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Sophia Wang

Definitions - 98 views

Alpha and Beta accutally have interesting meanings in business. Alpha 1. A measure of performance on a risk-adjusted basis. Alpha takes the volatility (price risk) of a mutual fund and compares it...

financial crisis definitions

started by Ms Cuttle on 12 Dec 10 36 follow-ups, last by Sophia Wang on 14 Jan 11
Ariel Shain

Who Is To Blame For The Subprime Crisis? - 0 views

www.investopedia.com/...subprime-blame.asp

financial crisis what caused economics blame

shared by Ariel Shain on 12 Jan 11 - No Cached
  • In the instance of subprime mortgage woes, there is no single entity or individual to point the finger at. Instead, this mess is a collective creation of the world's central banks, homeowners, lenders, credit rating agencies and underwriters, and investors.
  • Biggest Culprit: The LendersMost of the blame should be pointed at the mortgage originators (lenders) for creating these problems. It was the lenders who ultimately lent funds to people with poor credit and a high risk of default.
  • When the central banks flooded the markets with capital liquidity, it not only lowered interest rates, it also broadly depressed risk premiums as investors sought riskier opportunities to bolster their investment returns. At the same time, lenders found themselves with ample capital to lend and, like investors, an increased willingness to undertake additional risk to increase their investment returns.
  • ...12 more annotations...
  • Lenders lost money on defaulted mortgages as they were increasingly left with property that was worth less than the amount originally loaned. In many cases, the losses were large enough to result in bankruptcy.
  • Partner In Crime: HomebuyersWhile we're on the topic of lenders, we should also mention the home buyers. Many were playing an extremely risky game by buying houses they could barely afford. They were able to make these purchases with non-traditional mortgages
  • However, instead of continued appreciation, the housing bubble burst, and prices dropped rapidly
  • As a result, when their mortgages reset, many homeowners were unable to refinance their mortgages to lower rates, as there was no equity being created as housing prices fell. They were, therefore, forced to reset their mortgage at higher rates, which many could not afford. Many homeowners were simply forced to default on their mortgages. Foreclosures continued to increase through 2006 and 2007.
  • subprime mortgage originations grew from $173 billion in 2001 to a record level of $665 billion in 2005, which represented an increase of nearly 300%. There is a clear relationship between the liquidity following September 11, 2001, and subprime loan originations
  • a collateralized debt obligation (CDO). In this process, investment banks would buy the mortgages from lenders and securitize these mortgages into bonds, which were sold to investors through CDOs.The chart below demonstrates the incredible increase in global CDOs issues in 2006.
  • Investment Banks Worsen the SituationThe increased use of the secondary mortgage market by lenders added to the number of subprime loans lenders could originate. Instead of holding the originated mortgages on their books, lenders were able to simply sell off the mortgages in the secondary market and collect the originating fees. This freed up more capital for even more lending, which increased liquidity even more. The snowball began to build momentum.
  • Rating Agencies: Possible Conflict of InterestA lot of criticism has been directed at the rating agencies and underwriters of the CDOs and other mortgage-backed securities that included subprime loans in their mortgage pools. Some argue that the rating agencies should have foreseen the high default rates for subprime borrowers, and they should have given these CDOs much lower ratings than the 'AAA' rating given to the higher quality tranches. If the ratings had been more accurate, fewer investors would have bought into these securities, and the losses may not have been as bad.
  • The argument is that rating agencies were enticed to give better ratings in order to continue receiving service fees, or they run the risk of the underwriter going to a different rating agency
  • Fuel to the Fire: Investor BehaviorJust as the homeowners are to blame for their purchases gone wrong, much of the blame also must be placed on those who invested in CDOs. Investors were the ones willing to purchase these CDOs at ridiculously low premiums over Treasury bonds. These enticingly low rates are what ultimately led to such huge demand for subprime loans.
  • Final Culprit: Hedge FundsAnother party that added to the mess was the hedge fund industry. It aggravated the problem not only by pushing rates lower, but also by fueling the market volatility that caused investor losses. The failures of a few investment managers also contributed to the problem.
  • there is a type of hedge fund strategy that can be best described as "credit arbitrage". It involves purchasing subprime bonds on credit and hedging these positions with credit default swaps. This amplified demand for CDOs; by using leverage, a fund could purchase a lot more CDOs and bonds than it could with existing capital alone, pushing subprime interest rates lower and further fueling the problem.
Han Kyul Lee

Crisis Pie Infographic - 55 views

Rating agencies, sub-prime mortgage lenders and investment banks are DEFINITELY the biggest titles at fault. The main reasons have already been covered; rating agencies failed to rate the toxic ass...

financial crisis economics crisis blame Financial caused what pie infographic

started by Abdiwahab Ibrahim on 14 Jan 11 7 follow-ups, last by Han Kyul Lee on 19 Jan 11
Han Kyul Lee

America's foreclosure plan: Can't pay or Won't pay? | The Economist - 0 views

www.economist.com/...13145239

the financial crisis economics homeownership barack obama mortgages

shared by Han Kyul Lee on 10 Jan 11 - No Cached
  • Is it that homeowners cannot afford to pay; or is it that they are declining to do so, because their homes are now worth less than their mortgages, the phenomenon known as negative equity?
  • One school thinks that, even in cases of negative equity, most homeowners will not default if they can afford the payments—not least because defaulting will wreck their credit records.
  • A second school believes that once the home is worth less than the mortgage, homeowners have a significant incentive to walk away even if they can make the payment, since in many states lenders cannot then pursue them for the shortfall.
  • ...1 more annotation...
  • If negative equity is the real problem, principal will have to be reduced to stem the foreclosures. But lenders are reluctant: they worry that many homeowners who can afford their payments will choose to default, or that investors in the loans will sue them. With house prices still falling, many borrowers would soon have negative equity again.
  • Han Kyul Lee on 10 Jan 11
     
    Published February 19, 2009 Notes - Barack Obama pledges $75 billion to reduce the mortgage payments of homeowners at risk of default - A previous effort by George Bush, whose first plan was to help up to 240,000 subprime borrowers refinance their debts into goverment-backed, fixed-rate mortgages, resulting in only 4000 doing so - A Democrat-inspired plan of $300B to guarantee up to 400k mortgages only attracted 517 applications, since lenders were bugged because they had to first write down the principal - This is an issue of whether homeowners cannot afford to pay, or that they refuse to pay, since now their homes are worth less than their mortgages - Economists divide up their opinions - First school: even in cases of negative equity, most homeowners will not default should they be able to afford the payments - Second school: once the home is worth less than the mortgage, homeowners have a significant incentive to walk away from the payment, since lenders cannot then pursure them for the shortfall - Should negative equity be the real issue, the principal for the loans would have to be reduced, but lenders are reluctant as either the homeowners would choose to default or the investors would sue the lenders - House prices are still falling, so many homeowners are ought to have negative equity again
Tahmid Rouf

The financial crisis for dummies: Why Canada is immune from a U.S.-style mortgage meltd... - 0 views

network.nationalpost.com/...mortgage-meltdown-kind-of.aspx

financial crisis economics canada

shared by Tahmid Rouf on 12 Jan 11 - No Cached
  • very reassuring Sept. 25 report from Scotiabank that explains, quite persuasively, why Canada isn't going to suffer the same sort of subprime-mortgage-fueled financial-market meltdown that's wreaked so much havoc in the United States.
  • In Canada, household liabilities as a percentage of assets sits at 20% — close to the stable, sustainable level it's been at since the late 1980s.
  • Canada's subprime mortgage market (to the extent the bottom end of our mortgage market can even be called "subprime" in the American sense) represents only about one in every 20 mortgages.
  • ...7 more annotations...
  • In the United States, homeowners' net equity as a percentage of home value has plummeted from around 65% to 45% over the last two decades. with more than half that drop coming since 2000. In Canada, on the other hand, this ratio has remained stable at between 65% and 70% since the 1980s.
  • Less off-balance-sheet mortgages. The frenzy of mortgage securitization that gripped the United States in recent years (famously explained/satirized in this comic strip) never really took off here. According to Scotiabank "The majority of mortgages are held on balance sheet in Canada, with only 24% having been securitized." That's huge, because it is the radioactive quality of these securities — many of which contain a tangled welter of mortgages of varying quality — that has really sunk the U.S. credit market: Since no one knows how much these complex instruments are really worth, they still haven't established an equilibrium price level, thereby freezing the credit market for any entity that has a large number of them on their books. (What's more, even those 24% have mostly been securitized through the CMHC, a Crown corp. with government backing.)
  • Finally, there is the fact that Canada simply has a different — and more prudent — banking culture:
  • Canada banks continue to apply prudent underwriting standards. In other words, they have always checked, and continue to check, incomes, verify job status, asks for sales contracts, etc.,
  • On average, Canadian home prices are roughly 200% what they were in 1989. In the United States, the corresponding ratio peaked at 260% before crashing down to 220%.
  • This is the most shocking stat of all. In the United States, a full 4.5% of mortgages are in 90-day arrears (i.e. the local sheriff is ready to move in and tack a notice to the door). In Canada, the figure is one 20th that level — just 0.27%.
  • All in all, what do these figures show? A prudent, risk-averse, well-regulated Canadian real estate and mortgage community that — on both the seller, mortgagor and buyer sides — has avoided the pitfalls swallowing up the United states.
  • Tahmid Rouf on 12 Jan 11
     
    Very interesting. Highlights the main aspects that may have prevented us from being hit as hard as the States. It is important to note that our financial system is different in many aspects from the one in the states that triggered the recession.  This should be helpful for the housing/home-buyer people.
Jasmine Ding

Raters Ignored Proof of Unsafe Loans, Panel Is Told - NYTimes.com - 0 views

www.nytimes.com/...27ratings.html

Goldman Sachs financial crisis econ inquiry proof

shared by Jasmine Ding on 12 Jan 11 - No Cached
  • Yet, Clayton found, Wall Street was placing many of the troubled loans into bundles known as mortgage securities.
  • The Massachusetts attorney general recently accused Morgan Stanley of deceptive practices in its financing of mortgage lenders during this period, saying that the firm had knowingly placed dubious mortgages into securitized pools. Morgan Stanley settled with the attorney general in June and paid $102 million. The facts in that case relied on Clayton reports of loan quality commissioned by Morgan Stanley.
  • According to testimony last week, from January 2006 to June 2007, Clayton reviewed 911,000 loans for 23 investment or commercial banks, including Citigroup, Deutsche Bank, Goldman Sachs, UBS, Merrill Lynch, Bear Stearns and Morgan Stanley.
  • ...5 more annotations...
  • The statistics provided by these samples, according to Mr. Johnson and Vicki Beal, a senior vice president at Clayton who also testified before the inquiry commission, indicated that only 54 percent of the loans met the lenders’ underwriting standards, regardless of how stringent or weak they were.
  • Some 28 percent of the loans sampled over the period were outright failures — that is, they were unable to meet numerous underwriting standards and did not have positive factors that compensated for their failings. And yet, 39 percent of these troubled loans still went into mortgage pools sold to investors during the period, Clayton’s figures showed.
  • At Goldman Sachs, 19 percent of loans failed to make the grade in the final quarter of 2006 and the first half of 2007, but 34 percent of those loans were still sold by the firm. Throughout this period, Goldman Sachs was also betting against the mortgage market for its own account, according to documents provided to government investigators.
  • A Goldman Sachs spokesman said the percentage of deficient loans that went into its pools was smaller than Clayton’s average, indicating that the firm had done a better job than its peers. Because these loan samples were provided to the Wall Street investment banks that commissioned them, they could see throughout 2006 and into 2007 that the mortgages they were financing and selling to investors were becoming increasingly sketchy.
  • A more proper procedure, analysts said, would have been for lenders like these — New Century Financial and Fremont Investment and Loan among them — to buy back the problem loans and replace them with higher-quality mortgages. But because these companies did not have enough capital to do that, they were happy to sell the troubled mortgages cheaply to the brokerage firms.
  • Jasmine Ding on 12 Jan 11
     
    "The commission, a bipartisan Congressional panel, has been holding hearings on the origins of the financial crisis. D. Keith Johnson, a former president of Clayton Holdings, a company that analyzed mortgage pools for the Wall Street firms that sold them, told the commission on Thursday that almost half the mortgages Clayton sampled from the beginning of 2006 through June 2007 failed to meet crucial quality benchmarks that banks had promised to investors. "
Ariel Shain

What Caused the Current Financial Crisis? - 0 views

www.stock-market-investors.com/...-current-financial-crisis.html

financial crisis what caused economics blame

shared by Ariel Shain on 12 Jan 11 - Cached
  • This was the case with the real estate bubble too and that was one of the main factors leading to the current financial crisis: the excess capital globally pushed an enormous amount of money into the US mortgage market thanks to the securitization and the fact that almost 80% of the US mortgage market is securitized.
  • The Problem with Securitization of Mortgages Basically, securitization is a wonderful financial vehicle. Mortgages are pooled together as securities and sold to investors. Of course, as securities, they can also be resold. Securitization creates diversification and liquidity.
  • However, the problem with securitization stems from the fact that it does not provide protection against systematic risk. And unfortunately, such a systematic risk was also not priced into the subprime mortgage pools... not until things went wrong and subprime borrowers started defaulting on their mortgages.
  • ...3 more annotations...
  • The subprime lending increased the homeownership rate in the United States significantly and about 5 million people went from tenants to homeowners. As a result, rents went down and house prices went up till they reached unsustainable heights relative to rents.
  • Thus, when the rise in housing prices stopped in 2006, inevitably many subprime borrowers had difficulty making their mortgage payments. The housing bubble and particularly the excesses of the subprime mortgage market became even more evident when many subprime mortgage lenders began declaring bankruptcy around March 2007.
  • Confidence in many financial institutions was shaken and the stock market witnessed systemic weakness across financial sectors. The share prices for large, small, and investment banks all significantly dropped and between July 2007 and March 2008, lost about a third of their value. What is more, banks stopped trusting other banks and interbank lending was disrupted.
Jeff He

The American Spectator : The True Origins of This Financial Crisis - 0 views

spectator.org/...1

blame financial crisis

shared by Jeff He on 14 Jan 11 - No Cached
    • Jeff He
      Jeff He on 14 Jan 11
       
      Very nice article that shows the root of the cause of the financial crisis. It places the blame on everyone, but shows that poor lending policies/standards advocated by the government triggered everything.
  • Tax laws further amplified the problems of the housing bubble and diminished levels of home equity, especially the deductibility of interest on home equity loans.
  • The GSEs’ purchases of sub-prime and Alt-A loans affected the rest of the market for these mortgages in two ways. First, it increased the competition for these loans with private-label issuers.
  • ...11 more annotations...
  • Second, the increased demand from the GSEs and the competition with private-label issuers drove up the value of sub-prime and Alt-A mortgages, reducing the risk premium that had previously suppressed originations. As a result, many more marginally qualified or unqualified applicants for mortgages were accepted.
  • Since these mortgages aggregate more than $2 trillion, this accounts for the weakness in bank assets that is the principal underlying cause of the current financial crisis.
  • state-based residential finance laws give homeowners two free options that contributed substantially to the financial crisis. First, any homeowner may, without penalty, refinance a mortgage whenever interest rates fall or home prices rise to a point where there is significant equity in the home, enabling them to extract any equity that had accumulated between the original financing transaction and any subsequent refinancing.
  • The homeowner’s opportunity to walk away from a home that is no longer more valuable than the mortgage it carries exacerbates the effect of the cash-out refinancing.
  • From 2005 to 2007, Fannie and Freddie bought approximately $1 trillion in sub-prime and Alt-A loans.
  • interest on home equity loans is deductible no matter how the funds are used. As a result, homeowners are encouraged to take out home equity loans to pay off their credit card or auto loans or to make the purchases that would ordinarily be made with other forms of debt.
  • Bank regulatory policies should also shoulder some of the blame for the financial crisis.
  • Bank assets are assigned to different risk categories, and the amount of capital that a bank holds for each asset is pegged to the asset’s perceived riskiness.
  • These rules provided an incentive for banks to hold mortgages in preference to commercial loans or to convert their portfolios of whole mortgages into an MBS portfolio rated AAA, because doing so would substantially reduce their capital requirements.
  • U.S. housing policies are the root cause of the current financial crisis. Other players--greedy investment bankers; incompetent rating agencies; irresponsible housing speculators; shortsighted homeowners; and predatory mortgage brokers, lenders, and borrowers--all played a part, but they were only following the economic incentives that government policy laid out for them.
  • our first order of business should be to correct the destructive housing policies of the U.S. government.
Tahmid Rouf

Truth and Lies about the Financial Crisis - a knol by Marc Samuel - 1 views

knol.google.com/...ies-about-the-financial-crisis

financial crisis economics hedge funds global recession

shared by Tahmid Rouf on 12 Jan 11 - No Cached
  • Because Hedge Funds' management are opaque, because they are located in Tax Havens, because the bonuses of their top managers are way above that of Goldman Sach's heads, they are regularly criticized by politicians, who perceived them as a threat to the financial stabilization
  • so the Hedge Fund Industry in general brought many suspicion with the current crisis; however, things are quite different now. Let's recall why:
  • When oil soared till mid-2008, many said hedge funds were speculating on a continuous rise with a 200 $ target for the barrel. But the rise of oil was led by simple supply & demand criteria, and the Hedge Funds had nothing to do with it.
  • ...13 more annotations...
  • The graph below shows the evolution of Hedge Fund indices recently, for each strategy used (Equity Market Neutral, Convertible Arbitrage, Event Driven, Macro & Equity Hedge); it proves that Hedge Funds suffered the crisis (because of spreads widenings and liquidity contraction).
  • One common argument you may hear is that traders' desire to get big bonuses led them to take too many risks, which ended up in the crisis; this is completely false
  • Actually, a good trader is an efficient risk-manager, and not a speculator. Inside a trader's book, there are - sometime complex - financial instruments that carry some risks (rate risk, credit risk, forex risk....), and the trader's job consists in managing those risks to hedge his book.
  • This is a touchy part that deserves a clear explanation; when American banks started to lend money to individuals who didn't meet underwriting guidelines, they didn't keep these loans in their balance sheet, using a sophisticated financial technique called securitization: described simply, a bank create a pool of the mortgages embedded in its balance sheet and produce a financial security (called ABS, "asset-backed security")  which is in turn sold to investors, and freely negotiated on capital markets.
  • Once those mortgages were packaged in MBS (for "Mortgage-Backed Securities"), they were traded on capital markets, either directly or through tranches of CDO (for "collateralized-debt obligations"); those products were supposed to offer a very interesting risk-reward profile, so many investors and banks buy those products throughout the World, and consequently regional banks in Germany, Scandinavia turned out to have subprime mortgages in their balance sheets; they were exposed to the US Real Estate market.
  • The conclusion is that banks' balance sheets and assets are so much intertwined that flaws in securities built on American Mortgages impacted banks in the entire World; an interesting thing to underline is that bankers faced fierce criticism for creating sophisticated derivatives products, but no one ever thought of asking to treasurers in smaller banks and financial institutions why they bought those complicated products.
  • And as one can see, every financial crisis that occured during the past thirty years had nothing to do with structured products and/or derivatives; the subprime crisis of 2007-2008 had one simple reason: the end of the rise of the Real Estate Market in the US, that is shown on the graph below:
  • Since the mortgages lent to American borrowers were based on the value of their houses, and not on their own wealth, things started deteriorating when the Real Estate market stopped rising. Obviously, US bankers that recommanded those mortgages were not absolutely honest...
  • Some pointed at the Rating Agencies (Moody's, S&P, Fitch) for they role in the crisis; but not enough, to my mind... and even if more regulation is being discussed at the time, one could wander if strong decisions will be taken in the end.
  • A Rating Agency assesses the credit worthiness of a firm which issues bonds; this credit worthiness is symbolized by letters, from AAA (the company has very little chance of defaulting) to C or D (the company has defaulted or is close to default); surprisingly, and though many banks fiercly compete with each others to get customers, rating agencies almost form a monopoly: only three major rating agencies exist, two of them acting as leaders on the market (Fitch is a little less active).
  • The way they work carries some conflict of interest; the firm who want to have its debt ranked has to pay the agency, which in turn must be as objective as possible when assessing the firm...
  • The Rating Agencies not only rated debts issued by companies, but also the famous Asset Backed Securities, Mortgage Backed Securtities and CDOs discussed above; many of those products got a very good grade, mostly AAA, though it appeared that the risks embedded in those products were largely undervalued.
  • As a matter of fact, the issue with the subprime crisis was that no one was fully aware of where lied the risks, no that there was too much risk.... the difference is important.
  • Tahmid Rouf on 12 Jan 11
     
    Very opinionated piece backed up by some facts. 
Han Kyul Lee

How to Help People Whose Home Values Are Underwater - WSJ.com - 0 views

online.wsj.com/...SB122697004441035727.html

no recourse mortgage homeowners default

shared by Han Kyul Lee on 12 Jan 11 - Cached
  • The no-recourse mortgage is virtually unique to the United States. That's why falling house prices in Europe do not trigger defaults. The creditors' ability to go beyond the house to other assets or even future salary is a deterrent.
    • Han Kyul Lee
      Han Kyul Lee on 12 Jan 11
       
      Would be why everyone is defaulting.
  • More than 12 million homeowners now have mortgage debt that exceeds the value of their homes. These negative-equity homeowners have an incentive to default because mortgages are generally "no recourse" loans. That means creditors can take the property if the individual defaults, but cannot take other assets or income to make up the difference between the unpaid loan balance and the lower value of the house.
  • If house prices continue to fall at the current rate for the next 12 months, as experts generally expect, the median loan-to-value ratio of negative-equity homeowners will increase to more than 135%. At that level, a very high fraction of negative-equity homeowners are likely to default.
  • ...3 more annotations...
  • Half of the homeowners with negative equity now owe more than 120% of the value of their homes.
    • Han Kyul Lee
      Han Kyul Lee on 12 Jan 11
       
      Shocking fact.
  • The key to preventing further defaults and foreclosures among current negative-equity homeowners is to shift those mortgages into loans with full recourse, allowing the creditor to take other property or a fraction of wages.
  • Substituting a full-recourse loan requires the inducement of a substantial write-down in the outstanding loan balance. Creditors have an incentive to accept some write-down in exchange for the much greater security of a full-recourse loan.
Paul Huynh

Ratings Agencies Greed and Fraud Magnified Credit Crisis :: The Market Oracle :: Financ... - 0 views

www.marketoracle.co.uk/Article7853.html

Rating agency moody greed fraud

shared by Paul Huynh on 12 Jan 11 - No Cached
  • Underlying the credit crisis gripping the U.S. and world economies is a crisis of confidence. Blame has been laid at the feet of the U.S. Federal Reserve, and an investment bankers' brew of toxic financial products. Ultimately, however, it was the supposedly trustworthy rating agencies that got everyone to drink the poisoned Kool-Aid.
  • Letter and number ratings – such as AAA, Aa1, BBB and Caa1 – are financial shorthand for the due diligence supposedly done by rating agencies after they've examined an issuer or a security's financial structure, and evaluated the likelihood of its being able to pay interest and principal at maturity
  • most state insurance regulators require that only assets rated in the top four ratings categories by NRSROs are eligible investments. Similarly, money market funds can only invest in securities with the highest NRSRO ratings. In fact, innumerable institutions – public and private, and domestic and international – mandate asset quality levels predicated on the major rating agencies' due diligence.
  • ...11 more annotations...
  • The problem with the business of rating the issuers of securities, and rating the securities they issue – such as mortgage-bcked securities and collateralized mortgage-backed obligations – is that the rating agencies are paid by the issuers to rate them. Objectivity aside, ratings firms are in business not to rate but to make money for themselves by rating issuers and their securities.
  • What was even more problematic in the scheme of the ratings business model was that analysts didn't understand how to analyze and rate the very complex cash flow structures of these new collateralized mortgage-backed securities. Not wanting to lose business to their competitors, who were all in the same boat, they used the same rating model structures that they used to rate corporate bonds , though the two different securities had nothing in common.
  • And there were problems. Lots of them. According to a Feb. 15 “Review & Outlook” piece in The Wall Street Journal , Joseph Mason, professor of finance at Drexel University, studied collateralized debt obligations rated “Baa” by Moody's and determined that they were 10 times more likely to default than equivalently rated corporate bonds.
  • o bend over backwards to accommodate issuers of mortgage-backed and structured finance paper. Clarkson was willing to switch analysts if clients complained, which several did, including Credit Suisse Group AG (ADR: CS ), UBS AG ( UBS ), and Goldman Sachs Group Inc.
  • EC's latest proposed rules changes. While the toothless wonder folded up like a pup tent once again on all substantive changes that would have created a more transparent and honest playing field, it did manage to sneak in some suggestions, including those that said: The rating agencies can't rate debt they help structure. Analysts can't participate in fee negotiations. Analysts can't be given gifts worth more than $25. Analysts must disclose a random 10% sampling of their ratings within six months. The ratings agencies must maintain a history of complaints against analysts. And that the agencies must record when an analyst's rating for structured debt differs from a quantitative model.
  • A 10-month “examination” by the SEC, concluded in July, uncovered, believe it or not, “poor disclosure practices and procedures guiding the analysis of mortgage-related debt and insufficient attention paid to managing conflicts of interest.”
  • According to the report, which included as exhibits several e-mail exchanges between analysts at unnamed ratings firms, there was an obvious degree of knowledge and complicity in playing the ratings game. In one exchange, an analyst said that their ratings model didn't capture “half” of the deal's risk but that “it could be structured by cows and we would rate it.” And in another even more famous exchange dated Dec. 15, 2006, a manager wrote that the firms continued to create an “even bigger monster – the CDO market. Let's hope we are all wealthy and retired by the time this house of cards falters.”
  • Moody's expanded and grabbed a huge piece of the deal-ratings-market pie. By 2006, the company was rating $9 out of every $10 raised in mortgage securities.
    • Paul Huynh
      Paul Huynh on 13 Jan 11
       
      Rating agencies' rating system for safe and dangerous investments
  • And in 2007 it was estimated that the firm rated 94% of the approximately $190 billion in mortgage and structured-finance CDOs floated during the year.
  • Moody's executive Paul Stevenson was quoted as saying that “the most recent problem is that the rating process became a negotiation
Ariel Shain

Subprime Is Often Subpar - 1 views

www.investopedia.com/...subprime.asp

financial crisis what caused economics blame subprime

shared by Ariel Shain on 12 Jan 11 - No Cached
  • Subprime mortgages are often associated with borrowers who have a tainted or limited credit history. This is because a subprime mortgage can offer a consumer a way to purchase a home while they repair or build their credit history.
  • Subprime 2/28 and 3/27 ARMs frequently have prepayment penalties. A prepayment penalty is a provision in the mortgage contract that requires the borrower to pay a certain percentage of the mortgage's remaining principal balance or a certain number of months' interest if the mortgage is paid off before the end of a prepayment penalty period
  • Subprime 2/28 and 3/27 ARMs sometimes lack interest rate cap structures. An interest rate cap structure limits the amount by which, and the rate at which, the fully indexed interest rate can increase at each scheduled interest rate adjustment date and/or over the life of the mortgage.
  • ...1 more annotation...
  • Because many subprime borrowers intend to refinance their adjustable-rate mortgage before, or at the end of, the fixed interest rate period, they frequently do not pay attention to how the fully indexed interest rate is calculated, ignore the mortgage's interest rate cap structure, or are sometimes ignorant of the fact that the mortgage has a prepayment penalty.
Han Kyul Lee

Economists Brace for Worsening Subprime Crisis : NPR - 1 views

www.npr.org/...story.php

'ARM adjustable-rate mortgage homeownership

shared by Han Kyul Lee on 13 Jan 11 - No Cached
  • lenders repurposed "creative financing" products that had previously been marketed to high-income borrowers seeking flexibility with their money. Among the most popular were variations on the adjustable-rate mortgage, or ARM.
  • ARMs are loans whose interest rates adjust up or down periodically. The initial rate is typically fixed for a period of two or three years. The benefit is that the starter rates are lower for ARMs than for traditional, fixed-rate mortgages. That means lower monthly payments, making homeownership more affordable and allowing borrowers to qualify for a bigger loan.
  • payment-option loans
  • ...3 more annotations...
  • interest-only
  • With the former, a borrower only pays the interest on the loan — not the principal balance — during the introductory period.
  • With payment-option ARMs, borrowers get to choose how much they pay each month: enough to cover the interest plus the principal, the interest only... or less than the interest. In that last scenario, the unpaid interest is tacked on to the principal, leaving borrowers owing more than the amount of the original loan.
  • Han Kyul Lee on 13 Jan 11
     
    Lenders created variations on the adjustable-rate mortgage to attract a growing pool of borrowers, especially homeowners. Adjustable-rate mortgages have interest rates that adjust up or down periodically, with a fixed rate for a period of two to three years. The starter rates are lower than the traditional starter rates, which makes homeownership more affordable and borrowing more easier.
Kripansh Sharma

Backdoor Bailout - Furor Over Bofa's $2.8b Mortgage Settlement | LoanWorkout.org - 0 views

loanworkout.org/...bofas-2-8b-mortgage-settlement

Retail_commercial financial crisis loans

shared by Kripansh Sharma on 12 Jan 11 - No Cached
  • Bank of America is getting blasted with accusations of a “backdoor bailout” for its $2.8 billion settlement with Fannie Mae and Freddie Mac over billions of bad mortgages.
  • faulty mortgages the bank sold to the pair during the housing bubble.
  • The outrage stems from BofA’s agreement to pay just $1.28 billion to Fannie and $1.52 billion to Freddie to resolve a dispute over loans purchased between 2005 and 2007 that the pair claims were improperly created.
  • ...1 more annotation...
  • BofA became the largest mortgage lender after it agreed to purchase troubled mortgage giant Countrywide Financial in 2008. It’s mostly loans originated by Countrywide that are viewed as the biggest problem for Fannie and Freddie.
Jeremy Ip

Has the U.S. Lost its Grip on the Credit-Rating Business? - Money Morning - 0 views

moneymorning.com/...credit-rating

Rating Agencies

shared by Jeremy Ip on 12 Jan 11 - No Cached
  • The rating agencies were paid by the issuer, which was theoretically a conflict of interest.
  • The problem arose with securitization. It is now clear that neither the originating banks nor the rating agencies really understood securitization credit risk. They took a portfolio of assets being securitized, looked at historical default rates and applied so-called"binominal distribution analysis" to calculate the probability of the bonds defaulting.
  • The problem came with assets of less-than-prime quality, and tranched securitizations, in which the top tranche would be issued as AAA-rated bonds and lower tranches as lower-rated bonds.
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  • According to modern financial theory, the probability of default of the top tranche of even subprime mortgages was very small, indeed. However, the theory failed to take account of the possibility that the defaults might be correlated. If underwriting standards deteriorated, all the mortgages written during a bubble might be of extra-poor quality. If house prices declined nationwide, all the riskier subprime mortgages would be in trouble.
  • The theory underlying the calculations of default risk was rubbish, so the ratings were rubbish. Yes, rating agencies were in a conflict of interest, and allowed the investment- bank quants to"help" them in their analysis. But the investment bank quants - who were paid only if deals got done - also did not think hard enough about possible flaws in the theory.
  • That was the catalyst for the collapse of the U.S. housing market. From late 2007, AAA-rated tranches of subprime mortgages started defaulting. Double securitizations, in which securitized assets were re-securitized (for example, BBB-rated tranches of mortgage bonds were packaged together and tranched again) were even more screwy than ordinary securitizations, because the errors in the calculation were doubled. Needless to say, rating agencies became pretty discredited. But they haven't been successfully sued, because they were able to claim that their ratings were just like a novel really - artistically elegant, but pure fiction.
Jeff He

The Big Picture - 0 views

bigpicture.typepad.com/...fannie-mae-and.html

Fannie Mae Freddie Mac financial crisis blame

shared by Jeff He on 14 Jan 11 - Cached
  • A nonfeasant Fed, that ignored lending standards, and ultra-low rates.
  • This nonfeasance under Greenspan allowed banks, thrifts, and mortgage originators to engage in all manner of lending standard abrogations.
  • "As Freddie Mac Chairman and CEO Richard Syron recently put it, the GSEs have been hit by a "100-year storm" in the housing market, accentuated by some higher-risk mortgages that they were forced to buy to meet government affordable-housing targets.
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  • • Competitors were "snatching lucrative parts" and market share away; • Between 2001-04, the subprime mortgage market grew from $160 to $540 billion • Between 2005-08, Fannie purchased or guaranteed at least $270 billion in loans to risky borrowers.  • By 2004, Fannie had lost 56% of its loan-reselling business to Wall Street; • Angelo Mozilo, Countrywide Financial CEO, the nation’s largest mortgage lender, threatened to end their partnership unless Fannie started buying Countrywide’s riskier loans; • Congress was pressuring for more loans to low-income borrowers; • Hedge fund managers and other investors pressured Fannie executives that the company was not taking enough risk in pursuing profits; • Like many other firms, Fannie’s computer systems did a poor job of analyzing risky loans; • Between 2005-07 -- afte rthe market's peak -- Fannie's acquisitions of mortgages with less than 10% down payments almost tripled; • Fannie expanded in hot real estate areas like California and Florida; • From 2004-06, Fannie operated without a permanent chief risk officer;
    • Jeff He
      Jeff He on 14 Jan 11
       
      Fannie Mae and Freddie Mac were pressured into taking on high risk mortgages by several entities - congress, shareholders, and banks. 
Han Kyul Lee

Bear Stearns Funds' Failure Opened the Door to Credit Crash - 6 views

www.larouchepub.com/...3427mbs_cdo_crash.html

shared by Han Kyul Lee on 13 Dec 10 - No Cached
    • Han Kyul Lee
      Han Kyul Lee on 10 Jan 11
       
      The failure of the two hedge funds by Bear Stearns resulted in a bailout by extending to the funds emergency loans of $1.6 to $3.2 billion.
  • the Plunge Protection Committee and Bear Stearns senior executives hammered out an arrangement, whereby Bear Stearns would fork out $3.2 billion in loans—equivalent to one-quarter of the bank's $13 billion in capital—to the two hedge funds, and thus to their creditors, rather than allow the creditors to sell CDOs, and rupture the system.
    • Han Kyul Lee
      Han Kyul Lee on 12 Jan 11
       
      The Plunge Protection Committee and Bear Stearns have arranged Bear Stearns to fork out $3.2 billion in loans to the hedge funds.
  • the Plunge Protection Committee and Bear Stearns senior executives hammered out an arrangement, whereby Bear Stearns would fork out $3.2 billion in loans—equivalent to one-quarter of the bank's $13 billion in capital—to the two hedge funds, and thus to their creditors, rather than allow the creditors to sell CDOs, and rupture the system.
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  • If CDOs were shown in a large sale in the market to be worth half or less of their claimed or rated value, then this would expose the fact that most CDOs, especially those linked to subprime housing, were worth only 50 cents on the dollar. The holders of CDOs would have to devalue their holdings, and not just Bear Stearns, but all financial firms that hold CDOs. This would mean the write-down of hundreds of billions of dollars worth of fictitious CDO asset valuation, wiping out overnight the $2.6 trillion-plus CDO market, one of the fastest-growing parts of the financial bubble.
  • The failure of CDOs, and the associated credit derivatives, has the potential to rupture the $750 trillion-plus world derivatives market—a rupture which would instantaneously bring down the world financial system.
  • The failure has caused the near-freezing up of the highly risky $2.6 trillion Collateralized Debt Obligations (CODs) market.
  • On June 22, Bear Stearns investment bank announced that it intended to bail out two of its failing hedge funds, by extending to them between $1.6 to $3.2 billion in emergency loans—the latest twist in Wall Street efforts to prevent a full-blown mortgage securities market crisis.
  • Han Kyul Lee on 13 Dec 10
     
    From the July 6, 2007 issue of Executive Intellignece Review Notes: July 6, 2007 issue of Executive Intelligence Review -two hedge funds of Bear Stearns had failed, causing the $2.6 trillion CDOs market to nearly freeze up -Mortgage-backed losses caused another hedge fund by Caliber Global Investments -June 22, 2007: Bear Stearns to bail out its two failing hedge funds by extending to them in emergency loans of $1.6-3.2 billion, whose purposes are to prevent the creditors from seizing and selling the assets, and to prevent the failure of the hedge funds to trigger a systematic breakdown of the financial system -the hedge funds were the High Grade Structured Credit Enhanced Leverage Fund (HGSCELF) and the High-Grade Structured Credit Fund (HGSCF) that were invested in really risky CDOs, predominantly invested in subprime mortgages.
Jeremy Ip

Ratings agencies involvement in the sub-prime mortgage crisis | The Casual Truth - 1 views

www.thecasualtruth.com/266

Rating Agencies

shared by Jeremy Ip on 12 Jan 11 - No Cached
  • The reality is they were at the core of the problem. They made the investments appear a lot better and safer than they really were – and the whole system relied on their ratings.
  • Over the past decade, a lot of people in America couldn’t really afford the money they borrowed for their house. These were called sub-prime mortgages.
  • These sub-prime mortgage contracts were grouped together with some safer mortgage contracts and other investments and sold on as one overall asset.
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  • These bundles of rubbish were known as Collateralised Debt Obligations (CDOs) and were sold on to the big investment banks that needed assets to balance out their liabilities.
  • However, before any buyer bought these CDOs, they checked their rating to see how risky they were. Most buyers (investors) would not buy something with a CC rating for instance. In fact, many savings funds like pensions had a rule of only investing in A or above rated investments.
  • Therefore, the banks needed the rating agencies to effectively lie and give them a higher rating.
  • So to sell these CDOs to investors, the rating had to qualify. The problem was many of the CDOs didn’t deserve a high rating because they were based on people who couldn’t realistically pay back their mortgage.
  • The rating agencies were more than willing to do this because if they didn’t, the bank would simply go to their competitor down the road who would gladly take the business. And with average rating fees of over US$300,000 and margins of 50 percent, it was no wonder.
  • The agencies also became advisers rather than independent judges. They would tell the banks how to restructure the dodgy asset so that they could give it a higher rating. And these changes were mostly technicalities rather than anything of sound substance.
  • There was a supposed safety net in the system which meant that each investment had to be rated by two different agencies. However, this just resulted in two false ratings effectively making the safety net useless
  • When investors complained that their supposedly safe investments were actually rubbish, the rating agencies pointed to a clause saying that they cannot be held liable for any incorrect ratings – basically “sorry, but sometimes we get it wrong”.
  • Yes the banks were at fault in pressuring the agencies to lie, but the agencies were clearly willing partners for their own financial gain.
Han Kyul Lee

Sub-prime Bailout--banks, not homeowners - 2 views

www.skeptically.org/...id14.html

shared by Han Kyul Lee on 10 Jan 11 - No Cached
    • Han Kyul Lee
      Han Kyul Lee on 11 Jan 11
       
      The collateral crisis - the collateral on a bank's balance sheets is not performing as well as they have announced. When homeowners are not paying their mortgages, banks that do hold these mortgages are not getting all the payments that they should be getting. The more loans that are not being paid off, the more trouble caused to these banks. Any mortgage-backed securities are in trouble because of the collateral crisis.
  • But why save Bear Stearns? The beneficiary of this bailout, remember, has often operated in the gray areas of Wall Street and with an aggressive, brass-knuckles approach. Until regulators came along in 1996, Bear Stearns was happy to provide its balance sheet and imprimatur to bucket-shop brokerages like Stratton Oakmont and A. R. Baron, clearing dubious stock trades.
  • Let’s not forget that Bear Stearns lost billions for its clients last summer, when two hedge funds investing heavily in mortgage securities collapsed.
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  • “Why not set an example of Bear Stearns, the guys who have this record of dog-eat-dog, we’re brass knuckles, we’re tough?” asked William A. Fleckenstein, president of Fleckenstein Capital in Issaquah, Wash., and co-author with Fred Sheehan of “Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve.” “This is the perfect time to set an example, but they are not interested in setting an example. We are Bailout Nation.”
  • But, who knows what those mortgages are really worth? According to Bear Stearns’s annual report, $29 billion of them were valued using computer models “derived from” or “supported by” some kind of observable market data.
  • And here is the unfortunate refrain.  Investors, already mistrusting many corporate and government leaders, were once again assured that nothing was wrong — right up until the very end. So is it any wonder investors react to every market rumor of an impending failure with the certainty that it’s true? In too many cases, the rumors turned out to be true, notwithstanding the attempts at reassurance by executives and policy makers.
  • Han Kyul Lee on 10 Jan 11
     
    Published March 16, 2008
Han Kyul Lee

FRONTLINE: inside the meltdown: watch the full program | PBS - 0 views

www.pbs.org/...view

economics frontline pbs documentary financial crisis Bear Stearns homeowners mortgages securities loans

shared by Han Kyul Lee on 11 Jan 11 - No Cached
  • Han Kyul Lee on 11 Jan 11
     
    It's when investors lose confidence that firms start to fail, since they all withdraw their money at the same time. This goes for Bear Stearns, whose way to 'riches' was through a heavy load of toxic assets, buying out the mortgages, bundles them up and loan them out as securities. These loan offers had attracted many homeowners who were so sure that housing prices would only go up. As stocks started dropping, investors lost confidence in Bear Stearns, dropping out on the stocks. By Thursday, with the reserve almost gone, Bear Stearns had turned to the Federal Reserve Bank for emergency loans that they may open tomorrow. Lots of toxic waste such as hidden subprime mortgage loans were found. Federal Reserve bails out Bear Stearns with emergency loans.
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