S&L Crisis

faterope's version from 2017-05-10 02:59

S&L Crisis

Question Answer
How did the poor managed to invest in stock market in '20's?They borrowed money from the banks; law allowed the use of borrowed funds as 10% collateral to a larger transaction
What kind of stock transactions appear more on Easy Credit?Riskier transactions increase when people use borrowed money
What is Insolvent?Liabilities on balance sheet are greater than assets
What is a Silent Run?Aggregated unusual transfer transactions through use of technology (computers)
Define Moral HazardProfits are privatized and loses are socialized
What role do banks play in Moral Hazards?conduct riskier transactions because there is no personal stake
What is a Slippery Slope?the practice of investing more to recover previous losses.
What is a Central Truth?The idea that with deregulation, greater oversight should follow.
What changes did Regulation Q put in place? why?Regulation Q put limitation on interest rates that could be offered by commercial banks. This was lobbied by the S&L league to dull competition. Regulation Q did not apply to S&Ls.
Freddie Mac's purpose purchase sound loans issued by S&L and provide the S&Ls funds to issue more loans.
What are Commercial Papers?Lending transactions between large corporations bypassing banks to raise capital.
What is Forbearance?Accounting practices which controversially made banks seem solvent when they were in dire financial conditions.
Was there a minimum in balance S&Ls were required to keep by law?Yes; the minimum was 6% capital for each S&L.
Examples of Forbearance...Appraised Equity: appraised value of real estate, not the actual paid for amount, is reported on the balance sheet as assets; Deferred Loan Losses: loans sold for a loss stays on the books and losses are amortized over a number of years; Regulatory Accounting Principles (RAP): set of accounting rules that are more conducive to Forbearance.
How did thrift executives game the system?Land Flip: sold and resold a property between fellow banks at higher prices to jack up the price of real estate in the neighborhoods; ADC Loans: lend amount of loan plus enough cash to make 2 year of payments on the loan; Golden Parachute: Large severance packages for executives
Describe Systemic Risk...When failure of one component could effect the larger organization/system, there exists a systemic risk.
List two reasons for the S&L failure (according to the professor, not logic or evidence)1.) Interest rate mismatch (long term loans paid less and short term deposits required higher rates) and 2.) Oil crisis
What is Hot Money and how is it used?For a fee, Investment banks collect small amounts of money to sum to a bigger package that is invested in higher interest bearing S&L accounts
What are three govt branches that service financial institution?Federal Reserve Board; FDIC; Office of the Comtroller of Currency
List the two functions of FRB1.)Central bank serves as lender of last resort and monetary policies; 2.) Bank Regulator to prevent systemic risk
Does FRB regulate banks?No, FRB regulates bank holding companies; the banks are regulated by OCC
What are the roles of FDIC?FDIC insurers all deposits and regulates non-fed state members.
What is Easy CreditIncrease in lending due to deposit insurance (moral hazard fuels it) and forbearance.
Federal Deposit Insurance (and moral hazard that goes with it):consumers become complacent and fail to review institutional financial health because their deposits are guaranteed
Bolstering of financial oversight—bank regulators and SEC:To prevent systemic risk, Federal Reserve Board oversees bank holding companies; independently, Office of the Comptroller of Currency oversees the banks. Central bank, under FRB, is the lender of last resort; Regulators, under FRB, regulate to avoid systemic risk (events that could collapse the entire financial system).
Separation of commercial banking and investment banking (Glass-Steagall) (but not for thrifts): Glass-Steagall created bank deposit insurance (to limit runs and increase customer confidence); the act also prohibited commercial banks from delving into investment bank business due to riskier activities (this server the link that caused 1929)
What efforts from Reagan further ruined the S&L situation?Reagan's administration denied S&L had a crisis; resorted to forbearance; drinking the Kool-aid: a misunderstanding that S&L will grow its way out of the crisis; deregulated yet cut oversight; allowed riskier investments; allowed industry to control the regulators.
How did S&L crisis change due to Reagan's policies?The crisis went from interest rate mis-match problem to bad assets problem; also, fraud increased as executives lived like kings due to poor oversight and conflict of interest.
What were key aspect of Bush's plans?1.) IOUs must be counted on the balance sheets 2.) companies must have auditors review internal controls 3.) FSLIC became FDIC 4.) All Fed insured must have a Fed regulator, even if they are state banks. 4.) Resolution Trust Corporation to sell assets without disrupting the normal flow of the market. 5.) Deregulation of financial services, by product, by geography, by bank sector (commercial, investment).
What is a derivative?Derivative is a contract that derives its value from an underlying entity.
List aftermath of the S&L...Development of Long-Term Capital Management (risky arbitrage opportunities in bonds); poor underwriting; hubris that giants in the industry will not default;


Question Answer
What is PCAOB stand for and what does it do?Public Company Accounting Oversight Board; it audits company auditors to ensure there is no conflict of interest.
Who writes the GAAP rules?Financial Accounting Standard Board (FASB)
What did SOX do?1.) eliminated the conflict of interest between auditors and companies 2.) made CEO personally responsible to review financial reports 3.) mandated that companies place a system that ensures that books are not tampered with.
What is Sunshine vs. Secrecy?Sunshine stands for transparency of financial disclosures (disinfectant to possibility of fraud)
List the differences between supervision and regulations...Regulation is set of rules an industry follows; supervision is monitoring whether the industry is following the set rules.

The Subprime Bubble

Question Answer
What is Asset Based Underwriting?practice which evaluates the property value, not the borrower; in place of traditional underwriting.
What is an ARM loan?Adjustable Rate Mortgages.
Describe 2/28s and 3/27ARM loans which offer low fixed rates for 2 or 3 years but turn into riskier adjustable rates for the remainder of the loan term (28 or 27).
What is a toxic asset?a real estate which is worth much less than the amount borrowed to finance its purchase.
What does the phrase "drinking the Kool-aid" mean?subprime: house prices will continue to rise; s&l: banks can grow out of their problems.
Slippery Slope is the idea that....subprime: invest in riskier subprime lending because it is more profitable (ignoring the risk); s&l: gamble investing in riskier initiatives and seek higher results.
What are the Looser and Looser rules?S&L crisis: FED and State regulators competed to be most lenient in order to attract bank executives to select them as the regulators for their institutes; subprime: FED disallowed States to enact new laws and made it that only FED could prosecute institutions for violations of existing State laws.
What is a Liar Loan?Loans issued to borrowers with insufficient documents to prove their employment, salary, assets, credit history, or any other documents that prove his or her ability to repay the loan.
Describe Private Label MBSSecurities issued on loans that do not meet government standards of being sound, low risk loans.
Describe Agency Label MBSSecurities guaranteed by Freddie and Fannie (the government); the loans which are part of these securities meet stringent underwriting standards (unlike those in private mbs).
What makes up Alt-A loans?Loans issued to borrowers who are not Prime borrowers yet they are stronger than typical subprime borrowers.
What is risk mitigation?attempt to reduce the seriousness or pain of risky ventures.
Define Special Purpose Vehicles (SPV)This practice removes the poor assets from US bank's balance sheet and transfers it to offshore banks that serve as shell institutes.
Describe Disparate ImpactWhen historic patterns of service do not hold for one portion of the population over another.
Define ForeclosureWhen homeowner walks away from paying back a mortgage and a bank has to sell the home at a discounted price to recoup as much as it can; foreclosures reduce the value of homes in their respective neighborhoods.


Question Answer
What are underlying causes of the subprime bubble?1.) Bush urged country to refinance and take out lines of credit, 2.) lower than market rates, 3.) asset-based underwriting (loans made without the regard to the borrower's ability to pay), 4.) no oversight (not even for fraud), 5.) lobbying ($2.3 billion; more than several industries combined), 6.) Excess (lavish lifestyle of the CEO's and out of control spending on events), 7.) Moral Hazard (Privatized gain, Socialized risk), and 8.) failure to write rules for lending as directed by Congress in 1994.
What role did rating agencies play in the crisis?Private-labels were not government backed and rating agencies decision to grade the MBS at the highest rating (AAA) wrongly legitimized them.
List the three risks of mortgage lending1.) Interest-rate mismatch, 2.) Prepayment, 3.) default
List Greenspan's fumbles during the crisis...staunch believer in deregulation and less oversight; refused to follow congressional orders to create lending rules and standards; drank the Kool-aid that home prices will continue to go up; pushed preemption; expanded FDIC to subsidiaries and affiliates, not just to commercial banks.
Which government regulations bodies were influenced by companies?OTC; OCC (supported preemption); SEC (allowed change in capitalization).
Which simple laws did Greenspan resist?Traditional underwriting (people should be able to pay back loans); Companies must maintain books of transactions; Transaction reporting should be submitted to regulators.
Describe the conflict of interest during subprime crisisto satisfy stockholders short term goals, bankers took advantage of customer's fund and invested in riskier investments.
Question Answer
How was the subprime crisis different from S&L crisis?Morphed from a toxic asset problem to a bigger toxic asset problem.
What role did bankers play in the crisis?Moral hazard; lobbying; lavish lifestyle; irresponsible investments; large compensation and bonuses.

Long Term Capital Management (LTCM)

Question Answer
What did LTCM do?devised computerized models meant to reduce risk in investments.
What mistake did LTCM make?failure to underwrite; LTCM leveraged greater amounts of capitals, rising from $5 billion (from 15 of the largest banks) to $1 trillion, into investments based on computer predictions. The models did not compensate for confounding, extraordinary events such as the shocks from Russian crisis.
What were the impact from LTCM's faliure?The failure presented a systemic risk which affected Bear and Sterns, Lehmans, and many other banks. Few regulations have been put in place to avoid another LTCM.
How were LTCM were able to get away with their strategy?Executives claimed their products were too complex to explain but assured that most qualified professionals are involved in the details. Governments officials lazily bought in.

The Dodd-Frank Act

Question Answer
List the major changes enacted by the Dodd-Frank Act1.) Only traditional underwriting is allowed, 2) On most loans, prepayment penalties are not allowed, 3) The consumer protection shifts from FED regulators to a new agency (Consumer Financial Protection Bureau); 4.) Rating agencies can be held liable by consumers on ratings issued without proper due diligence; 5.) Mortgage brokers will not receive kickback from selling loans with higher interest rates (essentially the commission is flat for all loans sold).