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The Credit Crisis Of 2008a
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The Credit Crisis Of 2008a

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Background of Credit Crisis

Background of Credit Crisis

Published in Business , Economy & Finance
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  • 1. What Happened?
  • 2. NASDAQ People moved assets from stocks to Housing after the crash of 2000.
  • 3. Case Schiller Housing Price Index 1890-2008 and prediction Based on past adjustments bottom by 2010 200___ 190___ 180___ 170___ 160___ 150___ 140___
  • 4.  
  • 5. Borrower Mortgage Broker Lender Loan $$$ Loans facilitated by Mortgage Brokers who had no continuing Interest Principal Agent Problem
  • 6. Borrower Mortgage Broker Lender Issuer Investors Credit Rating Underwriter Loan $$$ $$$ Loan Monthly $ Security $$$ Monthly $ Lenders sell their loans to Others to recapitalize and continue Loaning. Issuers bundle loans into securities (Collateralized Debt Obligations) To resale to investors
  • 7. Spreading the Risk
  • 8. Some Common Companies Borrower Countrywide FNMA Bear Stearns Goldman Sachs Moody’s Loan $$$ $$$ Loan Monthly $ Security $$$ Monthly $
  • 9.
    • FNMA: Federal National Mortgage Administration (founded 1938)
    • FHLMC: Federal Home Loan Mortgage Corporation (NYSE:FRE)(Founded 1968)
    • Private, but “government sponsored”
    • Secondary mortgage market
    • Bought and resold mortgages from lenders
    • Guaranteed security to investors
  • 10. Security Insurance Insurer Investor Default Protection Security Security Investor’s seek insurance to cover unexpected defaults on loans
  • 11. Credit Default Swaps Goldman Sachs AIG
  • 12.
    • Reselling the CDS’s
    • Reselling the mortgage
    • Reselling the securitized instrument
    AIG Hedge Fund Sovereign Wealth Fund
  • 13. The Whole System Borrower Countrywide FNMA Goldman Sachs Loan $$$ $$$ Loan Monthly $ Security $$$ Monthly $ AIG Premium CDS Hedge Fund
  • 14. What Went Wrong Borrower Countrywide FNMA Goldman Sachs Loan $$$ $$$ Loan Monthly $ Security $$$ Monthly $ Premium CDS Insurance Borrower AIG Hedge Fund Borrower defaults
  • 15. Multiplied Losses Borrower Countrywide FNMA Goldman Sachs Loan $$$ $$$ Loan Monthly $ Security $$$ Monthly $ Premium CDS Insurance Borrower $1 $1 $1 $1 $1 AIG Hedge Fund
  • 16.
    • Increase lending (2007)
    • Guarantee Bear Stearns’ “value” for purchase by Morgan Stanley (3/08)
    • Let Lehman Brother’s collapse (9/15)
    • Facilitate Merrill Lynch sale to Bank of America
    • AIG—too big to fail (9/16 loan, equity)
    • Change Morgan and Goldman to “banks” to access credit (9/21)
  • 17.
    • Wachovia Bank bought 9/29/08 by Citigroup
    Balance Sheet as of 6/30/08
    • Note:
    • Banks are illiquid
      • Short term liability & long term investment
    Assets Current $110 b Long term: Investments $600 Other: $100 Total $810 Liabilities Short Term: $505 Long term: $230 Equity: $ 75 Total: $810
  • 18.
    • Insolvency
      • The long term investments (e.g. mortgages) have lost value (at least at short term, market price)
      • Plus, no one wants to buy (value declines more)
    Value of investments for illustration only, unknown value Assets Current $110 b Long term: Investments $500 Other: $100 Total $710 Liabilities Short Term: $505 Long term: $230 Equity: $ 0 Total: $735
  • 19.
    • Sell Assets
      • Citigroup buys bank, covers up to $42b in loss
      • FDIC covers amount over $42b
        • Gets $12B in stock warrants in Citigroup
  • 20.
    • Federal Government agencies buy up bad debt that couldn’t be sold.
    • This removes bad asset & injects liquidity
  • 21.
    • Feds Buy Now, Sell Later
      • Willingness to buy stabilizes prices
      • Some problem loans will be ok
      • Net cost = ?
  • 22.
    • 1(a) Authority to Purchase.–The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States.
    • 6. The Secretary’s authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time
  • 23.
    • Sec. 8. Review.
    • Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.
  • 24.  
  • 25.
    • Government will buy bad debts
      • Republicans wanted to just insure
    • Limits on Executive pay
    • Limited bankruptcy and foreclosure reform
      • Democrats wanted to require loan adjustments
    • Limits on discretion
    • Net loss after 5 years recouped by new taxes on banks
    • Disburse in portions, not full $700b.
    • New bill=400 pages
  • 26.
    • Economist Magazine
      • www.economist.com
    • Wall Street Journal
      • www.wsj.com