The Old Days

1. The Old Days Mortgage $

2. 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

3. The Financial Crisis (a very quick view) • The build up (1980s – 2008) • The end of the party (Sept-Oct 2008) • The responses (2008-present)

4. The Build-Up (1980s-2008) • Deregulation of finance (“free market” ideology)

5. Financial Deregulation • Gramm-Leach Bliley replaces Glass Steagall in 1998 • Commodities Futures Modernization Act (1999) • Sarbanes Oxley Rule (2002) • SEC deregulation of brokers (2004)

6. The Build-Up (1980s-2008) • Deregulation of finance (“free market” ideology) • Rise of complex “financial derivatives” and “securitization”

7. Mortgage-backed Securities MBS Collateralized Debt Obligation, CDO A big bunch of mortgages (or other assets) packaged together and sold to investors

8. Gets a fee for every mortgage made! Mortgage Broker Deregulates the industry Home Buyer Federal Reserve, other regulatory agencies, administration, Congress Specialized mortgage bank Servicer (MERS) Originator (e.g. Countrywide) Creates Credit Default Swaps Insurance company (e.g. AIG) Investment Bank (e.g. Goldman-Sachs) Manages the flow of interest and principal Mutual funds, pension funds, hedge funds… Creates MBSs and CDOs Institutional investor Rating agency End lenders Assigns credit rating to issued MBSs and CDOs. Is paid by the issuer of the security it is rating.

9. The Build-Up (1980s-2008) • Deregulation of finance (“free market” ideology) • Rise of complex “financial derivatives” and “securitization” • Increasing concentration of the financial industry • Increasingly close government-finance industry ties • Enormous profits and bonuses • Praised by many economists as healthy, contributing to stability, etc.

10. 1999

11. Problems • Sub-prime loans (predatory lending) fuels housing bubble

12. Gets a fee for every mortgage made! Mortgage Broker Deregulates the industry Home Buyer Federal Reserve, other regulatory agencies, administration, Congress Specialized mortgage bank Servicer (MERS) Originator (e.g. Countrywide) Creates Credit Default Swaps Insurance company (e.g. AIG) Investment Bank (e.g. Goldman-Sachs) Manages the flow of interest and principal Mutual funds, pension funds, hedge funds… Creates MBSs and CDOs Institutional investor Rating agency End lenders Assigns credit rating to issued MBSs and CDOs. Is paid by the issuer of the security it is rating.

13. Housing Price Bubble

14. Problems • Sub-prime loans (predatory lending) fuels housing bubble • Rating agencies give CDOs AAA ratings

15. Gets a fee for every mortgage made! Mortgage Broker Deregulates the industry Home Buyer Federal Reserve, other regulatory agencies, administration, Congress Specialized mortgage bank Servicer (MERS) Originator (e.g. Countrywide) Creates Credit Default Swaps Insurance company (e.g. AIG) Investment Bank (e.g. Goldman-Sachs) Manages the flow of interest and principal Mutual funds, pension funds, hedge funds… Creates MBSs and CDOs Institutional investor Rating agency End lenders Assigns credit rating to issued MBSs and CDOs. Is paid by the issuer of the security it is rating.

16. Problems • Sub-prime loans (predatory lending) fuels housing bubble • Rating agencies give CDOs AAA ratings • Credit default swaps become an enormous casino

17. Gets a fee for every mortgage made! Mortgage Broker Deregulates the industry Home Buyer Federal Reserve, other regulatory agencies, administration, Congress Specialized mortgage bank Servicer (MERS) Originator (e.g. Countrywide) Creates Credit Default Swaps Insurance company (e.g. AIG) Investment Bank (e.g. Goldman-Sachs) Manages the flow of interest and principal Mutual funds, pension funds, hedge funds… Creates MBSs and CDOs Institutional investor Rating agency End lenders Assigns credit rating to issued MBSs and CDOs. Is paid by the issuer of the security it is rating.

18. Credit Default Swap (CDS) • Like an insurance policy for CDO/MBS. • But not called “insurance,” since that would be regulated! • One doesn’t need to actually own any CDO/MBS to buy CDS, so it becomes a huge vehicle for speculation.

19. The CDS Market

20. Problems • Sub-prime loans (predatory lending) fuels housing bubble • Rating agencies give CDOs AAA ratings • Credit default swaps become an enormous casino • Leaders move back and forth from Wall Street to federal government

21. The End of the Party (Sept-Oct 2008) • Housing prices have fallen

23. The End of the Party • Housing prices have fallen • Trillions of $ of assets evaporate • Fannie Mae and Freddie Mac nationalized • Lehman Brothers goes bankrupt • Government bails out AIG • Merrill Lynch sold • Financial markets freeze up • Government announces TARP (Troubled Asset Relief Program) to prop up banks

25. The Responses • TARP bails out “too big to fail” investment banks (Citigroup, BofA, Goldman Sachs…) • Recoup bonuses paid? Only talked about. • Re-regulation of banks, rating agencies, etc? Not much. • Criminal prosecutions? Still waiting… • Help for homeowners under water? Not much. (And MERS, foreclosure mess)

26. 2010

27. Gets a fee for every mortgage made! Mortgage Broker Deregulates the industry Home Buyer Federal Reserve, other regulatory agencies, administration, Congress Specialized mortgage bank Servicer (MERS) Originator (e.g. Countrywide) Creates Credit Default Swaps Insurance company (e.g. AIG) Investment Bank (e.g. Goldman-Sachs) Manages the flow of interest and principal Mutual funds, pension funds, hedge funds… Creates MBSs and CDOs Institutional investor Rating agency End lenders Assigns credit rating to issued MBSs and CDOs. Is paid by the issuer of the security it is rating.