Financial Crisis
Content
Fincancial Crisis due to: 1.SUB PRIME MORTGAGES. 2.COLLATERALIZED DEBT OBLIGATIONS 3.FROZEN CREDIT MARKETS 4.CREDIT DEFAULT SWAPS Financial crisis brings 2 types of ppl together home owners and investors Home owners represnts there mortgages and investors represent there money these mortgages represent there houses and these money represents large institutions like insurance companies, sovereign funds mutual funds etc these 2 group brought together by financial institutions bunch of brokers and banks commonly known as wall street, wall street and home owners are connected let understand Years ago investors were sitting with there lot of money looking for opportunity to turn into more money traditionally they go to US federal reserve where they buy treasury bill to be safest investment but at the wake of .COM BUST in September 11, federal reserve Chariman alan greenspan lowers interest rate to only 1% to keep the economy strong, 1% is very low return on investment so investors say no thnx And the flip side bank on wall street can borrow from feb only for 1% after that general surplus from japan china and middleeast and there is abundance of cheap credit this makes borrowing money easy for banks and causes them to go crazy with leverage , leverage is borrowing money to amplify the outcome of a deal Here it works in a normal deal some 1 with $10000 buy a box for 10000 and he normally sells to some1 else for 11000 for 1000$ profit a gud deal but using leverage some1 with 10000 goes borrow $990000 more $ giving him 1$million in hand then he goes and buys 100 boxes with 1million$ sell to some1 with $1million 100000$ then he pays his $990000 + $10000 as interests with 90000$ as profits vs with 1000$ with other guys leverage turns gud deal this is a major way banks make their money In this way wall street takes a ton of credit makes them great deals and grows tremendously rich and pays it back , investors sees as opportunity and this gives wall street an idea they can keep connecting investors with home owners through mortages Here how it works a family wants a house so they say down payment and contact mortgage broker the mortgage broker connects the family to a lender who gives them mortgage the broker makes nice commission the family buys the house and becomes home owners theses is great deal because housing prices are rising pratically 4ever everything works out nicely. One day a lender gets a call from investment banker who wants to buy mortgage lender sells to him to a very nice fees then investor banker borrows millions of $ and buys thousands and thousands of more n more mortgages and puts them into a nice little box
that means every month he gets payment from home owners of all the mortgages in the box Then he fixes banker wizardry on it to work there financial magic which is basically cutting into 3 slices SAFE OK & Risky they pack slices again in the box and call it COLLATERALIZED DEBT OBLIGATION OR CDO a CDO works like a 3 cascading trays as money comes in SAFE tray fills first,then spills over to OK tray and then into RISKY TRAY,then money comes from home owners paying off there mortages if some home owners don’t pay the and default on there payment then less money comes in and bottom tray may not get fill,these makes bottom tray risker and top tray safer to compensate for higher risks the bottom tray receives a higher rate of interest suppose 10% and while top tray receives a lower interst suppose 4% BUT STILL a nice return. To make the top tray even safer the bank will insure it with small fee call CREDIT DEFAULT SWAP the banks do all this work so that credit rating agency stamp top SLICE as safe AAA rated investment a highest safest rateing the risk,OK SLICE is BBB they are pretty good,and they don’t bother to rate Risky SLICE because of AAA rating the investment banker can sell the safe slide to the investors who only want safe investments. He sells OK slice to other bankers and risky slice to Hedge Funds and another risk takers the investment banker makes millions of $ then he pays the loans finally investors have found good investment for there money much better then 1% treasury bill they are so please they want MORE CDO so the investment banker calls the lenders wanting more mortgages the lender calls the broker for more home owners but the borker cant find any1. Everybody qualify for mortgages already have one they have an idea when home owners default on there mortgage the lender gets the house and house are always increasing in value since they are covered if home owners default lender can start adding risk to new mortgages not requiring down payments no proof of income no documents required at all that’s exactly what they did so instead of lending to responsible home owners call Prime MORTGAGES they started to get some well less responsible these are SUB PRIME MORTGAGES these is turning Point. So just like always the Mortgages broker connects the family with lender and the mortgage making his commission the family buys BIG house the lender sell mortgage to investment banker who turns in to a CDO and slices to investors and others these actually works out nicely for every one and makes all of them RICH. No1 is worried because soon as mortgage sold to next guy was his problem if the home owners default who cared they are selling off there risk to next guy and making millions of $ like playing with time bomb not surpriseingly the home owners default on there mortgages which is at this moment owned by banker these menas he foreclose in his one of monthly payments turns into house no big deal he puts out for sale but more and more his monthly payments turn into houses now there are so many houses to sell in market.
Creating more supply then demand housing prices are not rising any more infact started to fall these creates an interesting problem for homeowners who are paying there mortgages as all the house in neighborhood goes on sale the value of there house goes down and they start wondering why they are paying back $300000 mortgage when house is worth only $90000 they decide it doesn’t make sense contine paying even though they can afford to they walk away there house the fall rates sweeps the country and price plum it. Now the investment banker is basically holding the box full off worthless house he calls his buddy the investor to sell his CDO but the investor isn’t it stupid so he says no thnx he knows the stream of money is not even dripping more banker trys to sell to every1 but no body wants to buy his BOMB his freaking out because he bought millions sometimes billions of $ to buy this BOMB and he cant pay it back whatever he trys he cant get rid off it but he is not the only 1.the investors have bought thousands of these bombs the lender calls up and try to to sell his mortgage but banker wont buy the whole financial system is frozen then thinks get DARK. Everybody starts filling bankrupt but that’s not all the investor calls up the home owner tell him his investments are worthless and the crisis began to flow in cycle
that means every month he gets payment from home owners of all the mortgages in the box Then he fixes banker wizardry on it to work there financial magic which is basically cutting into 3 slices SAFE OK & Risky they pack slices again in the box and call it COLLATERALIZED DEBT OBLIGATION OR CDO a CDO works like a 3 cascading trays as money comes in SAFE tray fills first,then spills over to OK tray and then into RISKY TRAY,then money comes from home owners paying off there mortages if some home owners don’t pay the and default on there payment then less money comes in and bottom tray may not get fill,these makes bottom tray risker and top tray safer to compensate for higher risks the bottom tray receives a higher rate of interest suppose 10% and while top tray receives a lower interst suppose 4% BUT STILL a nice return. To make the top tray even safer the bank will insure it with small fee call CREDIT DEFAULT SWAP the banks do all this work so that credit rating agency stamp top SLICE as safe AAA rated investment a highest safest rateing the risk,OK SLICE is BBB they are pretty good,and they don’t bother to rate Risky SLICE because of AAA rating the investment banker can sell the safe slide to the investors who only want safe investments. He sells OK slice to other bankers and risky slice to Hedge Funds and another risk takers the investment banker makes millions of $ then he pays the loans finally investors have found good investment for there money much better then 1% treasury bill they are so please they want MORE CDO so the investment banker calls the lenders wanting more mortgages the lender calls the broker for more home owners but the borker cant find any1. Everybody qualify for mortgages already have one they have an idea when home owners default on there mortgage the lender gets the house and house are always increasing in value since they are covered if home owners default lender can start adding risk to new mortgages not requiring down payments no proof of income no documents required at all that’s exactly what they did so instead of lending to responsible home owners call Prime MORTGAGES they started to get some well less responsible these are SUB PRIME MORTGAGES these is turning Point. So just like always the Mortgages broker connects the family with lender and the mortgage making his commission the family buys BIG house the lender sell mortgage to investment banker who turns in to a CDO and slices to investors and others these actually works out nicely for every one and makes all of them RICH. No1 is worried because soon as mortgage sold to next guy was his problem if the home owners default who cared they are selling off there risk to next guy and making millions of $ like playing with time bomb not surpriseingly the home owners default on there mortgages which is at this moment owned by banker these menas he foreclose in his one of monthly payments turns into house no big deal he puts out for sale but more and more his monthly payments turn into houses now there are so many houses to sell in market.
Creating more supply then demand housing prices are not rising any more infact started to fall these creates an interesting problem for homeowners who are paying there mortgages as all the house in neighborhood goes on sale the value of there house goes down and they start wondering why they are paying back $300000 mortgage when house is worth only $90000 they decide it doesn’t make sense contine paying even though they can afford to they walk away there house the fall rates sweeps the country and price plum it. Now the investment banker is basically holding the box full off worthless house he calls his buddy the investor to sell his CDO but the investor isn’t it stupid so he says no thnx he knows the stream of money is not even dripping more banker trys to sell to every1 but no body wants to buy his BOMB his freaking out because he bought millions sometimes billions of $ to buy this BOMB and he cant pay it back whatever he trys he cant get rid off it but he is not the only 1.the investors have bought thousands of these bombs the lender calls up and try to to sell his mortgage but banker wont buy the whole financial system is frozen then thinks get DARK. Everybody starts filling bankrupt but that’s not all the investor calls up the home owner tell him his investments are worthless and the crisis began to flow in cycle
