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    6 views36 pages

    ESM 2013 - CH 5 - The US and European Financial Crises PDF

    Uploaded by

    Cosmin Reissler

    Copyright:

    © All Rights Reserved
    Download as PDF or read online from Scribd
    Flag for inappropriate content
    of 36
    ro CHAPTER 5 The U.S. and European Financial Crises Confidence m marke and ntutions tsa ke oxygen. When youve 1 yond’ even thnk aout Tdpenele. Vou ca go years aout thinking about i When is gone for five manats, ts he only thing you tink aint, The confidence ha een sce oof the cet marke and ginning inthe summer of 2007, firs the United States, followed bythe European and ‘Asan financial markets, incurred nancial rises, The global ere cris, which eropted in sepremter 200, was ust winang down Ln heal or 2009 when sovereign detours began toreaheriss conditions in Greece an then rela within ne European Union, Tas ‘Shaper provides an overvew othe origins diveminaton, snd repercussions thse an: ‘Sl eres onthe cond of global buns. The impacts un the mulinsonal enterprise fre ikely tobe both significant and sin, Nostdnt of liana sins should De without a lear understanding of the eames sd consequences of his breakdown in global ‘inal market The Credit Crisis of 2008-2009 {As the so-caled dot-com bubble elapsed in 2000 and 200, capt lowed toward the ral state sectors the United Sates. Although corporate lending mast relatively how, the USbanking sector found mortgage lending bight profitable and xp axpanding mar ot The following years sa investment and specaaton i he ral esate set ineease Tap Ax paces tone and pecan increas, rowing numba ofthe borrowers Were ‘tlomes an ower credit quality. These borrowers ad tele aeciated mrtgge agree ments the infamous sbprie debt, om cried higher debe servis obligations with lower ‘nd lower income and cashflow capbities. In tadional nancial management es, deb service coverage was inceningly inadequate Financlal Sector Deregulation ‘A numberof deregulation eforts inthe United States in 199 and 2000 had opened up ‘he el ett financing marketplace to more financial organizations andinsitaons than Tne US. ar Eoean Fea Cases HAP EH 18 ver before. One of the major openings was the US. Congress’ passage ofthe Gramm Leach Bley Financial Services Modernization Ast of 1999, which repent the last vestiges ‘ofthe Glas Stagal Ast of 193, eliminating the last hariers between commis an including underwriting and proprietary dealing. One key result was that the banks now competed aggressively forthe loan busaess of customers ofall Kinds, offering bortowers tore and more erestive morgage forme a lower and lower interest rates-a lee iil "Thee new and open marks added sgificant presse on the extn finial esto repulston Te Federal Deposit Insurance Corporation (FDIC), esbshed sn 1933, naured ‘Mequat eaptl base fo each bank and to conduct pide npecions fo assue the cet ‘ual ofthe banks loans, By mos esses it had worked wel forthe period leading ip toi. Investment banks an stock brokerage firms were regulated separately bythe Scurtis| sng Exetange Commision (SEC). These banks and orkerape Tas dele Teh ket "etnies than the commercin banks, These stv included rock an bond underweing ‘tte participation n derivatives a insurance markets and investment subprime debt snd other morgage, sing ther own equity and debt atl ~ not the depos of consumers The two ses a stitutions snd repulators now found thnslves operating aa much moee omplex combined mare. Mortgage Lending ‘One of the key outcomes of this new marke! openness and competitiveness ws hat many ‘orromer won previous ies could ot have quale for merigges now could New and inmnay cates lower quality borrowers borrowed a feting rater, priced wt LIBOR pus an Sntrest rate spread, wl oa resetng at ch higher aed rates within 1900 Se years (Other forms snctuded loan agement that were intrest only in the early years, requiring a seeqaent step up in payments with principal reduction or complete refinancing at ater dates In some cases, loans were tinal ats that were far below market ate. Credit Quality. Mortgage lens in the US. marketplace ae normally categrized ss prime (Gr A-pape) Ara (Altemative-A paper), and subprime, a increasing oder of skins. A ‘rime morgage woul categorized a conforming (aso efered tesa conventional oa), ‘meaning it would meet the guarantee requirements and Tsale to Government Sponsored Enterprises (GSES), Fannie Mac and Fredsie Mat ‘AltA morgage, however, were consigered relatively low kloan and the borrower cretworty. but for some reason were not ial conforming As the housing andrea estte Imarkets boomed in 2008 and 200, more and more mortgages were originated by Fenders who were inthe AI-A category. the prefered Toa fr many aon-cwer occupied proper "ies Investors wishing to Bay homes for resle purposes, flipping, would type ual for Sm AA morg bt orn y ec 28 thr warmer tha onn ‘The tied catagory of mortgage loan, subprime, dificult to dein. In precip, it reflects borrowers who do et meet underwriting ctta Subprime borrowers hives higher peeeived kof default, normaly a a result of some ceedit history elements, which ay Fncode bankrupts, loan deinguency default, rsnply United expereneor history of db “They are neal exsuivly sting rate stactares, nd cary ignfantly higher interest ae spreads over the floating bases ike LIBOR. a COMMPTERS The US and European Financ Crees Subprine lending was isl the result of deregulation, Until 1980, moet sates inthe US. hud stuingent intrest rate caps on lndersborromers Even ifs lender wat wing ‘extend a mortgage to asubprime borrower ~at higher interest rata the borrower Ws ‘nling to payit state law prohibited Wal the passage ofthe 980 Depository fstutons Deregulation and Monetary Control Act (DIDMCA) federal aw superseded sate la ‘But wast unt the passage ofthe Tax Reform Act of 1985 that sbprime det came 4 ‘able market The TRA of 986 climinated tax deductibliy of onsuns oun, bt allowed {ac deductibility oa intrest charges ascisted with Doth a primary residence and a second smoigage loon. “The growing demand for lous or morgage these Dorower ld ore and ore ri ‘torsto provi the oat above market ate ginning nthe ie 18D By the 2009 2005 Prod thee subprime lous were a growing segment othe marke. Asilusated a Exhibit ‘Shthe grown both otal dames barroting and morgage based orrowin inthe United ‘Sues in the pot 2000 period was apd However, the collapse in morgage borrowing 26 ru o the 200 credit ers was even more dei ‘Asset Values. One of he Key nani elent ofthis rowing debt was the value ofthe sets collaterliing the mortgages ibe house andeal eat iaee Arthe market demands Pashed up prices, using aso ese ia market ale. The increased ales were then sed Eolstra in einncing. and in some case, atonal det inthe orm ofcesond margages | timed on the riing egy alc ofthe om, [EUIENERY vs wat et oroving 106-200 “lly wrt seo "Soin mre nye ee tnd 0 a antigo ny 7b ‘Gendt hy weet sos ome an he eae fs Recon Und Ses tt wis ‘ho US.andEucouen Franca bea CHAT us | ‘The Transmission Mechanisms Ttautprime debt was mela, then scisiiztion was the mosgito cari. Te vei fr {he greminglower quality debt was the secartiztion a repackaging provided by aseries of ‘ew finance derivatives: ‘Securtizaton. Securitization has long bee & force of change in global financial marks ‘Seung the process of tring gud aetna igui salable ast, The key ele ‘Rent was iit Liu, inthe il fiance the abit to exchange an asset fr cash, Frsanty at fair market value {UPI Howe Dstt ana Parent of Done name, 190-008 ae SnCe es OMAPTERS TheUS nd ucpen Frei Cres Although a multitude of pune ad used securitization ra metbod of creating Hiuid ‘markets for deb and equi fandng ace Wold War Il the United Sttstod ben onto the iSmaor dunalcounteso trodes econo ving sn lout ond comme cial banking ystems, aly doings in the 58 Inf purest form, eration eset Uypeis the traditional nancial intermediaries, pial banks, oo dre to investors themarkeplce inorder tobe vol andra funds As areal may often reduce te costs ‘ofTening and borowing, hile posbly increasing te returns o investors. “The growth in subprioe lnding and AIA lening in he post2000 U.S. deb markets

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