mini_case_Financial_Crisis_2011

mini_case_Financial_Crisis_2011 - Mini Case Study Financial...

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1 “Mini” Case Study Financial Mess! http://video.pbs.org/video/1082087546/
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Shocking headlines, but … Cool cartoons! 6
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8 Where to begin! Several corporate-finance issues in play with the government response to the financial crisis (i.e., gov’t bailouts) Risk of leverage Implicit “too big to fail” put option Agency/“moral hazard” issues Seniority of financial claims Consolidation in industries Appropriate payout policy for firms
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9 Background (entering fall 2008) Total mortgage debt in U.S. $10-12T Fannie Mae and Freddie Mac are publicly- owned government sponsored enterprises (GSE) They make home loan guarantees and “bundle” mortgages to provide liquidity to the mortgage market Allows securitization of mortgages (a secondary market) Allows more mortgages to be undertaken at lower interest rate Fannie and Freddie own or guarantee about one half of the mortgage market!
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10 Background (continued) Implicit government bailout guarantee – what if Fannie and Freddie fail? Will housing market be allowed to collapse? How will this affect the rate at which these companies can borrow? How will this affect capital structure choice of these companies?
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11 Background (continued) In 2007, subprime-mortgage crisis begins More and more borrowers defaulting on their mortgages (too lenient standards for the original loan and home equity evaporating with decline in housing prices) Losses for Fannie and Freddie – have guaranteed these mortgages would be paid (further losses from mortgage-backed securities they own)
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12 Problem! Fannie and Freddie have extremely high leverage (debt ratio of roughly 95% at end of 2007) Little room for error, easy to get into a liquidity crisis, easy to have actually negative value of book equity as write-down value of assets In August of 2008, rating agencies downgrade rating of the preferred stock of both companies
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Solution for Fannie and Freddie … 13
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15 First Big Government Bailout September 7, 2008 U.S. government takes over Fannie
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