US Home Loan Advocates » Credit Crisis

2008 Financial Crisis Explained For Kids

admin — Sun, 13 Sep 2009 22:16:49 +0000

At some point we are going to have a conversation about the 2008 Financial Crisis with our kids.

The embedded video may help set the scene for why our government continues to throw hundreds of billions of dollars at a multi-trillion dollar problem which was caused by over-leveraged investment models, deregulation of banking and insurance practices and non-existent mortgage borrowing guidelines.

Quick Outline:

The Financial Services Modernization Act of 1999 repealed certain aspects of a 100 year-old law which was established to prevent another Great Depression.

By enabling the co-mingling of Depository Banking and Investment Banking institutions, an overwhelming amount of free money became available to financial institutions who were able to package up mortgages (Collateralized Debt Obligations), insure for AAA investment grade ratings (Credit Default Swaps), and sell to institutional investors (Pension Fund Managers, Municipalities, Low-Risk Mutual Funds).

This entire 10 year investment / mortgage backed securities cycle was leveraged on one very important factor – property values increasing.

As long as property values continued to increase, banks thought that homeowners would keep making mortgage payments.

If people did not make their mortgage payments, then banks were able to foreclose, sell the home, and make a profit.

However, the bubble popped, equity disappeared and banks were sitting on worthless collateral.

Related Articles

Financial Services Modernization Act Explained

admin — Thu, 13 Aug 2009 22:24:11 +0000

Also known as the Gramm-Leach-Bliley Act (GLB), the Financial Services Modernization Act was passed 90 to 8 and signed into law by President Bill Clinton on November 12, 1999.

The Financial Services Modernization Act of 1999 eliminated restrictions on the integration of banking, insurance and stock trading imposed by the Glass-Steagall Act of 1933, which was one of the central pillars of Roosevelt’s New Deal.

Under the old law, banks, brokerages and insurance companies were effectively barred from entering each others’ industries, and investment banking and commercial banking were separated. Interesting source from Nov. 1, 1999.

Sen. Phil Gramm (R – Texas 1985-2002) is considered the “Father of the Credit Crisis” due to the specific language he co-authored into this Act which explicitly exempted security-based swap agreements (a derivative financial product based on another security’s value or performance) from regulation by the SEC Commission.

Basically, there was nobody to regulate the way financial banking and insurance institutions could use credit and leverage to sell things such as Credit Default Swaps on Derivatives for the purpose of Hedging against the failures of mortgage related investment products.

Simplified even further –

The GLB Act revisions made it possible for banks to create unregulated insurance products that essentially bet on the failure of their other financial programs. Unregulated meant that the banking / insurance conglomerates didn’t actually have to show proof of even a tiny percentage of the funds necessary to fulfill a claim placed on the products that they were insuring.

What were they insuring?

Mortgage related products called Collateralized Debt Obligations (CDO) that were sliced and diced until they could be re-sold as AAA credit rated safe investments.

Here are the three main killers from the GLB Act:

1. The definition of “security” in section 2(a)(1) does not include any security-based swap agreement (as defined in section 206B of the Gramm-Leach-Bliley Act [15 USCS § 78c note]).

2. The Commission is prohibited from registering, or requiring, recommending, or suggesting, the registration under this title of any security-based swap agreement[.] …

3. The Commission is prohibited from … promulgating, interpreting, or enforcing rules; or … issuing orders of general applicability; … as prophylactic measures against fraud, manipulation, or insider trading with respect to any security-based swap agreement[.]

If it sounds confusing, you’re not alone.

In all fairness to Mr. Gramm, the GLB Act is only part of the reason for our Credit Financial Crisis. Many economists and former Wall Street hustlers believe it has a lot to do with the stupidity and arrogance of the financial services industry in general.

Either way, the $300 million in political contributions by the financial services industry probably made it slightly difficult for anyone to make a clear judgement about the future consequenses de-regulation could have on our economy.

Related Articles

Credit Default Swaps Explained

admin — Mon, 13 Jul 2009 22:28:04 +0000

Called the Financial Weapons of Mass Destruction by Warren Buffett, a Credit Default Swap is simply an over the counter credit derivative (bet) between two parties about the financial solvency or outcome of something else.

Even though politicians and the media try and blame the housing bubble on speculative home investors and sub-prime borrowers, the United States Government’s approval of legalized gambling on Wall Street is in fact the cause of a much larger $60 trillion financial crisis.

Companies who issued Credit Default Swaps are very similar to the homeowners with good credit who purchased properties that they could never really afford, with zero money down, and without having to prove income or assets.

Everything from major companies, financial markets, to mortgage backed securities were “Insured” or bet against. For example, investors could purchase a derivative on whether or not sub-prime mortgage borrowers would default on their mortgages.

While a CDS sounds like an actual insurance product, it technically was called a “Swap” so that the banking and investment firms selling them wouldn’t fall under insurance or SEC regulations.

Actually, a little bill called the Commodity Futures Modernization Act of 2000 on the heals of the Financial Services Modernization Act of 1999 reversed a 67 year-old law that made it illegal for banks, investment firms, and insurance companies to participate in this form of gambling.

Unfortunately, CDS’s were too complex for many CEOs to understand, which is why AIG could rack up $440 Billion in debt before anyone knew what hit them.

Here are the key components and history of the Credit Default Swap:

Invented in 1997 by a few physics and math wizards at JP Morgan Chase
Sellers of CDS aren’t regulated
Transactions are conducted by two entities in an over the counter environment
Sellers are not required to have cash reserves to cover the losses they are insuring
Purchasers of CDS don’t have to own the securities being insured

—————————–

How Credit Default Swaps Destroyed US

Related Articles

Mortgage Backed Securities Explained

admin — Mon, 13 Jul 2009 21:51:56 +0000

What are Mortgage Backed Securities, and why do I need to learn all of these complicated terms just to get a loan modification?

Before the foreclosure / credit crisis, homeowners never had to concern themselves with complicated mortgage fundamentals such as mortgage backed securities, credit default swaps, and Net Present Value.

With a booming economy, low unemployment, and an abundance of home equity, very few borrowers were faced with the nightmare of navigating the foreclosure process.

Unfortunately, the Making Home Affordable Loan Modification Program is just one of the many foreclosure terms that has become the topic of everyday conversations.

Among the most frequently asked loan modification questions that we hear on a daily basis, confusion about who actually owns the mortgage note is generally at the top of the list.

It seems that most lenders would be willing to negotiate with a distressed homeowner who had a reasonable hardship and properly packaged loan modification application.

However, understanding the basics of how mortgage money is created and traded on the secondary market will help explain some of the obstacles borrowers are facing when they call the number on their mortgage payment coupon in search of help.

_________

What is a Mortgage Backed Security (MBS)?

_________

According to Wikipedia –

A mortgage-backed security (MBS) is an asset-backed security or debt obligation that represents a claim on the cash flows from mortgage loans, most commonly on residential property.

First, mortgage loans are purchased from banks, mortgage companies, and other originators. Then, these loans are assembled into pools. This is done by government agencies, government-sponsored enterprises, and private entities. Mortgage-backed securities represent claims on the principal and payments on the loans in the pool, through a process known as Securitization. These securities are usually sold as bonds, but financial innovation has created a variety of securities that derive their ultimate value from mortgage pools.

Translated -

A Mortgage Backed Security is piece of a large pool of mortgages that an investor can purchase in the form of a bond.

Without getting too detailed about how these bonds are given their value or credit rating, the main purpose of pooling mortgages together and re-selling them in groups is primarily to keep the originating banks liquid so that they can continue lending mortgage money to borrowers.

Basically, a homeowner goes to their bank to get a mortgage. The bank will then combine a bunch of their mortgages together and sell them to an investment bank on Wall Street. From that point, the mortgages are sliced up and sold to different types of investors based on a historic model of expected return for that particular type of loan.

Obviously, this process is too complex to articulate in a few sentences, but the main point is that one borrower’s single home loan may pass through several hands before it ends up as a small piece of another person’s investment portfolio.

So, whom am I making my mortgage payment to?

In most cases, a third-party loan servicing company handles the collection of monthly payments and distribution of principal, interest, taxes, and insurance.

The servicer will purchase the mortgage servicing rights to essentially handle the basic bill collecting duties in exchange for a small fee.

With a sudden boom in foreclosures over the past few years, servicers simply weren’t prepared, properly staffed or experienced to handle the overwhelming loan modification or foreclosure prevention requests from homeowners.

_________

Videos – What is a Mortgage Backed Security (MBS)?

_________

Related Articles

Credit Crisis Explained

admin — Sat, 13 Jun 2009 22:30:07 +0000

What caused this credit and housing crisis? Is there really one person to blame, or did we all play a part?

The embedded video was produced by Jonathan Jarvis to help define the relationships between homeowners (Main Street), bankers and brokers (Wall Street), and institutional investors.

This video easily explains how Sub Prime Mortgages, Collateralized Debt Obligations, Frozen Credit and Credit Default Swaps created the perfect storm.

____________

Credits: The Crisis of Credit Visualized from Jonathan Jarvis

____________

It is certainly amazing how a couple of recent changes to a law passed in 1933 could have such a significant impact on the destruction of the world’s economy.

Regardless of what the media or politicians try to say, this credit crisis it is NOT the original fault of sub-prime borrowers. In fact, there are many strong debates that put government policy and corruption as the root cause for the current pain being felt by Americans and others around the world.

On one side, the Financial Services Modernization Act of 1999 created an opportunity for banks and affiliated insurance companies to participate in a form of legalized gambling where they could manipulate the credit rating of a risky investment product and sell it to institutional investors such as pension fund managers and municipalities.

The opposing team believes that a government mandate in the Community Reinvestment Act of 1977 by Carter and amendments in 1995 by Clinton encouraged banks to find creative ways of lending to borrowers who did not have sufficient credit, income, employment, down payments, or assets to obtain FHA or Conventional financing.

The fact that Fanie Mae made a commitment to purchase sub-prime mortgages helped fuel the fire as well.

Either way, leverage, lack of transparency, and limited regulation are all to blame for this crisis of credit.

Related Articles