Submission Number: 2

Group Number: 67

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Marcius Lima
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1
MScFE 560 Financial Markets

Group #: 67 Submission #: 2
Global Financial Crisis – An Inside Job
/Submission 1/

In 1994, a group of bankers from the Global Derivatives Group of JP Morgan assembled in Florida
to discuss a lot of pressing issues, among which was “How to reduce risk?”. They wanted to find
ways for financial institutions to pass risk between themselves. One way was to sell loans while
another was to separate the risk of the loan going bad from the loan itself. The result of that
discussion was Credit Default Swaps (CDS) - a derivative that insures loans against default.
Bankers borrowed this idea from the commodities market and applied it to loans. The first CDS
that JPM sold involved Exxon taking a multi-billion-dollar letter of credit from JPM and afterwards
JPM passing it off to the European Bank for Reconstruction and Development. Credit derivatives
made it possible for banks to pass on their loan to someone else and skirt capital requirements.
JPM was looking to expand credit derivatives operations in 1998. They thought of putting
together a portfolio of credit risk involving corporate names. They created tranches of 306
entities' loan portfolio by slicing it into different risk levels. This insured JPM against default by
those 306 companies. Then they began selling such derivatives that were bet on portfolios, even
the ones that banks didn't own. These were known as Synthetic CDOs. The Derivatives market
was an unregulated and private off-exchange market. The next big thing was to apply the same
idea to portfolios of consumer credit risk and the higher the risk, the better. The banks wanted
to create something that has a high rating and a high yield. Now with the merging of traditional
& investment banking, banks and Wall Street started making fast money for themselves using
derivatives. Being successful at using regulatory arbitrage to make money, bankers descended
on European capitals offering derivative solutions to financially unknowledgeable clients.

In 2003, bankers from Bear Stearns tricked city officials from a town called Cassino near Rome by
signing an interest rate swap. The interest rate, the deal was pegged to, began to rise. Cassino
found itself paying millions more in interest than it bargained for. Eventually, over 1,000
municipalities and institutions across Europe entered similar deals with major banks. Goldman
Sachs sold Greece giant swaps that helped cut Greece's debt by 2%. It was a secret off-balance-
sheet loan, legal within the rules at the time. Then other banks began looking for other similar
shady deals. Between 2001-08, Greece's debt had doubled. Bond traders started dumping Greek
sovereign bonds. In 2010, the value of the euro dropped precipitously. Ireland, Portugal, Spain,
and Italy started their own downward spirals. What was originally perceived as an isolated
problem quickly became a systemic problem for the Eurozone.

Back in the early 2000s, the Fed dropped interest rates below the inflation rate to 1%. House
prices went up by 15% in 2005. More people (subprime borrowers) started buying homes, which
they couldn’t otherwise afford. Bankers started packaging these loans and passing them off to
Wall Street. Every player started passing along these mortgage-backed securities and it was all
sunshine until the subprime borrowers defaulted on their payments and the investors started

2
MScFE 560 Financial Markets

Group #: 67 Submission #: 2
panic-selling these securities. Housing prices dived all over the country. This was the beginning
and crucial reason for the Great Recession. In 2008, when the music stopped in the fall, they
pulled out the chairs, they were several chairs short.

The 2008 Financial Crisis shook the world at a scale unseen since the Great Depression of 1929.
Subprime mortgage loans, the main reason behind the financial collapse, inevitably led to some
crucial events. Here is an overview of important events, which showcase the crisis, some of its
casualties and government doings, and their impact on the market.

Market Impact
Date Event
(Ticker, Close, Change %)
Mortgage company Freddie Mac DJI 12,216.24 -3.29%
stops buying the riskiest subprime IXIC 2,407.86 -3.86%
loans.
February 27, 2007 Former Federal Reserve Chairman
Alan Greenspan says the economy GSPC 1,399.04 -3.47%
could fall into a recession by the
end of 2007.
Real estate investment trust New DJI 12,382.30 0.23%
April 2, 2007 Century Financial files for IXIC 2,422.26 0.03%
bankruptcy. GSPC 1,424.55 0.26%
Two subprime hedge funds, which DJI 13,211.99 -1.10%
July 31, 2007 had lost nearly all of their value, are IXIC 2,546.27 -1.43%
liquidated by Bear Stearns. GSPC 1,455.27 -1.26%
Mortgage lender American Home DJI 13,468.78 2.18%
August 6, 2007 Mortgage Investment files for IXIC 2,547.33 1.44%
bankruptcy. GSPC 1,467.67 2.42%
DJI 13,270.68 -2.83%
BNP Paribas freezes three funds
August 9, 2007 IXIC 2,556.49 -2.16%
containing subprime loans.
GSPC 1,453.09 -2.96%
Largest U.S. mortgage lender DJI 12,845.78 -0.12%
August 16, 2007 Countrywide Financial draws down IXIC 2,451.07 -0.32%
$11.5 billion bank credit line. GSPC 1,411.27 0.32%
DJI 12,606.30 -1.92%
Countrywide Financial is bought by IXIC 2,439.94 -1.95%
January 11, 2008
Bank of America for $4.1 billion.
GSPC 1,401.02 -1.36%
The largest single-year drop in U.S. DJI 12,378.61 0.88%
January 24, 2008 home sales in a quarter of a century IXIC 2,360.92 1.92%
is announced. GSPC 1,352.07 1.01%

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MScFE 560 Financial Markets

Group #: 67 Submission #: 2
Market Impact
Date Event
(Ticker, Close, Change %)
DJI N/A N/A
Bear Stearns is bought by JPMorgan
March 16, 2008 IXIC N/A N/A
Chase for $1.2 billion.
GSPC N/A N/A
IndyMac is put into conservatorship DJI 11,100.54 -1.14%
July 11, 2008 by the Federal Deposit Insurance IXIC 2,239.08 -0.83%
Corporation. GSPC 1,239.49 -1.11%
Fannie Mae and Freddie Mac are DJI N/A N/A
September 7, 2008 put into conservatorship by the IXIC N/A N/A
Federal Housing Finance Agency. GSPC N/A N/A
Merrill Lynch is bought by Bank of DJI 10,917.51 -4.42%
America for $50 billion. IXIC 2,179.91 -3.60%
September 15, 2008
Investment bank Lehman Brothers
GSPC 1,192.70 -4.71%
files for bankruptcy.
American International Group DJI 11,059.02 1.30%
receives an $85 billion federal IXIC 2,207.90 1.28%
September 16, 2008
bailout for 79.9% stake in the
GSPC 1,213.60 1.75%
company.
Largest U.S. S&L Washington DJI 11,022.06 1.82%
September 25, 2008 Mutual Bank is bought by JPMorgan IXIC 2,186.57 1.43%
Chase for $1.9 billion. GSPC 1,209.18 1.97%
DJI 10,365.45 -6.98%
Congress rejects $700 billion
September 29, 2008 IXIC 1,983.73 -9.14%
Troubled Asset Relief Program.
GSPC 1,106.42 -8.81%
Bush signs TARP. DJI 10,325.38 -1.50%
October 3, 2008 Wachovia is bought by Wells Fargo IXIC 1,947.39 -1.48%
& Co. for $15.1 billion. GSPC 1,099.23 -1.35%
DJI 9,258.10 -2.00%
Eight central banks cut interest
October 8, 2008 IXIC 1,740.33 -0.83%
rates by 0.5%.
GSPC 984.94 -1.13%
1.2 million Americans are DJI 8,943.81 2.85%
November 7, 2008 announced to have lost their jobs IXIC 1,647.40 2.41%
since the beginning of 2008. GSPC 930.99 2.89%
DJI 8,497.31 -3.82%
First G20 Summit after Lehman
November 14, 2008 IXIC 1,516.85 -5.00%
Brothers collapse.
GSPC 873.29 -4.17%

4
MScFE 560 Financial Markets

Group #: 67 Submission #: 2
Market Impact
Date Event
(Ticker, Close, Change %)
DJI 8,424.75 1.83%
Ford, General Motors, and Chrysler
November 18, 2008 IXIC 1,483.27 0.08%
request federal loans from TARP.
GSPC 859.12 0.98%
DJI N/A N/A
Citigroup receives $306 billion
November 23, 2008 IXIC N/A N/A
rescue from the U.S. government.
GSPC N/A N/A
General Motors receives $13.4 DJI 8,579.11 -0.30%
December 19, 2008 billion, and Chrysler receives $4.0 IXIC 1,564.32 0.77%
billion from TARP. GSPC 887.88 0.29%
DJI 7,978.08 2.79%
G20 agrees on $5 trillion global
April 2, 2009 IXIC 1,602.63 3.29%
stimulus package.
GSPC 834.38 2.87%
The Dodd–Frank Wall Street Reform DJI 10,120.53 -1.07%
July 21, 2010 and Consumer Protection Act is IXIC 1,916.20 0.36%
enacted. GSPC 1,069.59 -1.28%

*DJI - Dow Jones Industrial Average Index

*IXIC - NASDAQ Composite Index
*GSPC - S&P 500

The US government took actions to understand the causes of the crisis and create regulatory
measures. On the monetary side, the government decreased interest rates close to zero and
repurchased mortgages and government debt. By doing this it was able to rescue companies that
were close to bankruptcy but were still “breathing”. Some of the important reforms were the
Dodd-Frank Wall Street Reform and Consumer Protection Act, the Troubled Asset Relief Program
(TARP), the FDIC’s use of its Deposit Insurance Fund to assist the banking system and the
Treasury’s rescue of Fannie Mae and Freddie Mac.

What we know about the global financial crisis is that we don't know very much. The world is still
learning the lessons from these turbulent times and these lessons will repeat until learned.

5
MScFE 560 Financial Markets

Group #: 67 Submission #: 2
The Dodd-Frank Act
/Submission 2/

The Dodd-Frank Act, passed by President Obama on the 21st of July 2010, was one of the most
important regulatory measures taken after the Great Recession. This reform brought the greatest
legislative change to the US financial regulation. It provided the needed structural reorganization
so that the possible future crisis will not be extremely harsh to the US financial system.

The enactment of the Dodd-Frank Act in 2010, changed the financial system of the United States
at its core. One of the consequences of the Act was the creation of The Financial Stability
Oversight Council (FSOC). Its major role is in preventing the risk for the financial market imposed
by the emergence of companies “too big to fail”. This is done by regulations imposed by the FSOC,
as well as direct control over the companies’ structures. Another huge consequence is the
introduction of more frequent and deliberate stress tests to all financial institutions, aiming to
see how prepared they are for hypothetical future recessions and financial tremors. If a given
entity shows an inability to cope in such situations, it can be directly regulated by the authorities,
so the problems can be fixed most quickly. Since one of the main reasons for the Great Recession
was the creation of CDOs, products too complicated to be explained to the crowds, it was logical
that an entity to protect them was introduced. This is The Consumer Financial Protection Bureau
(CFPB), which aims to protect people from possible frauds presented by complicated financial
products. People can directly send complaints to the Bureau, which can then fine financial
entities and provide oversight of all financial entities. CDOs and other trading instruments were
at the core of another regulation of the Dodd-Frank Act, the Volcker Rule. It prohibits banks from
participating in investment activities, using own accounts, unless they are doing it as a necessity
to continue running their business. They are allowed to trade only as a representative for their
customers’ interests. Financing hedge funds and private equity firms is also forbidden by this law.
The Securities and Exchange Commission (SEC) was also given more responsibility. It started
regulating derivatives trading between entities, in order to detect risky activities that can present
a problem for the financial system. The Office of Credit Ratings (OCR) was created at the
Securities and Exchange Commission, so that problematic activity by the rating agencies, such as
the one in the years leading to the Great Recession, can be detected, and stopped. The SEC also
started overlooking hedge funds who were forced to register with the Commission and present
vital information of their endeavors. The insurance sector was also affected, as the Federal
Insurance Office (FIO) was created, as an advisory member of the FSOC, looking to monitor all
insurance-related practices.

Several amendments were made after the enactment of the law in 2010. Some of those are the
loosening of the bank regulations in 2018, with the argument that small and big banks cannot be
controlled by the same regulations. Another change was made in the Volcker Rule in 2020
allowing banks to make venture capital investments, and lowering capital requirements.

6
MScFE 560 Financial Markets

Group #: 67 Submission #: 2

Key reforms in the Dodd-Frank Act

Systemic Risk Regulation Securitisation – Credit Risk Retention

Financial Stability Oversight Council Credit Rating Agencies

Office of Financial Research Elimination of the OTS

Enhanced Prudential Standards Deposit Insurance Reforms

Living Wills Enhanced Regulation of Banking Entities

Orderly Liquidation Authority Payment, Clearing and Settlement Systems

Volcker Rule Consumer Financial Protection

Swaps Pushout rule Restrictions on Emergency Stabilisation

Bank Capital (Collins Amendment) Federal Reserve Governance

Derivatives Pay it Back Act

Hedge Funds Insurance

Investor Protection International Sovereign Assistance

Enhanced Regulation of Securities Markets Mortgage Market Reforms

Table from “The Financial Panic of 2008 and Financial Regulatory Reform”, Randall D. Guynn,
Davis Polk & Wardwell LLP.

After it was released, the Dodd-Frank Act was greeted with positive sentiment, presenting a new
hope for people, that risky attitudes by banks, insurers and other financial institutions will be
stopped, and people’s money will be far more secure. Even though Dodd-Frank can make
institutions safer due to the capital constraints imposed by the legislation and reduce the
potential harm that can occur if financial markets spiral out of control, it also makes the market
become illiquid and reduces the profit-making potential of the economy. There are 225 new rules
across agencies being put by the Dodd-Frank Act. The companies then pass on these costs of
implementation to the consumers. And most importantly, Fannie Mae and Freddie Mac continue
to operate untouched after the deployment of legislation intended to help protect consumers.
These companies run by the government still have the issues which helped to create the
subprime lending crisis.

7
MScFE 560 Financial Markets

Group #: 67 Submission #: 2
Eleven years later, and tens of billions of dollars later in enactment costs, experts are on the
opposite poles regarding its effectiveness. Some argue that it has made going through and
recovery from the Covid-19 much easier, while others debate that the Dodd-Frank Act should be
renewed with better regulatory practices.

References

1. “Timeline: Key Events in Financial Crisis.” USA Today, Gannett Satellite Information
Network, 9 Sept. 2013,
https://eu.usatoday.com/story/money/business/2013/09/08/chronology-2008-
financial-crisis-lehman/2779515/.
2. Kingsley, Patrick. “Financial Crisis: Timeline.” The Guardian, Guardian News and Media, 7
Aug. 2012, https://www.theguardian.com/business/2012/aug/07/credit-crunch-boom-
bust-timeline.
3. “Seeking Alpha: Stock Market Analysis & Tools for Investors.” SeekingAlpha,
https://seekingalpha.com/.
4. “CONCLUSIONS.” Get the Report: Conclusions: Financial Crisis Inquiry Commission,
http://fcic.law.stanford.edu/report/conclusions.
5. Guynn, Randall. “The Financial Panic of 2008 and Financial Regulatory Reform.” The
Harvard Law School Forum on Corporate Governance, 20 Nov. 2010,
https://corpgov.law.harvard.edu/2010/11/20/the-financial-panic-of-2008-and-financial-
regulatory-reform/.
6. Ferguson, Charles H., et al. Inside Job. Sony Pictures Classics, 2010.
7. Maggio, John, director. Panic: The Untold Story of the 2008 Financial Crisis, HBO, 1 May
2019, https://www.youtube.com/watch?v=QozGSS7QY_U. Accessed 25 Oct. 2021.
8. Aronson, Raney. Money, Power, and Wall Street, Part 1. Money, Power and Wall Street:
Part One, FRONTLINE, 14 Aug. 2021, https://www.youtube.com/watch?v=W-
Q9AOp2FW8. Accessed 25 Oct. 2021.
9. CNBC. CNBC Interviews Ben Bernanke, Tim Geithner and Henry Paulson - Sept. 12, 2008,
CNBC, 12 Sept. 2018, https://www.youtube.com/watch?v=PRVXfiDzdM4. Accessed
25Oct. 2021.
10. “Dodd–Frank Wall Street Reform and Consumer Protection Act.” Wikipedia, Wikimedia
Foundation, 20 Oct. 2021, https://en.wikipedia.org/wiki/Dodd–
Frank_Wall_Street_Reform_and_Consumer_Protection_Act.
11. Smith, Kelly Anne. “How the Dodd-Frank Act Protects Your Money.” Forbes, Forbes
Magazine, 20 July 2020, https://www.forbes.com/advisor/investing/dodd-frank-act/.
12. “The Impact of Dodd-Frank, 5 Years Later.” AAF, American Action Forum, 17 July 2015,
https://www.americanactionforum.org/dodd-frank/.
13. Gelzinis, Gregg, et al. “The Importance of Dodd-Frank, in 6 Charts.” Center for American
Progress, 27 Mar. 2017, https://www.americanprogress.org/article/importance-dodd-
frank-6-charts/.