econ423lec21 - 7/20/2009 1 FINANCIAL CRISIS FINANCIAL...

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Unformatted text preview: 7/20/2009 1 FINANCIAL CRISIS FINANCIAL CRISIS JULY 20 TH , 2009 Lauren Heller Econ 423, Financial Markets The Plan for Today b Homework Quiz #7 b Putting it All Together: Financial Crisis b Housing and Mortgage Crisis b Bailouts, Anyone? b The Way Forward Who said this about the housing crisis? b Rising prices affected both banks and their customers with an optimism which swept aside the conservative standards of experience and promoted extravagance and speculation. b It was not long, however, until the continuously rising prices, the encouragement of the bankers, and the methods used by governmenthad convinced the majority that the debt was a blessing in disguise b Bankers found their accustomed standards of credit analysis growing obsolete, for [property] values increased automatically with the passage of time. Who said this about the housing crisis? b Hence it was that, as the speculative fever gained a foothold and grew and the demands for bank funds enlarged, credit was extended to all manner of persons on or without all kinds of security, excess lines became commonplaceand fraudulent enterprises were discounted for rich rewards b Borrowing for the purpose of relending became an established practice. Time and time again the banks were saved from the effects of their ill-advised acts by the continuous growth of deposits. b Who wrote this? When? Who said this about the housing crisis? b Fred Garlock, in 1926 b In the Journal of Land & Public Utility Economics b About a bank crisis in Iowa b What have (or havent!) we learned about banks and financial crisis? Recall from previous classes b Collateralized debt obligation (CDO) b A derivative security that is issued against a portfolio of underlying securities, like mortgages. b Under certain assumptions, CDOs are much less risky than the underlying mortgages. b How, exactly, can a CDO lower risk? 7/20/2009 2 CDOs and Risk b Suppose there are two $1.00 securities with two possible outcomes: $1.00 and $0. b Each IOU has a 90% probability of full payment. b Payments are assumed to be independent events . b Suppose instead that two new securities are created: b The senior security pays $1.00 unless both IOUs default. b The junior security pays $1.00 if either IOU defaults....
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This note was uploaded on 08/31/2009 for the course ECON 423 taught by Professor Vd during the Summer '08 term at UNC.

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econ423lec21 - 7/20/2009 1 FINANCIAL CRISIS FINANCIAL...

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