Lesson 11: Crime and Punishment on Wall Street

October 4, 2018

Review:

• Recovery and Affordability
• Exam 2 on Thu, Oct 11
• Sign up (upstairs) for group advising

Presentation:

• Mortgage Crisis – Key Culprits
  • Wall Street Banks selling MBS and CDO securities
    • Losers: Bear Stearns, Lehman Brothers, Merrill Lynch
    • Winners: Goldman Sachs, Citigroup, JP Morgan, others
  • Subprime Loan Originators pushing ARMs and other non-traditional loans on low-income borrowers
    • New Century Financial
    • Countrywide Financial
  • Federal Reserve
    • Keeping interest rates too low for too long
    • Failing to regulate mortgage market and derivatives
  • Rating Agencies issuing AAA ratings on low quality MBS and CDOs
    • Moody’s
    • Standard and Poor’s
  • Professional Investors/Hedge Funds
    • Increasing volatility through use of excessive leverage
  • Fannie and Freddie
    • Purchasing subprime loans in the secondary market
    • Providing liquidity for ongoing subprime lending

• Fannie Mae and Freddie Mac
  • Fannie Mae = Federal National Mortgage Association (FNMA)
  • Freddie Mac = Federal Home Loan Mortgage Corporation (FHLMC)
  • Government Sponsored Enterprises (GSEs)
    • Fannie chartered by congress in 1968
    • Freddie chartered by congress in 1970
    • President of the US appoints 5 of 18 member board of directors
    • Treasury is authorized to purchase securities from Fannie and Freddie
    • Regulated by Dept of Housing and Urban Development (HUD) and Federal Housing Finance Agency (FHFA)
    • Implicit guarantee of federal bailout
  • Secondary Market for mortgage loans
    • Provide liquidity to loan originators
    • Gives lenders flexibility
    • Monopoly for Fannie and Freddie issuing securities
    • Monopoly ended when Wall Street joined the party ~2000
    • When Fannie/Freddie market share decreased (after 2000), they began purchasing and guaranteeing subprime loans
  • Government Rescue: Conservatorship
    • Losses piled up in 2007
    • FHFA placed Fannie and Freddie under govt control on Sep 6, 2008
  • Federal Housing Administration (FHA)
    • Increasingly competitive between FHA + Fannie/Freddie

• Why was no one punished?
  • No consequences = incentive to repeat
  • The Untouchables (Frontline video)

Assignment:

• Study for Exam 2