This preview has intentionally blurred sections. Sign up to view the full version.View Full Document
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 government…had 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 commonplace…and 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 haven’t!) 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 CDO’s 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 IOU’s default. b The junior security pays $1.00 if either IOU defaults....
View Full Document
- Summer '08
- Current Account Deficit, Subprime mortgage crisis, CDO