wlmac economics

Interest Rates Cut To Near Zero

Government Invests In Financial Institutions

Citigroup Struggles To Survive, Must Break Apart

Massive Federal Spending Aims To End Slump

As Banks Fail, Americans Wonder What’s Safe

Homeowners Offered New Mortgage Help

Treasury Increases Stake In Fannie & Freddie

AIG Bonus Outrage Adds Insult To Injury

Money Recovered As AIG’s Volunteer CEO Departs

Stress Tests Put Banks Under Microscope

Test Results Reveal Stronger And Weaker Banks

Recession Leaves Automakers On Risky Road

Big Three In Big Trouble, GM & Chrysler Bankrupt

Dramatic Changes Start To Take Effect

Economy Shows Signs Of Improvement

Lehman Rocks Wall Street, Declares Bankruptcy

The Treasury Department and Federal Reserve watched Lehman implode, unable to predict the scope of the global financial damage that would follow.

While Lehman Brothers failed to find a buyer, Merrill Lynch succeeded

Merrill’s CEO Stan O’Neal was so fixated on the revenue generated by the mortgage business, he didn’t just want to securitize them, he wanted to originate them, too. So, in 2007, Merrill bought mortgage lender First Franklin.

Bank Of America Rescues Merrill From ExtinctionBy September 2008, Merrill Lynch was suffering huge mortgage-related losses.

Although Bank of America’s purchase of Merrill ultimately saved the company, the transaction later came under intense scrutiny because of larger-than-expected losses and controversial year-end bonuses paid to Merrill executives.

Fed Accused Of 'Cover Up' In BofA, Merrill Deal

“Too Big To Fail,” Feds Take Control Of AIG

Paulson And Bernanke Issue Dire Warning

Paulson requested $700 Billion from Congress for a program intended to buy toxic assets from banks and infuse financial institutions with capital

contained no rules and standards for oversight. Infuriated politicians

Washington Mutual, weighed down by mortgage-related losses, was seized by federal regulators and sold to JPMorgan Chase.

largest bank failure in U.S. history, caused by an old fashioned, Depression-like run on WaMu’s deposits, following rumors about the bank’s ability to survive. 

Dow Jones Industrial Average plunged a record 778 points, its biggest drop in history.

Congress acted again. This time, lawmakers  approved the package, known as the Troubled Asset Relief Program. It included significantly greater oversight of the $700 Billion and more specific details on how it would be used to bolster the U.S. banking system.

Paulson’s “tough love” was a bitter pill for some bank bosses to swallow.

Bears Stearns was struggling, so was the Main Street retail bank Washington Mutual

Many more well-known companies would collapse

But no real action was taken until early 2008, when the subprime meltdown brought down one of the most legendary firms on Wall Street.

much of the real estate wealth that had accumulated “on paper” was contracted instead of expanding

Defaults and Foreclosure Begin Rapid Rise

Hedge fund manager Kyle Bass was anything but blind.

some investors bought insurance policies called Credit Default Swaps, issued by companies such as AIG.  A CDS guaranteed an investor would not lose money, even on the riskiest asset, assuring a payment even if the underlying security defaulted.

Flush with billions, hedge funds and sovereign wealth funds gobbled up these CDOs.

One former Moody’s analyst says it was easy to “turn crap into Triple A.”

So Fannie and Freddie lowered their standards, just as the lenders had done. They began buying lesser-quality mortgages, including subprime loans, exactly the kind they avoided years earlier.

In an e-mail to the friend, he described himself as "the fabulous Fab standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstrosities!!!"

interest-only

With the former, a borrower only pays the interest on the loan — not the principal balance — during the introductory period.

One: Historians won out over economists. No single group of professionals took a worse battering during the economic slump than economists. Not even bankers.

Two: Hedge funds over bankers. If Lehman Brothers Holdings Inc. had a dollar for every time someone warned that hedge funds would bring the financial system to its knees, the bank wouldn’t have gone bust. While hedge funds took plenty of criticism, and are still facing calls or more regulation, the simple fact remains that they didn’t blow up the way many predicted.

It was the mainstream banks that caused the crisis. That will influence regulators and investors for many years. Whatever people say now, it’s the banks that will face more scrutiny, not hedge funds. The result? The lightly regulated, cash-rich hedge funds will grow in importance, while the tightly controlled, capital- constrained banks stagnate.

Baseless Fears Three: Germany over Britain. For much of the past decade, the fast-growing U.K. was gaining on Germany for the role of Europe’s most influential nation. Almost 20 years after reunification, fears of a resurgent Germany turned out to be baseless. It was Britain, with its financial center, that was emerging as the leading European nation. The credit crunch will throw that into reverse.

Four: The right over the left. The credit crunch was probably the perfect moment for left-wing, anti-capitalist and anti-globalization movements to make their mark. After all, if this wasn’t a failure of capitalism, it is hard to imagine what might be. Vladimir Lenin would have led the overthrow of a dozen governments presented with an opportunity like this. But his heirs on the left failed to advance any cogent arguments. Nor did they develop any alternatives to free-market, finance-led capitalism. The plate was empty, but the anti-globalization movement failed to step up to it.

Five: Frugality over extravagance: The nub of the credit crunch was an attempt to load more and more debt onto people -- mainly in the U.S. and U.K. -- whose real wages were stagnant or growing very modestly. That will be thrown into reverse, and for the next decade, people will be paying down debt rather than accumulating it. House prices will be subdued as finance remains scarce, and household budgets will be tight. The result will be that companies will thrive if they offer value, drive down costs, and make themselves the lowest-cost supplier.

The Great Depression of the 1930s dominated the way people thought about the economy for the next 50 years. The great recession of 2008 and 2009 may not have such a long-lasting impact. But in those five ways, it will dominate policy for at least a decade.

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.