Government Policy, Moral Hazard And The Endless Financial Crisis

1962 words - 8 pages

The story begins in 1938 when Roosevelt establishes Fannie Mae to purchase mortgages from lenders and sell them to investors as mortgaged backed securities. Loan originators are no longer exposed to mortgage default risks, and they have a continuous supply of money to lend as they sell each loan to Fannie. In 1970, congress creates Freddie Mac to buy and securitize private loans not guaranteed by Fannie Mae. Because Freddie Mac and Fannie Mae are government sponsored enterprises (GSE), investors believe the securities are backed by the US Government and thus very low risk. Later, the Community Reinvestment Act gives Fannie Mae an affordable housing credit for buying subprime loans, and ...view middle of the document...

Investors believe large institutions are intrinsically safer than small ones since they are implicitly guaranteed by government.
Fast forward. The Dot-com bubble swells and pops, the World Trade Center is attacked, and the Fed responds by lowering the federal funds rate from 6.5% to a 45 year low of 1% to stimulate economic growth. Acquiring dept is now inexpensive. Treasury bond yields fall forcing investors to look elsewhere for safe investments.
Zoom out, rewind, and press play. As interest rates and lending standards fall, Americans are borrowing to buy homes and taking out equity loans to finance consumer spending. Household debt swells from $705 billion in 1975 to $7.4 trillion in 2001, and finally to $14.5 trillion in 2008. With mortgage rates at a record low, home demand skyrockets, and home prices follow. The housing bubble is born. Consumers borrow to speculate in real estate which is appreciating at 10% per year in most areas. In 2005, 40% of all home purchases will be non-principle residences. The supply of good mortgages are soon exhausted, and lending standards continue to decline as little risk is perceived in issuing a note backed by appreciating real estate. During the bubble years, $3.2 trillion will be loaned to homeowners with bad credit, undocumented income, and little or no down payment. Despite the reduced standards, there still aren’t enough loans to satisfy investor demand. The financial industry will develop derivatives to take their place.
Zoom in, way in. A credit default swap (CDS) ensures a collateralized debt obligation (CDO, a complex type of mortgage backed security, MBS) against default allowing the seller to take the same risk as if they held the CDO. A synthetic CDO consists of a portfolio of CDS’s and essentially allows investment banks to sell the same package of sub-prime loans over and over again as long as investors will buy them. The Federal Reserve requires that financial securities be rated by at least two of the three major credit agencies (Fitch, Moody's, and Standard and Poor’s). However the creators of the securities are paying the agencies to rate them while the agencies compete with each other for this lucrative business. During 2000-2006, credit rating agencies will earn 40% of their revenue giving mortgage backed securities AAA ratings, the same rating given a government guaranteed bond. The Securities and Exchange Commission will allow banks holding these presumably very safe AAA rated securities to take higher leverage, and they do. Investment and depository banks will borrow heavily, driving their debt to equity ratios as high as 40:1 to buy “AAA” rated CDO’s and synthetic CDO’s. By 2008, these contracts will total 33 to 47 trillion dollars.
Zoom out and fast forward to 2006. Median home prices nationwide have declined 3.3%. Because many homeowners purchased with little or no down payment, this small decrease in price leaves them with negative equity and an...

Other Essays Like Government Policy, Moral Hazard And The Endless Financial Crisis

The Great Divide Indigenous Health and Federal Government Policy

2268 words - 10 pages Name Course Instructor Date of Submission The Great Divide Indigenous Health and Federal Government Policy Closing the Gap The ‘closing the gap’ is a strategy whose aims are to give a boost to the indigenous people life expectancy rates. This policy was made in reference to the sensitive areas of child mortality, life expectancy, early childhood education, achievements in education and the employment

Social and Moral Policies of Government

1013 words - 5 pages Social and Moral Policies of Government Philosophy 2000 – Ethics August 13, 2011 Introduction The movie “Thelma and Louise” is based on two friends taking a vacation for a few days to get away from every day social regulations. Thelma’s is married to her high school sweet heart and is a victim of social rules laid by her husband. Louise is the total opposite of Thelma; she does what she wants when she wants. Louise has

Global Financial Crisis Impact and Cause

3004 words - 13 pages to the United States. In the US the responsibility in their financial system “is shared between four or five buck-passing authorities”, proving to be an enormous problem when the Credit Crisis hit. 
 The American government responded in a similar manner to the Australian government. It aimed to improve the macroeconomic environment, promote market stability and advance structural repair. The monetary authorities reacted relatively quickly in

The Role of Government in Policy-Making

873 words - 4 pages Human service organizations are governed by a legislative and judiciary system. The judiciary system decides what policy is legal and illegal, and can require the executive or legislative branch to fix it, in some cases the judiciary can impose a remedy. The legislature system shapes public policy by passing laws, and approving budgets. The Maryland Department of Human Resources is the state's social services provider. The Maryland

What Were the Cause of the Financial Crisis of 2008 and 2009”

1126 words - 5 pages analysis on the 2008 financial crisis asserts that the cause was also due to erroneous monetary policy moves and poor housing policies. The federal government encouraged the expansion of risky mortgages to under-qualified borrowers. Congress pushed for the support of affordable housing through extended procurement of non-prime loans for applicants with low income (Zandi, 2008). The cutting down of interest rates to low levels to supplement for

Overall Monetary Policy of the Government and Its Impact on the Macro Economic Objectives

1202 words - 5 pages Overall Monetary Policy of the Government and its Impact on the Macro Economic Objectives 1. Introduction to the Monetary Policy The Monetary Policy of any country is an important one, as it defines the role and establishment of a central bank within a country and through it attempts to regulate and manage the money supply within an economy in order to achieve specific goals such as Constraining Inflation or Deflation

Impact of the Asian Financial Crisis in 1997 and Effect to Latin America

1898 words - 8 pages Russian financial crisis enhanced the fears concerning the viability of the economy of Brazil and as a result more US$20 billion was drained from the country. Regardless of the negotiations for support grant from the IMF and the United States Treasury, the monetary drainage persisted and Brazil was forced to devalue its currency. As a result, the Brazilian government authorized the real to float, while it abandoned linking its currency to the U.S

A Very Fickle Whim: the Moral Crisis of Huckleberry Finn

769 words - 4 pages A Very Fickle Whim: The Moral Crisis of Huckleberry Finn Of his book, The Adventures of Huckleberry Finn, Mark Twain said that when a sound heart and deformed conscience collide, “conscience suffers defeat”. There is, however, much that Twain does not reveal here: the character who possesses the heart and conscience, when and where the collision takes place, and just how the reader witnesses the conscience’s defeat. The answer is

The Chinese Trend in the Global Financial Crisis

707 words - 3 pages of benefit policies of export ,such as reduce the export Customs tax, decline the export price for self-saving which are advantages to Chinese importation of material .Secondly, it is the chance for Chinese government to reform . Some inefficient economic structures should be washed out. And Chinese government would pay more attention to the internal demand that will make Chinese economic development healthier. Thirdly, the financial crisis may

The Impact Of The Global Financial Crisis On Economic Growth

3967 words - 16 pages overall level of economic activity. The policy utilizes the Commonwealth Government’s Budget to achieve the government’s economic objectives such as by altering the level of government expenditure and taxation manipulating the level of economic activity and hence influencing economic growth. In response to the Global Financial Crisis, the Australian Labour Government had implemented a Budget deficit where total government expenditure exceeded total

Australian and New Zealand Schemes During Global Financial Crisis

2967 words - 12 pages 1.0 Introduction The global financial crisis of 2007 transmitted shock waves worldwide urging international governments to prepare defensive measures to combat this economic turmoil. Hence, on 12th October 2008, the Australian and New Zealand governments introduced analogous schemes to guarantee liabilities issued by a wide range of financial institutions whereby prior to this phenomenon, neither nation had deposit insurance arrangements in

Related Papers

Moral Hazard And The Mortgage Industry

792 words - 4 pages Stearns, AIG, and other financial institutions were rescued by the government as a preventive measure against a total economic and financial collapse. The moral hazard in such measure is that it serves as a precedent for the future and some organizations might reiterate such behavior despite the tough terms associated with a bailout. References Bernanke, B. (2012, March 22). The Federal Reserve after World War II , Lecture 2 George

Bhp Billiton And The Financial Crisis

2441 words - 10 pages . (PAR, 2009 pp 5) The market for petroleum and indeed the mining industry as a whole was unsure what effect the global financial crisis would have and what action affected parties would take during the period. Regardless of the changes, such a large and important company as BHP would have to study the potential changes and start, if necessary, reformatting their financial planning/strategies and other control processes. These would have to be

Government Policy And Outcome Essay

1608 words - 7 pages Virtual Economy – Government Policy and Outcomes INTRO Within our model we have changed five variables (as shown in figure 1): lowered the basic rate of income tax to 20%, lowered VAT to 12% and increased government spending on health, education and employment, and defence each by 5%. This report will explain the impact upon mainly 3 economic indicators: unemployment, inflation and government debt, before analysing different implications on

The 2008 Financial Crisis Essay

1869 words - 8 pages available to the banks in the Bank of England's Special Liquidity scheme. Secondly the Government will increase the banks' market capitalisation, through the Bank Recapitalisation Fund, with an initial £25 billion and another £25 billion to be provided if needed. Thirdly the Government will temporarily underwrite any eligible lending between British banks up to around £250 billion. Conclusion and recomendation: The current financial crisis