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    Subprime crisis Subprime crisis Document Transcript

    • Subprime mortgage crisis From Wikipedia, the free encyclopedia Jump to: navigation, search The subprime mortgage crisis is an ongoing financial crisis triggered by a dramatic rise in mortgage delinquencies and foreclosures in the United States, with major adverse consequences for banks and financial markets around the globe. The crisis, which has its roots in the closing years of the 20th century, became apparent in 2007 and has exposed pervasive weaknesses in financia industry regulation and the global financial system. l Many USA mortgages issued in recent years are subprime, meaning that little or no downpayment was made, and that they were issued to households with low incomes and assets, and with troubled credit histories. When USA house prices began to decline in 2006-07, mortgage delinquencies soared, and securities backed with subprime mortgages, widely held by financial firms, lost most of their value. The result has been a large decline in the capital of many banks and USA government sponsored enterprises, tightening credit around the world. Contents [hide]  1 Background o 1.1 The mortgage market o 1.2 Credit risk  2 Causes o 2.1 Boom and bust in the housing market o 2.2 Speculation o 2.3 High-risk mortgage loans and lending practices o 2.4 Securitization practices o 2.5 Inaccurate credit ratings o 2.6 Government policies o 2.7 Policies of central banks o 2.8 Financial institution debt levels and incentives o 2.9 Credit default swaps  3 Impact o 3.1 Financial sector downturn o 3.2 Market weaknesses, 2007 o 3.3 Market downturns and impacts, 2008 o 3.4 Indirect economic effects  4 Responses o 4.1 Legislative and regulatory responses  4.1.1 Federal Reserve Bank  4.1.2 Regulation
    •  4.1.3 Economic Stimulus Act of 2008  4.1.4 Housing and Economic Recovery Act of 2008 o 4.2 Failures and government bailouts of financial firms  4.2.1 Emergency Economic Stabilization Act of 2008 o 4.3 Lending industry action  4.3.1 Hope Now Alliance o 4.4 Bank capital replenishment from private sources o 4.5 Litigation o 4.6 Law enforcement o 4.7 Ethics investigation  5 Effect on the financial condition of USA governmental units  6 Expectations and forecasts  7 See also  8 References  9 Further reading  10 External links [edit] Background Factors Contributing to Housing Bubble – Diagram 1 of 2 Domino Effect As Housing Prices Declined – Diagram 2 of 2 The crisis began with the bursting of the United States housing bubble[1][2] and high default rates on quot;subprimequot; and adjustable rate mortgages (ARM), beginning in approximately 2005–2006. Government policies and competitive pressures for several years prior to the crisis encouraged higher risk lending practices.[3][4] Further, an increase in loan incentives such as easy initial terms and a long-term trend of rising housing prices had encouraged borrowers to assume difficult mortgages in the belief they would be able to quickly refinance at more favorable terms. However, once interest rates began to rise and housing prices started to drop moderatelyin 2006–2007 in many parts of the U.S., refinancing became more difficult. Defaults and foreclosure activity increased dramatically as easy initial terms expired, home prices failed to go up as anticipated, and ARM interest rates reset higher. Foreclosures accelerated in the United States in late 2006 and triggered a global financial crisis through 2007 and 2008. During 2007, nearly 1.3 million U.S. housing properties were subject to foreclosure activity, up 79% from 2006.[5] Financial products called mortgage-backed securities (MBS), which derive their value from mortgage payments and housing prices, had enabled financial institutions and investors around the world to invest in the U.S. housing market. Major banks and financial institutions had borrowed and invested heavily in MBS and reported losses of approximately US$435 bi lion as of 17 July 2008.[6][7] The liquidity and solvency concerns l regarding key financial institutions drove central banks to take action to provide funds to
    • banks to encourage lending to worthy borrowers and to restore faith in the commercial paper markets, which are integral to funding business operations. Governments also bailed out key financial institutions, assuming significant additional financial commitments. The risks to the broader economy created by the housing market downturn and subsequent financial market crisis were primary factors in several decisions by central banks around the world to cut interest rates and governments to implementeconomic stimulus packages. These actions were designed to stimulate economic growth and inspire confidence in the financial markets. Effects on global stock markets due to the crisis have been dramatic. Between 1 January and 11 October 2008, owners of stocks in U.S. corporations had suffered about $8 trillion in losses, as their holdings declined in value from $20 trillion to $12 trillion. Losses in other countries have averaged about 40%.[8] Losses in the stock markets and housing value declines place further downward pressure on consumer spending, a key economic engine.[9] Leaders of the larger developed and emerging nations met in November 2008 to formulate strategies for addressing the crisis.[10] [edit] The mortgage market Number of U.S. household properties subject to foreclosure actions by quarter. Main articles: Subprime crisis background information and Subprime crisis impact timeline Subprime lending is the practice of lending, mainly in the form of mortgages for the purchase of residences, to borrowers who do not meet the usual criteria for borrowing at the lowest prevailing market interest rate. These criteria pertain to the downpayment and the borrowing household's income level, both as a fraction of the amount borrowed, and to the borrowing household's employment status and credit history. If a borrower is delinquent in making timely mortgage payments to the loan servicer (a bank or other financial firm), the lender can take possession of the residence acquired using the proceeds from the mortgage, in a process called foreclosure. The value of USA subprime mortgages was estimated at $1.3 trillion as of March 2007, [11] with over 7.5 million first-lien subprime mortgages outstanding.[12] In the third quarter of 2007, subprime ARMs making up only 6.8% of USA mortgages outstanding also accounted for 43% of the foreclosures begun during that quarter.[13] By October 2007, approximately 16% of subprime adjustable rate mortgages (ARM) were either 90-days delinquent or the lender had begun foreclosure proceedings, roughly triple the rate of 2005.[14] By January 2008, the delinquency rate had risen to 21%.[15] and by May 2008 it was 25%.[16] The value of all outstanding residential mortgages, owed by USA households to purchase residences housing at most 4 families, was US$9.9 trillion as of yearend 2006, and US$10.6 trillion as of midyear 2008.[17] During 2007, lenders had begun foreclosure proceedings on nearly 1.3 million properties, a 79% increase over 2006.[18] As of August 2008, 9.2% of all mortgages outstanding were either delinquent or in foreclosure.[19] 936,439 USA residences completed foreclosure betweenAugust 2007 and October 2008.[20]
    • [edit] Credit risk Understanding financial leverage. Credit risk arises because a borrower has the option of defaulting on the loan he owes. Traditionally, lenders (who were primarily thrifts) bore the credit risk on the mortgages they issued. Over the past 60 years, a variety of financial innovations have gradually made it possible for lenders to sell the right to receive the payments on the mortgages they issue, through a process called securitization. The resulting securities are called mortgage backed securities (MBS) and collateralized debt obligations (CDO). Most American mortgages are now held by mortgage pools, the generic term for MBS and CDOs. Of the $10.6 trillion of USA residential mortgages outstanding as of midyear 2008, $6.6 trillion were held by mortgage pools, and $3.4 trillion by traditional depository institutions. [21] This quot;originate to distributequot; model means that investors holding MBS and CDOs also bear several types of risks, and this has a variety of consequences. There are four primary types of risk:[22][23] 1. Credit risk - the risk that the homeowner or borrower will be unable or unwilling to pay back the loan; 2. Asset price risk - the risk that assets (MBS in this case) will depreciate in value, resulting in financial losses, markdowns and possibly margin calls; 3. Liquidity risk - the risk that a business entity will be unable to obtain financing, such as from the commercial paper market; and 4. Counterparty risk - the risk that a party to a contract will be unable or unwilling to uphold their obligations. The aggregate effect of these and other risks has recently been called systemic risk, which refers to when formerly uncorrelated risks shift and become highly correlated, damaging the entire financial system.[24] When homeowners default, the payments received by MBS and CDO investors decline and the perceived credit risk rises. This has had a significant adverse effect on investors and the entire mortgage industry. The effect is magnified by the high debt levels (financial leverage) households and businesses have incurred in recent years. Finally, the risks associated with American mortgage lending have global impacts, because a major consequence of MBS and CDOs is a closer integration of the USA housing and mortgage markets with global financial markets. Investors in MBS and CDOs can insure against credit risk by buying credit defaults swaps (CDS). As mortgage defaults rose, the likelihood that the issuers of CDS would have to pay their counterparties increased. This created uncertainty across the system, as investors wondered if CDS issuers would honor their commitments. [edit] Causes
    • The reasons proposed for this crisis are varied[25][26] and complex.[27] The crisis can be attributed to a number of factors pervasive in bot housing and credit markets, factors h which emerged over a number of years. Causes proposed include the inability of homeowners to make their mortgage payments, poor judgment by borrowers and/or lenders, speculation and overbuilding during the boom period, risky mortgage products, high personal and corporate debt levels, financial produc that distributed and perhaps ts concealed the risk of mortgage default, monetary policy, and government regulation (or the lack thereof).[28] Utimately, though, moral hazard lay at the core of many of the causes.[29] In its quot;Declaration of the Summit on Financial Markets and the World Economy,quot; dated 15 November 2008, leaders of the Group of 20 cited the following causes: “ quot;During a period of strong global growth, growing capital flows, and prolonged stability earlier this decade, market participants sought higher yields without an adequate appreciation of the risks and failed to exercise properdue diligence. At the same time, weak underwriting standards, unsound risk management practices, increasingly complex and opaque financial produc and consequent ts, excessive leverage combined to create vulnerabilities in the system. Policy- makers, regulators and supervisors, in some advanced countries, did not adequately appreciate and address the risks building up in financial markets, keep pace with financial innovation, or take into account the systemic ramifications of domestic regulatory actions.quot;[30] ” [edit] Boom and bust in the housing market Main articles: United States housing bubble and United States housing market correction Existing homes sales, inventory, and months supply, by quarter. Common indexes used for adjustable rate mortgages (1996–2006). A culture of consumerism is a factor quot;in an economy based on immediate gratification.quot;[31] Starting in 2005, American households have spent more than 99.5% of their disposable personal income on consumption or interest payments.[32] If imputations mostly pertaining to owner-occupied housing are removed from these calculations, American households have spent more than their disposable personal income in every year starting in 1999.[33] Low interest rates and large inflows of foreign funds created easy credit conditions for a number of years prior to the crisis.[34] The USA home ownership rate increased from 64% in 1994 (about where it had been since 1980) to an all-time high of 69.2% in 2004.[35] Subprime lending was a major contributor to this increase in home ownership rates and in the overall demand for housing.
    • This rise in demand fueled rising house prices and consumer spending.[36] Between 1997 and 2006, the price of the typical American house increased by 124%.[37] During the two decades ending in 2001, the national median home price ranged from 2.9 to 3.1 times median household income. This ratio rose to 4.0 in 2004, and 4.6 in 2006.[38] This housing bubble resulted in quite a few homeowners refinancing their homes at lower interest rates, or financing consumer spending by taking out second mortgages secured by the price appreciation. USA household debt as a percentage of annual disposable personal income was 142% at the end of 2007, versus 101% in 1999.[39] Household debt grew from $705 billion at yearend 1974, 60% of disposable personal income, to $7.4 trillion at yearend 2000, and finally to $14.5 trillion in midyear 2008, 134% of disposable personal income.[40] During 2008, the typical USA household owned 13 credit cards, with 40% of households carrying a balance, up from 6% in 1970.[41] This credit and house price explosion led to a building boom and a surplus of unsold homes. Easy credit, and a belief that house prices would continue to appreciate, encouraged many subprime borrowers to obtain adjustable-rate mortgages. These mortgages enticed borrowers with a below market interest rate for some predetermined period, followed by market interest rates for the remainder of the mortgage's term. Borrowers who could not make the higher payments once the initial grace period ended would try to refinance their mortgages. Refinancing became more difficult, once house prices began to decline in many parts of the USA. Borrowers who found themselves unable to escape higher monthly payments by refinancing began to default. By September 2008, average U.S. housing prices had declined by over20% from their mid-2006 peak.[42][43] This major and unexpected decline in house prices means that many borrowers have zero or negative equity in their homes, meaning their homes were worth less than their mortgages. As of March 2008, an estimated 8.8 million borrowers — 10.8% of all homeowners — had negative equity in their homes, a number that is believed to have risen to 12 million by November 2008. Borrowers in this situation have an incentive to quot;walk awayquot; from their mortgages and abandon their homes,even though doing so will damage their credit rating for a number of years.[44] The reason is that unlike what is the case in most other countries, American residential mortgages are non-recourse loans; once the creditor has regained the property purchased with a mortgage in default, he has no further claim against the defaulting borrower's income or assets. As more borrowers stop paying their mortgage payments, foreclosures and the supp of homes for sale increase. ly This places downward pressure on housing prices, which further lowers homeowners' equity. The decline in mortgage payments also reduces the value of mortgage-backed securities, which erodes the net worth andfinancial health of banks. This vicious cycle is at the heart of the crisis.[45] Increasing foreclosure rates increases the inventory of houses offered for sale. The number of new homes sold in 2007 was 26.4% less than in the preceding year. By January 2008, the inventory of unsold new homes was 9.8 times the December 2007 sales volume, the highest value of this ratio since 1981.[46] Furthermore, nearly four million existing homes were for sale,[47] of which almost 2.9 million were vacant.[48] This overhang of unsold homes lowered house prices. As prices declined, more homeowners were at risk of default
    • or foreclosure. House prices are expected to continue declining until this inventory of unsold homes (an instance of excess supply) declines to normal levels. [edit] Speculation Speculation in residential real estate has been a contributing factor. During 2006, 22% of homes purchased (1.65 million units) were for investment purposes, with an additional 14% (1.07 million units) purchased as vacation homes. During 2005, these figures were 28% and 12%, respectively. In other words, a record level of nearly 40% of homes purchases were not intended as primary residences. David Lereah, NAR's chief economist at the time, stated that the 2006 decline in investment buying was expected: quot;Speculators left the market in 2006, which caused investment sales to fall much faster than the primary market.quot;[49] While homes had not traditionally been treated as investments, this behavior changed during the housing boom. For example, one company estimated that as many as 85% of condominium properties purchased in Miami were for investment purposes. Media widely reported condominiums being purchased whie under construction, then being quot;flippedquot; l (sold) for a profit without the seller ever having lived in them.[50] Some mortgage companies identified risks inherent in this activity as early as 2005, after identifying investors assuming highly leveraged positions in multiple properties.[51] Economist Robert Shiller argues that speculative bubbles are fueled by quot;contagious optimism, seemingly impervious to facts,that often takes hold when prices are rising. Bubbles are primarily social phenomena; until we understand and address the psychology that fuels them, they're going to keep forming.quot;[52] Keynesian economist Hyman Minsky described three types of speculative borrowing that contribute to rising debt and an eventual collapse of asset values:[53][54]  The quot;hedge borrower,quot; who expects to make debt payments from cash flows from other investments;  The quot;speculative borrower,quot; who borrows believing that he can service the interest on his loan, but who must cont nually roll over the principal into new investments; i  The quot;Ponzi borrower,quot; who relies on the appreciatio of the value of his assets to n refinance or pay off his debt, while being unable to repay the original loan. Speculative borrowing has been cited as a contributing factor to the subprime mortgage crisis.[55] [edit] High-risk mortgage loans and lending practices Lenders began to offer more and more loans to higher-risk borrowers,[56] including illegal immigrants.[57] Subprime mortgages amounted to $35 billion (5% of total originations) in 1994,[58] 9% in 1996,[59] $160 billion (13%) in 1999,[58] and $600 billion (20%) in 2006.[59][60][61] A study by the Federal Reserve found that the average difference between subprime and prime mortgage interest rates (the quot;subprime markupquot;) declined from 280 basis points in 2001, to 130 basis points in 2007. In other words, the risk premium required by lenders to offer a subprime loan declined. This occurred even though the credit ratings
    • of subprime borrowers, and the characteristics of subprime loans, both declined during the 2001–2006 period, which should have had the opposite effect. The combination of declining risk premia and credit standards is common to classic boom and bust credit cycles.[62] In addition to considering higher-risk borrowers, lenders have offered increasingly risky loan options and borrowing incentives. In 2005, the median down payment for first-time home buyers was 2%, with 43% of those buyers making no down payment whatsoever.[63] One high-risk option was the quot;No Income, No Job and no Assetsquot; loans, sometimes referred to as Ninja loans. Another example is the interest-only adjustable-rate mortgage (ARM), which allows the homeowner to pay just the interest (not principal) during an initial period. Still another is a quot;payment optionquot; loan, in which the homeowner can pay a variable amount, but any interest not paid is added to the princi al. An estimated one-third p of ARMs originated between 2004 and 2006 had quot;teaserquot;rates below 4%, which then increased significantly after some initial period, as much as doubling the monthly payment.[64] Mortgage underwriting practices have also been criticized, including automated loan approvals that critics argued were not subjected to appropriate review and documentation.[65] In 2007, 40% of all subprime loans resulted from automated underwriting.[66][67] The chairman of the Mortgage Bankers Association claimed that mortgage brokers, while profiting from the home loan boom, did not do enough to examine whether borrowers could repay.[68] Outright fraud has also increased.[69] [edit] Securitization practices Borrowing under a securitization structure. Securitization, a form of structured finance, involves the pooling of financial assets, especially those for which there is no ready secondary market, such as mortgages, credit card receivables, student loans. The pooled assets serve as collateral for new financial assets issued by the entity (mostly GSEs and investment banks) owning the underlying assets.[70] The diagram at right shows how there are many parties involved. Securitization, combined with investor appetite for mortgage-backed securities (MBS), and the high ratings formerly granted to MBSs by rating agencies, meant that mortgages with a high risk of default could be originated almost at will, with the risk shifted from the
    • mortgage issuer to investors at large. Securitization meant that issuers could repeatedly relend a given sum, greatly increasing their fee income. Since issuers no longer carried any default risk, they had every incentive to lower their underwriting standards to increase their loan volume and total profit. The traditional mortgage model involved a bank originating a loan to the borrower/homeowner and retaining the credit (default) risk. With the advent of securitization, the traditional model has given way to the quot;originate to distributequot; model, in which the credit risk is transferred(distributed) to investors through MBS and CDOs. Securitization created a secondary market for mortgages, and meant that those issuing mortgages were no longer required to hold them to maturity. Asset securitization began with the creation of private mortgage pools in the 1970s.[71] Securitization accelerated in the mid-1990s. The total amount of mortgage-backed securities issued almost tripled between 1996 and 2007, to $7.3 trillion. The securitized share of subprime mortgages (i.e., those passed to third-party investors via MBS) increased from 54% in 2001, to 75% in 2006.[62] Alan Greenspan has stated that the current global credit crisis cannot be blamed on mortgages being issued to households with poor credit, but rather on the securitization of such mortgages.[72] Investment banks sometimes placed the MBS they originated or purchased into off-balance sheet entities called structured investment vehicles or special purpose entities. Moving the debt quot;off the booksquot; enabled large financial institutions to circumvent capital requirements, thereby increasing profits but augmenting risk. Such off-balance sheet financing is sometimes referred to as the shadow banking system, and is thinly regulated.[73] Some believe that mortgage standards became lax because securitization gave rise to a form of moral hazard, whereby each link in the mortgage chain made a profit while passing any associated credit risk to the next link in the chain.[74][75] At the same time, some financial firms retained significant amounts of the MBS they originated, thereby retaining significant amounts of credit risk and so were less guilty of moral hazard. Some argue this was not a flaw in the securitization concept per se, but in its implementation.[22] According to Nobel laureate Dr. A. Michael Spence, quot;systemic risk escalates in the financial system when formerly uncorrelated risks shift and become highly correlated. When that happens, then insurance and diversification models fail. There are two striking aspects of the current crisis and its origins. One is that systemic risk built steadily in the system. The second is that this buildup went either unnoticed or was not acted upon. That means that it was not perceived by the majority of participants until it was too late. Financial innovation, intended to redistribute and reduce risk, appears mainly to have hidden it from view. An important challenge going forward is to better understand these dynamics as the analytical underpinning of an early warning system with respect to financial instability.quot; [76] In 1995, the Community Reinvestment Act(CRA) was revised to allow CRA mortgages to be securitized. In 1997, Bear Sterns was the first to take advantage of this law.[77] Under the CRA guidelines, a mortgage issuer receives credit for originating subprime mortgages, or buying mortgages on a whole loan basis, but not holding subprime mortgages. This
    • rewarded issuers for originating subprime mortgages, then selling them to others who would securitize them. Thus any credit risk in subprime mortgages was passed from the issuer to others, including financial firms and investors around the globe. [edit] Inaccurate credit ratings Main article: Credit rating agencies and the subprime crisis MBS credit rating downgrades, by quarter. Credit rating agencies are now under scrutiny for having given investment-grade ratings to CDOs and MBSs based on subprime mortgage loans. These high ratings were believed justified because of risk reducing practices, including over-collateralization (pledging collateral in excess of debt issued), credit default insurance, and equity investors willing to bear the first losses. However, there are also indications that some involved in rating subprime-related securities knew at the time that the rating process was faulty. Emails exchanged between employees of rating agencies,dated before credit markets deteriorated and put in the public domain by USA Congressional investigators, suggest that some rating agency employees suspected that lax standards for rating structured credit products would result in major problems.[78] For example, one 2006 internal Email from Standard & Poor's stated that quot;Rating agencies continue to create and [sic] even bigger monster—the CDO market. Let's hope we are all wealthy and retired by the time this house of cards falters.quot;[79] High ratings encouraged investors to buy securities backed by subprime mortgages, helping finance the housing boom. The reliance on agency ratings and the way ratings were used to justify investments led many investors to treat securitized products — some based on subprime mortgages — as equivalent to higher quality securities. This was exacerbated by the SEC's removal of regulatory barriers and its reduction of disclosure requirements, all in the wake of the Enron scandal.[80] Critics allege that the rating agencies suffered from conflicts of interest, as they were paid by investment banks and other firms that organize and sell structured securities to investors.[81] On 11 June 2008, the SEC proposed rules designed to mitigate perceived conflicts of interest between rating agencies and iss ers of u structured securities.[82] Between Q3 2007 and Q2 2008, rating agencies lowered the credit ratings on $1.9 trillion in mortgage backed securities. Financial institutions felt they had to lower the value of their MBS and acquire additional capital so as to maintain capital ratios. If this involved the sale of new shares of stock, the value of the existing shares was reduced. Thus ratings downgrades lowered the stock prices of many financial firms.[83] [edit] Government policies Main article: Government policies and the subprime mortgage crisis Both government action and inaction have contributed to the crisis. Some are of the opinion that the current American regulatory framework is outdated. President George W. Bush stated in September 2008: quot;Once this crisis is resolved, there will be time to update
    • our financial regulatory structures. Our 21st century global economy remains regulated largely by outdated 20th century laws.quot;[84] The Securities and Exchange Commission (SEC) has conceded that self-regulation of investment banks contributed to the crisis.[85][86] Increasing home ownership was a goal of the Clinton and Bush administrations.[87][88][89] There is evidence that the Federal government leaned on the mortgage industry, including Fannie Mae and Freddie Mac (the GSE), to lower lending standards.[90][91][92] Also, the U.S. Department of Housing and Urban Development's (HUD) mortgage policies fueled the trend towards issuing risky loans.[93][94] In 1995, the GSE began receiving government incentive payments for purchasing mortgage backed securities which included loans to low income borrowers. Thus began the involvement of the GSE with the subprime market.[95] Subprime mortgage originations rose by 25% per year between 1994 and 2003, resulting in a nearly ten-fold increase in the volume of subprime mortgages in just nine years.[96] The relatively high yields on these securities, in a time of low interest rates, were very attractive to Wall Street, and while Fannie and Freddie generally bought only the least risky subprime mortgages, these purchases encouraged the entire subprime market.[97] In 1996, HUD directed the GSE that at least 42% of the mortgages they purchased shou have been issued to borrowers whose ld household income was below the median in their area. This target was increased to 50% in 2000 and 52% in 2005.[98] On September 10, 2003, U.S. Congressman Ron Paul gave a speech to Congress in which he predicted that the high-leveraging and tolerance of poor credit by the GSE would lead to a bailout[99], and he introduced a bill to abolish these policies, which was rejected. By 2008, the GSE owned, either directly or through mortgage pools they sponsored, $5.1 trillion in residential mortgages, about half the amount outstanding.[100] The GSE have always been highly leveraged, their net worth as of 30 June 2008 being a mere US$114 billion.[101] When concerns arose in September 2008 regarding the ability of the GSE to make good on their guarantees, the Federal government was forced to place the companies into a conservatorship, effectively nationalizing them at the taxpayers' expense.[102][103] Liberal economist Robert Kuttner has suggested that the repeal of the Glass-Steagall Act by the Gramm-Leach-Bliley Act of 1999 may have contributed to the subprime meltdown, but this is controversial.[104][105] The Federal government bailout of thrifts during the savings and loan crisis of the late 1980s may have encouraged other lenders to make risky loans, and thus given rise to moral hazard.[106] [107] Economists have also debated the possible effects of the Community Reinvestment Act (CRA), with detractors claiming that the Act encouraged lending to uncreditworthy borrowers.[108][109][110][111] and defenders claiming a thirty year history of lending without increased risk.[112][113][114][115] Detractors also claim that amendments to the CRA in the mid- 1990s, raised the amount of mortgages issued to otherwise unqualified low-income borrowers, and also allowed for the first time the securitization of CRA-regulated mortgages even though some of these were subprime.[116][117] [edit] Policies of central banks
    • Central banks manage monetary policy and may target the rate of inflation. They have some authority over commercial banks and possibly other financial institutions. They are less concerned with avoiding asset price bubbles, such as the housing bubble and dot-com bubble. Central banks have generally chosen to react after such bubbles burst so as to minimize collateral damage to the economy, rather than trying to prevent or stop the bubble itself. This is because identifying an asset bubble and determining the proper monetary policy to deflate it are matters of debate among economists.[118][119] Some market observers have been concerned that Federal Reserve actions could give rise to moral hazard.[120] Some industry officials said that the Federal Reserve Bank of New York's rescue of Long-Term Capital Management in 1998 would encourage large financial institutions to believe that the Federal Reserve would intervene on their behalf if things went sour because they had made risky loans.[121] A contributing factor to the rise in house prices was the Federal Reserve's lowering of interest rates early in the decade. From 2000 to 2003, the Federal Reserve lowered the federal funds rate target from 6.5% to 1.0%.[122] This was done to soften the effects of the collapse of the dot-com bubble and of the September 2001 terrorist attacks, and to combat the perceived risk of deflation.[118] The Fed believed that interest rates could be lowered safely primarily because the rate of inflation was low; it disregarded other important factors. Richard W. Fisher, President and CEO of the Federal Reserve Bank of Dallas, said that the Fed's interest rate policy during the early 2000s was misguided, because measured inflation in those years was below true inflation, which led to a monetary policy that contributed to the housing bubble.[123] [edit] Financial institution debt levels and incentives Leverage Ratios of Investment BanksIncreased Significantly 2003–2007 Many financial institutions, investment banks in particular, issued large amounts of debt during 2004–2007, and invested the proceeds in mortgage-backed securities (MBS), essentially betting that house prices would continue to rise, and that households would continue to make their mortgage payments. Borrowing at a lower interest rate and investing the proceeds at a higher interest rate is a form of financial leverage. This is analogous to an individual taking out a second mortgage on his residence to invest in the stock market. This strategy proved profitable during the housing boom, but resulted in large losses when house prices began to decline and mortgages began to default. Beginning in 2007, financial institutions and individual investors holding MBS also suffered significant losses from mortgage payment defaults and the result ng decline in the value of MBS.[23] i A 2004 SEC ruling allowed USA investment banks to issue substantially more debt, which was then used to purchase MBS. Over 2004-07, the top five US investment banks each significantly increased their financial leverage (see diagram), which increased their vulnerability to the declining value of MBSs. These five institutions reported over $4.1 trillion in debt for fiscal year 2007, about 30% of USA nominal GDP for 2007. Three investment banks either went bankrupt (Lehman Brothers) or were sold at fire sale prices to
    • other banks (Bear Stearns and Merrill Lynch) during September 2008. The failure of 3 of the 5 large USA investment banks augmented theinstability in the global financial system. The remaining two investment banks, Morgan Stanley and Goldman Sachs, opted to become commercial banks, thereby subjecting themselves to more stringent regulation.[124] The New York State Comptroller's Office has said that in 2006, Wall Street executives took home bonuses totaling $23.9 billion. quot;Wall Street traders were thinking of the bonus at the end of the year, not the long-term health of their firm. The whole system—from mortgage brokers to Wall Street risk managers—seemed tilted toward taking short-term risks while ignoring long-term obligations. The most damning evidence is that most of the people at the top of the banks didn't really understand how those [investments] worked.quot;[38] [edit] Credit default swaps Credit defaults swaps (CDS) are insurance contracts used to protect debth olders, in particular MBS investors, from the risk of default. As the net worth of banks and other financial institutions deteriorated because of losses related to subprime mortgages, the likelihood increased that those providing the insurance would have to paytheir counterparties. This created uncertainty across the system, as investors wondered which companies would be required to pay to cover mortgage defaults. Like all swaps and other financial derivatives, CDS may either be used to hedge risks (specifically, to insure creditors against default) or to profit from speculation. The volume of CDS outstanding increased 100-fold from 1998 to 2008, with estimates of the debt covered by CDS contracts, as of November 2008, ranging from US$33 to $47 trillion.[125] CDS are lightly regulated. As of 2008, there was no central clearinghouse to honor CDS in the event a party to a CDS proved unable to perform his obligations under the CDS contract. Required disclosure of CDS-related obligations has been criticized as inadequate. Insurance companies such as American International Group (AIG), MBIA, and Ambac faced ratings downgrades because widespread mortgage defaults increased their poten tial exposure to CDS losses. These firms had to obtain additional funds (capital) to offset th is exposure. AIG's having CDSs insuring $440 billion of MBS resulted in its seeking and obtaining a Federal government bailout.[126] Like all swaps and other pure wagers, what one party loses under a CDS, the other party gains; CDSs merely reallocate existing wealth. Hence the question is which side of the CDS will have to pay and will it be able to do so. When investment bank Lehman Brothers went bankrupt in September 2008, there was much uncertainty as to which financial firms would be required to honor the CDScontracts on its $600 billion of bonds outstanding.[127][128] Merrill Lynch's large losses in 2008 were attributed in part to the drop in value of its unhedged portfolio of collateralized debt obligations (CDOs) after AIG ceased offering CDS on Merrill's CDOs. The loss of confidence of trading partners in Merrill Lynch's solvency and its ability to refinance its short-term debt led to its acquisition by the Bank of America.[129][130] [edit] Impact
    • Main articles: Financial crisis of 2007–2008 and Global financial crisis of 2008 [edit] Financial sector downturn Main article: List of writedowns due to subprime crisis FDIC Graph - U.S. Bank & Thrift Profitability By Quarter As of August 2008, financial firms around the globe have written down their holdings of subprime related securities by US$501 billion as of August 2008.[131] Mortgage defaults and provisions for future defaults caused profits at the 8533 USA depository institutions insured by the FDIC to decline from $35.2 billion in 2006 Q4 billion to $646 million in the same quarter a year later, a decline of 98%. 2007 Q4 saw the worst bank and thrift quarterly performance since 1990. In all of 2007, insured depository institutions earned approximately $100 billion, down 31% from a record profit of $145 billion in 2006. Profits declined from $35.6 billion in 2007 Q1 to $19.3 billion in 2008 Q1, a decline of 46%.[132][133] The crisis began to affect the financial sector in February2007, when HSBC, the world's largest (2008) bank, wrote down its holdings of subprime-related MBS by $10.5 billion, the first major subprime related loss to be reported.[134] During 2007, at least 100 mortgage companies either shut down, suspended operations or were sold.[135] Top management has not escaped unscathed, as the CEOs of Merrill Lynch and Citigroup resigned within a week of each other.[136] As the crisis deepened, more and more financial firms either merged, or announced that they were negotiating seeking merger partners.[137] [edit] Market weaknesses, 2007 A MetaView diagram shows the key subprime mortgage stocks as they undergo a chain reaction. On July 19, 2007, the Dow Jones Industrial Average hit a record high, closing above 14,000 for the first time.[138] On August 15, 2007, the Dow dropped below 13,000 and the S&P 500 crossed into negative territory for that year. Similar drops occurred in virtually every market in the world, with Brazil and Korea being hard-hit. Through 2008, large daily drops became
    • common, with, for example, the KOSPI dropping about 7% in one day,[139][dead link] although 2007's largest daily drop by the S&P 500 in the U.S. was in February, a result of the subprime crisis. Mortgage lenders[140][dead link][141] and home builders[142][143][dead link] fared terribly, but losses cut across sectors, with some of the worst-hit industries, such as metals & mining companies, having only the vaguest connection with lending or mortgages.[144] Stock indices worldwide trended downward for several months since the first panic in July–August 2007. [edit] Market downturns and impacts, 2008 The TED spread – an indicator of credit risk – increased dramatically during September 2008. The crisis caused panic in financial markets and encouraged investors to take their money out of risky mortgage bonds and shaky equities and put it into commodities as quot;stores of valuequot;.[145] Financial speculation in commodity futures follo wing the collapse of the financial derivatives markets has contributed to the world food price crisis and oil price [146][147] increases due to a quot;commodities super-cycle.quot; Financial speculators seeking quick returns have removed trillions of dollars from equities and mortgage bonds, some of which has been invested into food and raw materials.[148] Beginning in mid-2008, all three major stock indices in the United States (the Dow Jones Industrial Average, NASDAQ, and the S&P 500) entered a bear market. On 15 September 2008, a slew of financial concerns causedthe indices to drop by their sharpest amounts since the 2001 terrorist attacks. That day, the most noteworthy trigger was the declared bankruptcy of investment bank Lehman Brothers. Additionally, Merrill Lynch was joined with Bank of America in a forced merger worth $50 billion. Finally, concerns over insurer American International Group's ability to stay capitalized caused that stock to drop over 60% that day. Poor economic data on manufacturing contributed to the day's panic, but were eclipsed by the severe developments of the financial crisis. All of these events culminated into a stock selloff that was experienced worldwide. Overall, the Dow Jones Industrial plunged 504 points (4.4%) while the S&P 500 fell 59 points (4.7%). Asian and European markets rendered similarly sharp drops. The much anticipated passage of the $700 billion bailout plan was struck down by the House of Representatives in a 228–205 vote on September 29. In the context of recent history, the result was catastrophic for stocks. The Dow Jones Industrial Average suffered a severe 777 point loss (7.0%), its worst point loss on record up to that date. The NASDAQ tumbled 9.1% and the S&P 500 fell 8.8%, both of which were the worst losses those indices experienced since the 1987 stock market crash. Despite congressional passage of historic bailout legislation, which was signed by President Bush on Saturday, Oct. 4, Dow Jones Index tumbled further when markets
    • resumed trading on Oct. 6. The Dow fell below 10,000 poi ts for the first time in almost n four years, losing 800 points before recovering to settle at -369.88 for the day.[149] Stocks also continued to tumble to record lows ending one of the worst weeks in the Stock Market since September 11, 2001.quot;[150] [edit] Indirect economic effects Main article: Indirect economic effects of the subprime mortgage crisis The subprime crisis has had a number of actual and likely economic effects. Declining house prices have reduced household wealth and the collateral forhome equity loans, which is placing downward pressure on consumption.[151] Members of USA minority groups received a disproportionate number of subprime mortgages, and so have experienced a disproportionate level of the resulting foreclosures. Minorities have also born the brunt of the dramatic reduction in subprime lending.[152][153] House-related crimes such as arson have increased.[154] There have been significant job losses in the financial sector, with over 65,400 jobs lost in the USA as of September 2008.[155] Many renters became innocent victims, by being evicted from their residences without notice, because their landlords' property has been foreclosed.[156] In October 2008, Tom Dart, the elected Sheriff of Cook County, Illinois, criticized mortgage lenders for their actions vis-a-vis tenants, and announced that he was suspending all foreclosure evictions.[157] The tightening of credit has caused a major decline in the sale of motor vehicles. Between October 2007 and October 2008, Ford sales were down 33.8%, General Motors sales were down 15.6%, and Toyota sales had declined 32.3%. One in five USA car dealerships are expected to close in Fall of 2008.[158] [edit] Responses Various actions have been taken since the crisis became apparent in August 2007. In September 2008, major instability in world financial markets increased awareness and attention to the crisis. Various agencies and regulators, aswell as political officials, began to take additional, more comprehensive steps to handle the crisis. [edit] Legislative and regulatory responses [edit] Federal Reserve Bank Main article: Federal Reserve responses to the subprime crisis The central bank of the USA, the Federal Reserve, in partnership with central banks around the world, has taken several steps to address the crisis. Federal Reserve Chairman Ben Bernanke stated in early 2008: quot;Broadly, the Federal Reserve's response has followed two tracks: efforts to support market liquidity and functioning and the pursuit of our macroeconomic objectives through monetary policy.quot;[15] The Fed has:
    •  Lowered the target for the Federal funds rate from 5.25% to 2%, and the discount rate from 5.75% to 2.25%. This took place in six steps occurring between 18 September 2007 and 30 April 2008;[159][160]  Undertaken, along with other central banks, open market operations to ensure member banks remain liquid. These are effectively short-term loans to member banks collateralized by government securities. Central banks have also lowered the interest rates (called the discount rate in the USA) they charge member banks for short-term loans;[161]  Used the Term Auction Facility (TAF) to provide short-term loans (liquidity) to banks. The Fed increased the monthly amount of these auctions throughout the crisis, raising it to $300 billion by November 2008, up from $20 billion at inception. A total of $1.6 trillion in loans to banks were made for various types of collateral by November 2008.[162]  Finalized, in July 2008, new rules for mortgage lenders;[163]  In October 2008, the Fed expanded the collateral it will lend against to include commercial paper, to help address continued liquidity concerns.[164] By November 2008, the Fed had purchased $271 billion of such paper, out of a program limit of $1.4 trillion.[165]  In November 2008, the Fed announced the $200 billion Term Asset-Backed Securities Loan Facility (TALF).This program supported the issuance of asset- backed securities (ABS) collateralized by loans related to auto credit cards, s, education, and small businesses. This step was taken to offset liquidity concerns.[166]  In November 2008, the Fed announced a $600 billion program to purchase the MBS of the GSE, to help lower mortgage rates.[167] [edit] Regulation Main article: Regulatory responses to the subprime crisis Regulators and legislators have contemplated taking action with respect to lending practices, bankruptcy protection, tax policies, affordable housing, credit counseling, education, and the licensing and qualifications of lenders.[168] Regulations or guidelines can influence the transparency and reporting required of lenders and the types of loans they choose to issue. Congressional committees are also conducting hearings to help identify solutions and apply pressure to the various parties involved.[169]  On 31 March 2008, a sweeping expansion of the Fed's regulatory powers was proposed, that would expand its jurisdiction over nonbank financial institutions, and its authority to intervene in market crises.[170]  Responding to concerns that lending was not properly regulated, the House and Senate are both considering bills to further regulate lending practices.[171]  Countrywide's VIP program has led ethics experts and key senators to recommend that members of Congress be required to disclose information about the mortgages they take out.[172]  Nondepository banks (e.g., investment banks and mortgage companies) are not subject to the same capital requirements as depository banks. Many investment banks had limited capital to offset declines in their holdings of MBSs, or to support their side of credit default insurance contracts.
    •  Nobel prize winner Joseph Stiglitz has recommended that the USA adopt regulations restricting leverage, and preventing companies from becoming quot;too big to fail.quot;[173]  British Prime Minister Gordon Brown and Nobel laureate A. Michael Spence have argued for an quot;early warning systemquot; to help detect a confluence of events leading to systemic risk.[174] Dr. Ram Charan has also argued for risk management early warning systems at the corporate board level.[175]  On 18 September 2008, UK regulators announced a temporary ban on short-selling [176] the stock of financial firms.  The Australian government will invest AU$4 billion in mortgage backed securities issued by nonbank lenders, in an attempt to maintain competit on in the mortgage i [177] market.  Fed Chairman Ben Bernanke stated there is a need for quot;well-defined procedures and authorities for dealing with the potential failure of a systemically important non-bank financial institution.quot;[178] [edit] Economic Stimulus Act of 2008 Main article: Economic Stimulus Act of 2008 On 13 February 2008, President Bush signed into law an economic stimulus package costing $168 billion, mainly taking the form of income tax rebate checks mailed directly to taxpayers.[179] Checks were mailed starting the week of 28 April 2008. However, this rebate coincided with an unexpected jump in gasoline and food prices. This coincidence led some to wonder whether the stimulus package would have the intended effect, or whether consumers would simply spend their rebates to cover higher food and fuel prices. Some Congressmen even contemplated a second round of tax rebates to ensure that the American economy would indeed be stimulated. Secretary of the Treasury Henry Paulson strongly opposed such initiative. [edit] Housing and Economic Recovery Act of 2008 Main article: Housing and Economic Recovery Act of 2008 The Housing and Economic Recovery Act of 2008 included six separate major acts intended to restore confidence in the American mortgage industry.[180] The Act:  Insures $300 billion in mortgages, that will assist an estimated 400,000 borrowers;  Creates a new Federal regulator to ensure the safe and sound operation of the GSEs (Fannie Mae and Freddie Mac) and Federal Home Loan Banks;  Raises the ceiling on the dollar value of the mortgages the government sponsored enterprises (GSEs) may purchase;  Lends money to mortgage bankers to help themrefinance the mortgages of owner- occupants at risk of foreclosure.The lender reduces the amount of the mortgage (typically taking a significant loss), in exchange for sharing in any future appreciation in the selling price of the house via the Federal Housing Administration. The refinancing must have fixed payments for a term of 30 years;
    •  Requires that lenders disclose more information about the products they offer and the deals they close;  Helps local governments buy and renovate foreclosed properties. [edit] Failures and government bailouts of financial firms Main articles: List of bankrupt or acquired banks during the financial crisis of 2007–2008, Federal takeover of Fannie Mae and Freddie Mac, and Government intervention during the subprime mortgage crisis People queuing outside a Northern Rock bank branch in Birmingham, United Kingdom on September 15, 2007, to withdraw their savings because of the subprime crisis.  Northern Rock, encountering difficulty obtaining the credit it required to remain in business, was nationalized on 17 February 2008. As of 8 October 8 2008, United Kingdom taxpayer liability arising from this takeover had risen to £87 billion ($150 billion).[181]  Bear Stearns was acquired by J.P. Morgan Chase in March 2008 for $1.2 billion.[182] The sale was conditional on the Fed's lending Bear Sterns US$29 billion on a nonrecourse basis.[183]  The GSEs Fannie Mae and Freddie Mac were both placed in conservatorship in September 2008.[184]The two GSEs have more than US$ 5 trillion in mortgage backed securities(MBS) and other debt outstanding.[185]  Merrill Lynch was acquired by Bank of America in September 2008 for $50 billion.[186]  Scottish banking group HBOS agreed on 17 September 2008 to an emergency acquisition by its UK rival Lloyds TSB, after a major decline in HBOS's share price stemming from growing fears about its exposure to British and American MBSs. The UK government made this takeover possible by agreeing to waive its competition rules.[187]  Lehman Brothers declared bankruptcy on 15 September 2008, after the Secretary of the Treasury Henry Paulson, citing moral hazard, refused to bail it out.[188][189]  AIG received an $85 billion emergency loan in September 2008 from the Federal Reserve.[190] which AIG is expected to repay by gradually selling off its assets.[191] In exchange, the Federal government acquired a 79.9% equity stake in AIG.[191]  Washington Mutual (WaMu) was seized in September 2008 by the USA Office of Thrift Supervision (OTS).[192] Most of WaMu's untroubled assets were to be sold to J.P. Morgan Chase.[193]  British bank Bradford & Bingley was nationalised on 29 September 2008 by the UK government. The government assumed control of the bank's £50 billion
    • mortgage and loan portfolio, while its deposit and branch network are to be sold to Spain's Grupo Santander.[194]  In October 2008, the Australian government announced that it would make AU$4 billion available to nonbank lenders unable to issue new loans. After discussion with the industry, this amount was increased to AU$8 bi lion.[195] l  In November 2008, the U.S. government announced it was purchasing $27 billion of preferred stock in Citigroup, a USA bank with over $2 trillion in assets, and warrants on 4.5% of its common stock. The preferred stock carries an 8% dividend. This purchase follows an earlier purchase of $25 billion of the same preferred stock using TARP funds. [196] [edit] Emergency Economic Stabilization Act of 2008 Main article: Emergency Economic Stabilization Act of 2008 As of June 30, 2008, residential mortgages owed by USA households totalled US$10.6 trillion.[197] As of August 2008, 9.2% of these mortgages were either seriously delinquent or in foreclosure.[19] On 19 September 2008, the U.S. Federal government announced a plan, requiring Congressional approval, to purchase from financial institutions large amounts of MBSs and CDOs backed by subprime mortgages.[198] The estimated cost of this plan was at least $700 billion.[199] The plan also banned short-selling the stocks of financial firms.[200] On 29 September 2008, the House of Representatives rejected a revised version of the plan.[201] On 1 October 2008, the U.S. Senate approved an amended version of the plan,[202] which was ratified by the House on October3 and immediately signed into law by President Bush. [edit] Lending industry action Lenders and borrowers both may both benefit from avoiding foreclosure, which is a costly and lengthy process. Some lenders have offered troubled borrowers more favorable mortgage terms (i.e., refinancing, loan modification or loss mitigation). Borrowers have also been encouraged to contact their lenders to discuss alternatives.[203] Corporations, trade groups, and consumer advocates have begun to cite data on the numbers and types of borrowers assisted by loan modification programs. There is some disagreement regarding the data, and the adequacy of measures taken to date. A report January 2008 report stated tha mortgage lenders modified 54,000 loans and established t 183,000 repayment plans in the third quarter of 2007, a period in which there were 384,000 foreclosures were initiated. Consumer groups claimed these modifications affected less than 1% of the 3 million ARM subprime mortgages outstanding as of the third quarter.[204] The State Foreclosure Prevention Working Group, a coalition of state attorney generals and bank regulators from 11 states, reported in April 2008 that loan servicers could not keep up with the rising number of foreclosures. 70% of subprime mortgage holders are not getting the help they need. Nearly two-thirds of loan workouts require more than six weeks to complete under the current quot;case-by-casequot; method of review. In order to slow the growth of
    • foreclosures, the Group has recommended a more automated method of loan modification that can be applied to large blocks of struggling borrowers.[205] On October 5, 2008, the Bank of America, following on a legal settlement with several states, announced a more aggressive and systematic program intended to help an estimated 400,000 borrowers keep their homes. The program will limit payments as a fraction of household income, and reduce mortgage balances.[206] In November 2008, Fannie Mae, Freddie Mac and their network of mortgage service providers announced a streamlined loan modificatio program and foreclosure suspension, n [207][208] designed to help keep borrowers in their homes. Several Australian lenders have amended their policies for higher risk mortgage types. These changes have been relatively minor, with the exception of those nonconforming lenders that lend to credit impaired and subprime borrowers. It remains to be seen if this trend will continue, or if Australian lenders will eventually stop offering riskier loan products.[209] [edit] Hope Now Alliance Main article: Hope Now Alliance President George W. Bush announced a plan to voluntarily and temporarily freeze the mortgages of a limited number of mortgage debtors holding ARMs.[210][211] A refinancing facility called FHA-Secure was also created.[212] These actions are part of the Hope Now Alliance, an ongoing collaborative effort between the US Government and private industry to help certain subprime borrowers.[213] In February 2008, the Alliance reported that during the second half of 2007, it had helped 545,000 subprime borrowers with shaky credit, or 7.7% of 7.1 million subprime loans outstanding as of September 2007. A spokesperson for the Alliance acknowledged that much more must be done.[214] During February 2008, a program called quot;Project Lifelinequot; was announced. Six of the largest USA lenders, in partnership with the Hope Now Alliance, agreed to defer foreclosure actions for 30 days for borrowers 90 or more days delinquent on their mortgage payments. The intent of the program was to reduce foreclosures by encouraging loan adjustments.[215] [edit] Bank capital replenishment from private sources As of May 2008, major financial institutions had obtained over $260 billion in new capital, taking the form of bonds or preferred stock sold to private investors in exchange for cash.[216] This new capital has helped banks maintain required capital ratio (an important s measure of financial health), which have declined significantly due to losses on subprime loans or CDO investments. Raising additional capital has been advocated by the leadership of the U.S. Federal Reserve and the Treasury Department.[217] Well-capitalized banks are in a better position to lend at favorable interest rates, and to offset the falling liquidity and rising uncertainty in credit markets. Banks have obtained some of their new capital from
    • the sovereign wealth funds of developing countries, which may have political implications.[218] Certain major banks have also reduced their dividend payouts to stabilize their financial position.[219] Of the 3776 FDIC insured institutions that paid a dividend on their common stock in the first quarter of 2007, almost half (48%) paid a lower dividend in the first quarter of 2008, and 666 institutions reduced their dividend to zero. Insured institutions paid $14.0 billion in total dividends in the first quarter of 2008, down $12.2 billion (46.5%) from the first quarter of 2007.[220] [edit] Litigation Litigation related to the subprime crisis is underway. A study released in February 2008 indicated that 278 civil lawsuits were filed in federal courts during 2007 related to the subprime crisis. The number of filings in state courts was not quantified but is also believed to be significant. The study found that 43% of the cases were class actions brought by borrowers, such as those that contended they were victims of discriminatory lending practices. Other cases include securities lawsuits filed by investors, commercial contract disputes, employment class actions, and bankruptcy-related cases. Defendants included mortgage bankers, brokers, lenders, appraisers, title companies, home builders, servicers, issuers, underwriters, bond insurers, money managers, public accounting firms, and company boards and officers.[221] Former Bear Stearns managers were named in civil lawsuits brought in 2007 by investors, including Barclays Bank PLC, who claimed they had been misled.[222] An important issue related to the restructuring of mortgage loans involves the contractual rights of investors who purchased relatedMBS. Investor permission is often required to modify the underlying mortgages, resulting in a quot;case-by-casequot; loan modification regime. This presents a challenge for banks and governments who are attempting to limit foreclosures by helping large groups of homeowners re-negotiate the terms of their mortgages efficiently. A class-action lawsuit was filed in December 2008 that may have significant implications.[223] [edit] Law enforcement The number of FBI agents assigned to mortgage-related crimes increased by 50% between 2007 and 2008.[224] In June 2008, the FBI stated that its mortgage fraud caseload has doubled in the past three years to more than 1,400 pending cases.[225] Between 1 March and 18 June 2008, 406 people were arrested for mortgage fraud in an FBI sting across the country. People arrested include buyers, sellers and others acrossthe wide-ranging mortgage industry.[224] On 19 June 2008, two former Bear Stearns managers were arrested by the FBI, and were the first Wall Street executives arrested related to the subpr ime lending crisis. They were suspected of misleading i vestors about the risky subprime n mortgage market.[222] On 23 September 2008, two government officials stated that the Federal Bureau of Investigation was looking into the possibility of fraud by mortgage financing companies
    • Fannie Mae and Freddie Mac, Lehman Brothers, and insurer American International Group.[226] [edit] Ethics investigation Main article: Countrywide financial political loan scandal On 18 June 2008, a Congressional ethics panel started examining allega tions that Democrat Senators Christopher Dodd of Connecticut (the sponsor of a major $300 billion housing rescue bill) and Kent Conrad of North Dakota received preferential loans by troubled mortgage lender Countrywide Financial Corp.[227] [edit] Effect on the financial condition of USA governmental units See also: United states public debt Deficit and Debt Increases 2001–2008 The Federal government's efforts to support the global financial system have resulted in significant new financial commitments,totaling $7 trillion by November, 2008. These commitments can be characterized as investments, loans, and loan guarantees, rather than direct expenditures. In many cases, the government purchased financial assets such as commercial paper, mortgage-backed securitie or other types of asset-backed paper, to s, enhance liquidity in frozen markets.[228] As the crisis has progressed, theFed has expanded the collateral against which it is willing to lend to include higher-risk assets.[229] The extent to which the Federal government is at risk becauseof these investments and guarantees remains to be seen.[230] The upshot has been a US$1 trillion increase in the national debt of the USA during FY 2008, compared to an average increase of US$550 billion during the previous five years. The total debt reached $10 trillion in September 2008.[231] In addition, state and local government property tax collections are expected to decline because of an estimated $1.2 trillion reduction in housing prices, and a slowing of the overall American economy.[232] This expectation is affecting the ability of state governments to finance their operations through bond sales. Findin themselves unable to g borrow, the states of California and Massachusetts have requested that the Fed lend them the amounts they would have borrowed elsewhere under normal conditions. [edit] Expectations and forecasts Several years before the crisis Fairfax Financial's Prem Watsa warned:
    • quot;We have been concerned for some time about the risks in asset-backed bonds, particularly bonds that are backed by home equity loans, automobile loans or credit card debt (we own no asset- backed bonds). It seems to us that securitization (or the creation of these asset-backed bonds) eliminates the incentive for the originator of the loan to be credit sensitive... With securitization, the dealer (almost) does not care as these loans can be laid off through securitization. Thus, the loss experienced on these loans after securitization will no longer be comparable to that experienced prior to securitization (called a moral hazard)... This is not a small problem. There is $1.0 trillion in asset-backed bonds outstanding as of December 31, 2003 in the U.S.... Who is buying these bonds? Insurance companies, money managers and banks – in the main – all reaching for yield given the excellent ratings for these bonds. What happens if we hit an air pocket?[233] Stifel Nicolaus, writing in MarketWatch, has claimed that the problem mortgages are not confineed to the subprime niche: quot;the rapidly increasing scope and depth of the problems in the mortgage market suggest that the entire sector has plunged into a downward spiral similar to the subprime woes whereby each negative development feeds further deterioration,quot; calling it a quot;vicious cyclequot; and adding that lenders quot;continue to believe conditions will get worsequot;.[234] The crisis has led to a drastic decline in new housing starts in the USA. Historically, such declines precede a surge of unemployment in the following year.[235] This fact points to another possible consequence of the crisis. As of 22 November 2007, analysts at a leading investment bank estimated losses on subprime CDO could eventually amount to US$148 bil ion.[236] As of 22 December 2007, a l leading business periodical estimated subprime defaults between U.S. $200–300 billion.[237] As of 1 March 2008 analysts from three large financial institutions estimated the impact would be between U.S. $350–600 billion.[238] On 20 March 2008, the Organization for Economic Cooperation andDevelopment downgraded its economic forecasts for the United States, the Eurozone and Japan for the first half of 2008.[239] On 19 May, 2008, Nouriel Roubini, a professor at New York University and head of Roubini Global Economics, was quoted as saying that if the economy slips into recession quot;then you have a systemic banking crisis like we haven't had since the 1930squot;.[240] Because debt instruments backed by suprime mortgages were purchased worldwide, the International Monetary Fund (IMF) quot;says that worldwide losses stemming from the USA subprime mortgage crisis could run to $945 billion.quot;[241] Francis Fukuyama has argued that the crisis represents the end of Reaganism in the financial sector, which was characterized by lighter regulation, pared-back government, and lower taxes. Significant financial sector regulatory changes are expected as a result of the crisis.[242] Fareed Zakaria believes that the crisis may force Americans and their government to live within their means. Further, some of the best minds may be redeployed from financial engineering to more valuable business activities, or to science and technology.[243]
    • The crisis has cast doubt on the legacy of Alan Greenspan, the Chairman of the Federal Reserve System from 1986 to January 2006. Senator Chris Dodd claimed that Greenspan created the quot;perfect stormquot;.[244] Greenspan has remarked that there is a one-in-three chance of recession from the fallout. When asked to comment on the crisis, Greenspan spoke as follows:[118] quot;The current credit crisis will come to an end when the overhang of inventories of newly built homes is largely liquidated, and home price deflation comes to an end. That will stabilize the now-uncertain value of the home equity that acts as a buffer for all home mortgages, but most importantly for those held as collateral for residential mortgage-backed securities. Very large losses will, no doubt, be taken as a consequence of the crisis. But after a period of protracted adjustment, the U.S. economy, and the world economy more generally, will be able to get back to business.quot;