Great RecessionFinancial Crisis in Banking Industry

Regulation

• A form of government control with certain requirements, restrictions and guidelines

• Regulation creates, limits, or constrains a right, creates or limits a duty, or allocates a responsibility

• EXAMPLE: Glass-Steagall Act of 1932

Investment Banks

• Handles stocks and bonds sales (securities)• Investment banks went public in the 1980’s • Got lots of stockholders money and stock

traders got rich• Example: Goldman Sachs

Deregulation

• The act or process of removing or reducing government regulations

• Example: Savings and Loan Deregulation – Depository Institutions Deregulation and

Monetary Control Act of 1980 (DIDMCA)

Ronald Reagan

• President 1981 – 1989• DIDMCA – savings and loan deregulation• $124 billion cost to taxpayers• Garn–St. Germain Depository Institution Act

of 1982 – more bank deregulation• Appointed Alan Greenspan as Chairman of the

Federal Reserve

Charles Keating

• Lincoln Savings and Loan President who took advantage of loosened restrictions on banking regulations and when investigated was allowed preferential treatment by the review committee because of his association with 5 senators –

• Alan Greenspan write a report on his banking practices saying there was no risk – Greenspan given $40,000 for report

Alan Greenspan

• Chairman of the Federal Reserve under Ronald Reagan, George H. W. Bush, Bill Clinton, George W. Bush

• Economic Consultant prior to appointment• Supported deregulation• Ideology stayed the same

Larry Summers

• Harvard Economic Professor• Director of National Economic Council 2009• Secretary of the Treasury under Bill Clinton• Supported deregulation

Bill Clinton

• President 1993-2001• Deregulation Gramm Leach Bliley Act of 1999• Cusp of Internet Stock crash of 2001

Gramm Leach Bliley Act

• Removed restriction on mergers• Called the Financial Services Modernization

Act of 1999 • Banks could merge with insurance companies

or brokerages, etc.

Eliot Spitzer

• New York Attorney General 1999-2006• Against deregulation

Derivatives

• Agreement between two parties that is contingent on a future price movement of the asset it is linked to – such as a share, currency, commodity, or even the weather

• A bet• Credit default swap

Credit Default Swap (CDS)

• Insurance contract in which the buyer of the CDS makes a series of payments to the protection seller and, in exchange, receives a payoff if a security (collection of loans) goes into default

Mortgage Backed Securities

• Asset-backed security that is secured by a mortgage or collection of mortgages

• Theses must also be grouped in one of the top two ratings as determined by an accredited credit rating agency

• Pays periodic payments that are similar to coupon payments

• Mortgage must have originated from a regulated and authorized financial institution

Collateralized Debt Obligation (CDO’s)

• Structured asse-backed security whose value and payments are derived from a portfolio of fixed-income underlying assets.

• CDO’s are split into different rick classes, or trances – senior trances are the safest securities

• Interest and principal payments are made in order of seniority

Credit Rating Agencies

• Moody’s• Standard and Poor’s• Fitch• Assigns credit rating for issues of certain types

of securities – CDO’s and ABS

• AAA rating the highest • Just “an opinion”

Subprime Mortgages

• Classification of borrowers with a tarnished or limited credit history

• Usually the credit score is below 640• Subprime loans carry more credit risk, and as

such, will carry higher interest rates as well• 25% of mortgage originations were classified

as subprime

Security and Exchange Commission

• Agency that is suppose to monitor the stock market or any security transaction

• Ignored the derivative market that developed in 1994

Leverage

• Borrowed capital, such as margin, to increase the potential return of an investment

• Most commonly used in real estate transactions through the use of mortgages to purchase a home

• 0% - 20% down – less down – more leverage

Henry Paulson

• Secretary of the Treasury under George W. Bush

• Supported deregulation• Petitioned the SEC to relax limits to increase

borrowing (leverage)

George W. Bush

• Did not pursue Internet stock meltdown of overstatement of earnings

• Legislation supporting home ownership• President 2001-2009• Supported deregulation

Ben Bernanke

• Professor at Princeton 1996-2002• Chairman of the Federal Reserve under

President George W. Bush and Barack Obama• “A Wall Street Government”

Timothy Geithner

• President of the New York Federal Reserve until 2009

• Secretary of the Treasury for Barack Obama – 2009-2013

Investment Bank

• Goldman Sachs• Morgan Stanley• Lehman Brothers – filed bankruptcy• Merrill Lynch – bought by Bank of America• Bear Stearns

Financial Securities Insurance Companies

• AIG – American International Group• MBIA – Municipal Bond Insurance Agency• AMBAC – American Municipal Bond Assurance

Corporation

Financial Conglomerates

• Citigroup• JP Morgan – invented CDS in 1994

Bailouts under Bush

• Unemployment • Foreclosures• GM & Chrysler bailouts• Worldwide recession• Pay packages to CEO’s

Essay

• Based on the information you acquired through watching and discussing the documentary Inside Job, which sector do you think was most responsible for the 2008 recession that we are still recovering from today and why? Give specific examples.