Money & Banking

Week 5- day 2
Dot.Com Crash
• The internet gave rise to IT companies causing a
technology bubble and heavy investment in .com
companies
• They were overvalued and finally the bubble
burst in 2000
• As a respond to the recession the Fed lowered
rates from 6.5% to 1% to help the economy
• This made borrowing CHEAP …..
• There was a rise in credit card and mortgage
borrowing
Financial Crisis 2007
• Video on Moodle Part 2 of the credit crisis

• Think about who was at fault who was to

blame for the crisis?
Did everyone lose during the
financial crisis???
Who is this?
Financial Crisis Terminology

Match words with their

definitions (Group
Exercise)
Who’s fault was it?
• The Fed for making keeping rates low?
• The government policy promising a house for
all?
• The brokers lending to sub-prime borrowers?
• The sub-prime borrowers knowing they can’t
afford to pay the loan payments?
• The bankers for creating exotic derivative
models?
In groups explain the below terms:
• Mortgage Backed Securities
• Collateralized Debt Obligation
• Credit Default Swap
• Margin Buying
• Fannie Mae
• Freddie Mac
• Securities and Exchange Commission
• Too-big-to-fail
• FDIC
• Laissez- faire
• Moral Hazard
 MBS
• Mortgage-backed securities (MBS) are debt obligations that represent claims
to the cash flows from pools of mortgage loans, most commonly on
residential property. Mortgage loans are purchased from banks, mortgage
companies, and other originators and then assembled into pools by a
governmental, quasi-governmental, or private entity. The entity then issues
securities that represent claims on the principal and interest payments made
by borrowers on the loans in the pool, a process known as securitization.

• Most MBSs are issued by the Government National Mortgage Association

(Ginnie Mae), a U.S. government agency, or the Federal National Mortgage
Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation
(Freddie Mac), U.S. government-sponsored enterprises. Ginnie Mae, backed
by the full faith and credit of the U.S. government, guarantees that investors
receive timely payments. Fannie Mae and Freddie Mac also provide certain
guarantees and, while not backed by the full faith and credit of the U.S.
government, have special authority to borrow from the U.S. Treasury. Some
private institutions, such as brokerage firms, banks, and homebuilders, also
securitize mortgages, known as "private-label" mortgage securities.
Credit Default Swap as Insurance
• A credit default swap is, in effect, insurance against non-payment.
Through a CDS, the buyer can mitigate the risk of their investment
by shifting all or a portion of that risk onto an insurance company
or other CDS seller in exchange for a periodic fee. In this way, the
buyer of a credit default swap receives credit protection, whereas
the seller of the swap guarantees the credit worthiness of the
debt security. For example, the buyer of a credit default swap will
be entitled to the par value of the contract by the seller of the
swap, should the issuer default on payments.
• If the debt issuer does not default and if all goes well the CDS
buyer will end up losing some money, but the buyer stands to lose
a much greater proportion of their investment if the issuer
defaults and if they have not bought a CDS. As such, the more the
holder of a security thinks its issuer is likely to default, the more
desirable a CDS is and the more the premium is worth it.