the old days

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 federal regulations on what they can do (to prevent “moral they can do (to prevent “moral hazard”)hazard”)

Size of a bank is limitedSize of a bank is limited

22

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)

33

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)


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


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 Increasingly close government-finance industry tiesindustry ties

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





investorinvestor














CongressCongress


Housing Housing Price Price

BubbleBubble

ProblemsProblems


Rating agencies give CDOs AAA Rating agencies give CDOs AAA ratingsratings

1414





investorinvestor














CongressCongress


ProblemsProblems



Credit default swaps become an Credit default swaps become an enormous casinoenormous casino

1616





investorinvestor














CongressCongress


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 One doesn’t need to actually own any CDO/MBS to buy CDS, so own any CDO/MBS to buy CDS, so it becomes a huge vehicle for it becomes a huge vehicle for speculation.speculation.

1818

The CDS Market

ProblemsProblems



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

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





investorinvestor














CongressCongress


the old days

Documents

pension funds

regulatory agencies

financial crisis

federal regulations

sec deregulation of

industrythe buildup

sarbanes oxley rule

glass steagall