Homework#9- Inside the Meltdown
1. The housing bubble had burst causing the housing market to crash. Bear Stearns was having liquidity problems and was running out of money. His stock value was decreasing. This was due to the fact that Stearns had been making massive investments in subprime mortgages, which would become known as “toxics assets,” which were sold to investors.
2. Credit Default Swaps are a form of insurance. Bear had promised if bonds it insured failed, they would pay. But because ear had made credit default swap deals worth hundreds of billions of dollars to many people around the world, he became indebted to many of them, which would cause a cascade of failures.
3. The Federal Reserve Bank (aka the Fed) is one of the 12 regional banks established to maintain reserves, issue bank notes, and lend money to member banks. The Fed was prohibited from directly lending cash to Bear, an unregulated investment bank. So Ben Bernanke, head of the Fed, and JP Morgan CEO made a deal of giving a loan to JP Morgan and having it pass on the cash to Bear, so indirectly lending to them.
4. The Treasury Department has to approve the money going to the Fed. Henry Paulson was the head of the Treasury Dept. and he called JPMorgan CEO to buy Bear’s stocks for $2 a share instead of $4, because Paulson doesn’t want anyone to think that the government has a safety net for them whenever they need it. In the recent Wall Street Journal article, “Citi is Bracing to Miss a Profit Goal,” it explains how the Federal Reserve rejected Citigroup Inc.’s capital plan last month. The proposal was to boost the bank’s dividend and ramp up stock buybacks, saying it had failed to measure potential risks to its operations during a severe economic recession. The rejection would cause Citigroup to fail to hit its 2015 goal for return on tangible common equity. Their stock has fallen more than 7% and on Monday, they had also agreed to “pay $1.12 billion to investors to settle claims stemming from mortgage securities sold before the financial crisis, suggesting the bank is trying to put its legal woes behind it…” On March 3, Chief Financial Officer John Gerspach noted at a conference that the bank would increase the amount of capital it returned to shareholders, “subject to regulatory approval,” to meet the goal.
5. Systemic Risk is the risk of collapse of an entire financial system or entire market.
6. Moral hazard meant that if you bail somebody out of a problem that they themselves caused, that somebody will have a tendency to be more willing to take a risk, knowing that the consequences of such a risk will be borne on the person that helped bailed that somebody.
7. Banks gave these mortgages to these people, because the incentive is that they can turn the loans into bonds, and sell them to secondary markets and also be able to receive higher interest payments.
In The Wall Street Journal article, “New Mortgage Lending 14- year Low,” mortgage originations in February fell to their lowest level in at least 14 years due to the months-long plunge in refinancing activity and weak demand for loans to purchase new homes.
The mortgage data, by Black Knight Financial Services, gives some predictions of several industry executives who have said that the “U.S. mortgage market faces its greatest shift in more than a decade after an era of falling interest rates that began in 2000 ended abruptly last year.” The Mortgage Bankers Association reported on Wednesday that the share of mortgage applications for refinances hit their lowest level since July 2009. Last week, the share of refinance applications fell to 51% of all loan applications, down from 84% in late 2012, when mortgage rates fell to 3.5%. Paul Miller, a banking analyst at FBR Capital Markets, cut his “forecast for mortgage originations to $1.1 trillion from $1.2 trillion on Monday amid the weak first quarter numbers.” Miller estimates banks originated just $226 billion in mortgages during