated!
One doesn’t need to actually own One doesn’t need to actually own any CDO/MBS to buy CDS, so it any CDO/MBS to buy CDS, so it becomes a huge vehicle for becomes a huge vehicle for speculation.speculation.
1818
The CDS Market
ProblemsProblems
Sub-prime loans (predatory Sub-prime loans (predatory lending) fuels housing bubblelending) fuels housing bubble
Rating agencies give CDOs AAA Rating agencies give CDOs AAA ratingsratings
Credit default swaps become an Credit default swaps become an enormous casinoenormous casino
Leaders move back and forth from Leaders move back and forth from Wall Street to federal governmentWall Street to federal government
2020
The End of the Party The End of the Party (Sept-Oct 2008)(Sept-Oct 2008)
Housing prices have fallenHousing prices have fallen
2121
The End of the PartyThe End of the Party Housing prices have fallenHousing prices have fallen Trillions of $ of assets evaporateTrillions of $ of assets evaporate Fannie Mae and Freddie Mac nationalizedFannie Mae and Freddie Mac nationalized Lehman Brothers goes bankruptLehman Brothers goes bankrupt Government bails out AIGGovernment bails out AIG Merrill Lynch soldMerrill Lynch sold Financial markets freeze upFinancial markets freeze up Government announces TARP (Troubled Government announces TARP (Troubled Asset Relief Program) to prop up banksAsset Relief Program) to prop up banks
2323
2424
The ResponsesThe Responses
TARP bails out “too big to fail” TARP bails out “too big to fail” investment banks (Citigroup, BofA, investment banks (Citigroup, BofA, Goldman Sachs…)Goldman Sachs…)
Recoup bonuses paid? Only talked about.Recoup bonuses paid? Only talked about. Re-regulation of banks, rating Re-regulation of banks, rating agencies, etc? Not much. agencies, etc? Not much.
Criminal prosecutions? Still waiting…Criminal prosecutions? Still waiting… Help for homeowners under water? Not Help for homeowners under water? Not much. (And MERS, foreclosure mess)much. (And MERS, foreclosure mess)
2525
20102010
2626
OriginatorOriginator(e.g. Countrywide)(e.g. Countrywide)
Home BuyerHome Buyer
Investment Bank Investment Bank (e.g. Goldman-Sachs)(e.g. Goldman-Sachs)
Rating agencyRating agencyInstitutionalInstitutional
investorinvestor
End lendersEnd lenders
Insurance company Insurance company (e.g. AIG)(e.g. AIG)
Mortgage Broker Mortgage Broker
ServicerServicer(MERS)(MERS)
Assigns credit rating to Assigns credit rating to issued MBSs and CDOs. Is issued MBSs and CDOs. Is paid by paid by the issuer of the the issuer of the security it is rating. security it is rating.
Creates Creates MBSs and MBSs and CDOsCDOs
Gets a Gets a fee fee for every for every mortgage made!mortgage made!
Manages the Manages the flow of flow of interest and interest and principalprincipal
Specialized Specialized mortgage bankmortgage bank
Mutual funds, Mutual funds, pension funds, pension funds, hedge funds…hedge funds…
Creates Credit Creates Credit Default Swaps Default Swaps
Federal Reserve, Federal Reserve, other regulatory other regulatory
agencies, agencies, administration, administration,
CongressCongress
Deregulates the Deregulates the industryindustry