COPERATE FINANCE

Executive Summary
The financial crisis began in early 2006 when the subprime mortgage market in the U.S. began to
display an increasing rate of mortgage defaults. These defaults lead, in late 2006, to a decline in
US housing prices after nearly a decade of exceptionally high growth. Many Americans watched
as their primary source of wealth become increasingly devalued. By late 2007, the prime
mortgage markets were showing higher than normal default rates as well.
Collateralized Mortgage Obligations (CMOs), a type of collateralized debt obligations (CDOs),
allowed these problems to spread from the mortgage market to other sectors of the economy,
having especially widespread effects on financial markets as a whole. CMOs were mortgage-
backed securities issued by investment banks and other financial institutions, which since they
were not part of the commercial banking system, were allowed to operate unregulated by the
federal government. As the value of mortgages fell due to increasing default rates, the value of
these securities fell likewise.
The last months of 2008 witnessed what is being called the worst financial crisis since the Great
Depression of 1929-30. The first indications of a serious crisis appeared in January 2008. On 15
January, news of a sharp drop in the profits of the Citigroup banking led to a sharp fall on the
New York Stock Exchange. On 21 January a spectacular fall in share prices occurred in all
major world markets, followed by a series of collapses. A number of American and European
banks declared massive losses in their 2007 end of the year results.

Later months of the year witnessed the bankruptcy of Lehman Brothers, a 158-year old
investment bank, the takeover of the stock-broking firm and investment bank Merrill Lynch, and
the move by Goldman Sacks and Morgan Stanley to seek banking status in order to receive
protection from bankruptcy. During the same weeks, the remaining four investment banks on the
Wall Street all went under in one way or another. To stop further collapse and to ward off total
economic catastrophe, the US government made its most dramatic interventions in financial
markets since the 1930s. Only the infusion of hundreds of billions of dollars into the US banking
system, coinciding with equally colossal interventions in Europe, staved off an entire crash of the
worlds financial markets.

The collapse of financial markets is now being matched up by the decline of the real economy.
The world appears headed for a period of inevitable economic stagnation/recession (a period of
negative economic growth). After a year of financial shock and sharp economic loss, 2009 is
likely to be extremely difficult for the global economy. Many observers commented that the
turmoil in world financial markets has lead to a severe and still unfolding economic downturn in
most of the Western economies, and as a result, the world has come on the brink of the worst
economic downturn since the Second World War. In November 2008 the IMF released an
update to its October 2008 World Economic Outlook in which it highlighted the fast
deteriorating economic environment and downgraded global real GDP growth forecasts for
2008-2009.(1) Many developed countries are now expected to face a deeper recession than had
been anticipated. IMF downgraded its predictions for economic growth in 2008 and 2009, with
world GDP growth expected to be 2.2% in 2009 instead of 3.0% predicted in October, and 3.7%
in 2008 instead of 3.9% predicted in October. In the new forecast, the advanced economies are
expected to contract by percent on an annual basis in 2009. This would mark the first annual
contraction in the post-WW II period for these countries as a group. There are substantial
downgrades for 2009 real GDP growth even for the emerging economies, which are expected to
see overall growth of 5.1% in 2009, compared to 6.1% forecast in October 2008. The US
economy is predicted to shrink by -0.7% in 2009 while the UK is set to be the worst affected of
Western European countries with a contraction of -1.3% in 2008. Thus, it is expected that
emerging economies will account for 100 percent of global growth next year. The IMF report
indicates that the economic performance of the emerging economies will be critical in order to
attain the hoped-for revival of global growth after 2010
The problem was compounded by another financial product, the Credit Default Swap (CDS).
CDSs were nominally insurance contracts on CMOs, but they became a tangled web which
dragged the financial system down as sellers of CDSs bought matching CDSs to protect
themselves against default risk until nearly all the players in the investment banking market were
linked together by these liabilities.
These CMOs and CDSs became the infamous toxic assets. The defaults in the mortgage
markets caused a collapse in the value of the corresponding CMOs, which created a cascade of
additional problems as the multitude of CDSs were executed, dragging down the balance sheets
of the major players in investment banking. It was this that lead to the freezing of private credit
markets. The collapse in value of CMOs lead to a significant problem: since no one was trading
CMOs, it was no longer clear what they were worth. The financial system is based on trust.
The evaporation of trust meant that no private financial institution was willing to lend its scarce
cash to any other since the former couldnt trust that the latter was correctly revealing the extent
of its CMO holdings, and neither could be sure what those holdings were worth.
These liquidity problems turned to insolvency in September of 2008, when private lending froze
completely in a number of important credit markets, such as commercial paper. As a result, non-
financial businesses were unable to get access to the financing they required to function
normally, leading to problems in the real economy.
The real economy began to exhibit problems related to the financial crisis as early as March
2006, when investment expenditure on residential structures began to decline. In early 2008, this
decline spread to investment in business equipment and consumer spending on durable goods. It
wasnt until the summer of 2008 that consumer spending broadly and GDP began falling, signs
of a recession. (In December 2008, the National Bureau of Economic Research, official arbiter
of business cycles dated the formal beginning of the recession as December 2007.) While the
public had been concerned about recession for much of the year, it wasnt until the fall that the
economy began to decline at more than a 6% annual rate. Congress responded by passing the
TARP plan to assist failing financial institutions. This plan was meant to decrease the severity of
the recession by treating its cause: the financial crisis.
The financial crisis and recession in the U.S. spread globally through both financial and trade
linkages. Seeing housing prices in the U.S. rising, foreign banks sought opportunities to invest
in the U.S. housing market, such as through CMOs issued by investment banks. When the
mortgages backing these securities began to fall in value, the value of the securities themselves
began to fall. Seeing their asset prices falling, investors attempted to liquidate their holdings
beginning in August of 2007. These assets became frozen because of a lack of buyers in the
market. As credit became scarce and in response to a lack of confidence in U.S. financial
institutions, international banks began to raise the interest rate at which they lent money to one
another, known as the LIBOR.
Additionally, the economic slowdown in the U.S. led to declining U.S. imports from its major
trading partners, the European Union, Mexico and China. When export sales languished, foreign
GDPs fell too, spreading the recession worldwide. Despite recent claims that the US is no longer
the locomotive of the world economy, the current crisis shows those claims to be false.


The financial crisis that began in 2007 spread and gathered intensity in 2008, despite the efforts
of central banks and regulators to restore calm. By early 2009, the financial system and the
global economy appeared to be locked in a descending spiral, and the primary focus of policy
became the prevention of a prolonged downturn on the order of the Great Depression.

The volume and variety of negative financial news, and the seeming impotence of policy
responses, has raised new questions about the origins of financial crises and the market
mechanisms by which they are contained or propagated. Just as the economic impact of financial
market failures in the 1930s remains an active academic subject, it is likely that the causes of the
current crisis will be debated for decades to come.

Financial Crisis
The term financial crisis is applied broadly to a variety of situations in which some financial
institutions or assets suddenly lose a large part of their value. In the 19th and early 20th
centuries, many financial crises were associated with banking panics, and many recessions
coincided with these panics. Other situations that are often called financial crises include stock
market crashes and the bursting of other financial bubbles, currency crises, and sovereign
defaults.
Global Impacts of the Crisis
Investors lost confidence in the stock market.
Consumer spending slowed down due to lack of cash/ unwillingness.
U.S.As economic condition affected the global economy.
World economy slipped into recession.
Exports from China, Korea, Taiwan and India decreased.

Major causes of Financial Crisis
Imprudent Mortgage Lending: Against a backdrop of abundant credit, low interest rates,
and rising house prices, lending standards were relaxed to the point that many people
were able to buy houses they couldnt afford. When prices began to fall and loans started
going bad, there was a severe shock to the financial system.

Housing Bubble: With its easy money policies, the Federal Reserve allowed housing
prices to rise to unsustainable levels. The crisis was triggered by the bubble bursting, as it
was bound to do.
THE collapse of Lehman Brothers, a sprawling global bank, in September 2008 almost brought
down the worlds financial system. It took huge taxpayer-financed bail-outs to shore up the
industry. Even so, the ensuing credit crunch turned what was already a nasty downturn into the
worst recession in 80 years. Massive monetary and fiscal stimulus prevented a buddy-can-you-
spare-a-dime depression, but the recovery remains feeble compared with previous post-war
upturns. GDP is still below its pre-crisis peak in many rich countries, especially in Europe, where
the financial crisis has evolved into the euro crisis. The effects of the crash are still rippling
through the world economy: witness the wobbles in financial markets as Americas Federal
Reserve prepares to scale back its effort to pep up growth by buying bonds.
With half a decades hindsight, it is clear the crisis had multiple causes. The most obvious is the
financiers themselvesespecially the irrationally exuberant Anglo-Saxon sort, who claimed to
have found a way to banish risk when in fact they had simply lost track of it. Central bankers and
other regulators also bear blame, for it was they who tolerated this folly. The macroeconomic
backdrop was important, too. The Great Moderationyears of low inflation and stable
growthfostered complacency and risk-taking. A savings glut in Asia pushed down global
interest rates. Some research also implicates European banks, which borrowed greedily in
American money markets before the crisis and used the funds to buy dodgy securities. All these
factors came together to foster a surge of debt in what seemed to have become a less risky world.
Start with the folly of the financiers. The years before the crisis saw a flood of irresponsible
mortgage lending in America. Loans were doled out to subprime borrowers with poor credit
histories who struggled to repay them. These risky mortgages were passed on to financial
engineers at the big banks, who turned them into supposedly low-risk securities by putting large
numbers of them together in pools. Pooling works when the risks of each loan are uncorrelated.
The big banks argued that the property markets in different American cities would rise and fall
independently of one another. But this proved wrong. Starting in 2006, America suffered a
nationwide house-price slump.
The pooled mortgages were used to back securities known as collateralised debt obligations
(CDOs), which were sliced into tranches by degree of exposure to default. Investors bought the
safer tranches because they trusted the triple-A credit ratings assigned by agencies such as
Moodys and Standard & Poors. This was another mistake. The agencies were paid by, and so
beholden to, the banks that created the CDOs. They were far too generous in their assessments of
them.
Investors sought out these securitised products because they appeared to be relatively safe while
providing higher returns in a world of low interest rates. Economists still disagree over whether
these low rates were the result of central bankers mistakes or broader shifts in the world
economy. Some accuse the Fed of keeping short-term rates too low, pulling longer-term
mortgage rates down with them. The Feds defenders shift the blame to the savings glutthe
surfeit of saving over investment in emerging economies, especially China. That capital flooded
into safe American-government bonds, driving down interest rates.
Low interest rates created an incentive for banks, hedge funds and other investors to hunt for
riskier assets that offered higher returns. They also made it profitable for such outfits to borrow
and use the extra cash to amplify their investments, on the assumption that the returns would
exceed the cost of borrowing. The low volatility of the Great Moderation increased the
temptation to leverage in this way. If short-term interest rates are low but unstable, investors
will hesitate before leveraging their bets. But if rates appear stable, investors will take the risk of
borrowing in the money markets to buy longer-dated, higher-yielding securities. That is indeed
what happened.
As someone who spent the majority of his life as an international bank analyst and executive, I
learned, that to fix a problem, one needs to understand what caused it. It can be difficult to see
because sometimes it takes time for the effects of bad decisions to manifest themselves. It also
requires that we examine the facts rather than our emotional biases.
The facts are that approximately 6% of all mortgage loans in United States are in default.
Historically, defaults were less than one-third of that, i.e., from 0.25% to 2%. A huge portion of
the increased mortgage loan defaults are what are referred to as sub-prime loans. Most of the
sub-prime loans have been made to borrowers with poor credit ratings, no down payment on the
home financed, and/or no verification of income or assets (Alt-As). Close to 25% of sub-prime
and Alt-As loans are in default.
These loans increased dramatically as a 9/30/99 New York Times article explained, In a move
that could help increase homeownership rates among minorities and low income consumers, the
Fannie Mae Corp. is easing the credit requirements on loans that it will purchase from banks and
other lenders.
Why would banks make such risky loans? The answer is that the Clinton administration
pressured the banks to help poor people become homeowners, a noble liberal idea. Also the
Clinton Justice Department threatened banks with lawsuits and fines ($10,000 per application)
for redlining (discrimination) if they did not make these loans. Also ACORN (Obamas
community service organization) was instrumental in providing borrowers and pressuring the
banks to make these loans.
To allow Fannie Mae to make more loans, President Clinton also reduced Fannie Maes reserve
requirement to 2.5%. That means it could purchase and/or guarantee $97.50 in mortgages for
every $2.50 it had in equity to cover possible bad debts. If more than 2.5% of the loans go bad,
the taxpayers (us) have to pay for them. That is what this bailout is all about. It is not the
government paying the banks for the bad loans, it is us!!
Principally Senate Democrats demanded that Fannie Mae & Freddie Mac (FM&FM) buy more
of these risky loans to help the poor. Since the mortgages purchased and guaranteed by FM&FM
are backed by the U.S. government, the loans were re-sold primarily to investment banks which
in turn bundled most of them, taking a hefty fee, and sold the mortgages to investors all over the
world as virtually risk free. As long as the Federal Reserve (another government created agency)
kept interest rates artificially low, monthly mortgage payments were low and housing prices
went up. Many home owners got home equity loans to pay their first mortgages and credit card
debt.

Unfortunately home prices peaked in the winter of 2005-06 and the house of cards started to
crumble. People could no longer increase their mortgage debt to pay previous debts. Now, we
taxpayers are being told we have to bail out the banks and everyone in the world who bought
these highly risky loans. The politicians in Congress (mostly Democrats) do not want you to
know they caused the mess.
During the past eight years, the Bush administration made 17 attempts to reform FM&FM,
having been made aware by whistleblowers that the books had been cooked by Clinton
appointees, James Johnson and Franklin Raines (most recently Barack Obama financial advisors)
who gave large bonuses to themselves and other Clinton appointees by falsely showing huge
profits. In 2005, John McCain submitted a Fannie Mae reform bill. Democrats blocked it in
Committee from getting to the Senate floor for a vote.
By 2006 there was enough evidence of malfeasance that Raines was forced out. He had paid
himself over $90 million. Recently the court ordered him to pay back $40 million in fines,
bonuses and stock options that he gave himself based on false financial statements of Fannie
Mae profits.
In the 2006 elections, the Democrats took control of the House and Senate. There are plenty of
videos on the Internet showing many Democrats including Senate Banking Committee Chairman
Democrat Christopher Dodd and House Banking Committee Chairman Barney Frank,
responsible with overseeing FM&FM, assuring us that there were no problems with FM&FM
right up to their collapse.
Not surprisingly, virtually all the investment banks that are in trouble and being bailed out are
run by financial supporters of Obama and other Democrats. Secretary of the Treasury Paulsen
was head of Goldman Sachs. The new head of the $700 million bailout is also from Goldman
Sachs. This is like letting the fox be in charge of hen house security.
It was announced that our government will infuse capital into the troubled banks. This gives
whoever is in power of our government the ability to force the same kind of abuses that have
caused this massive banking crisis in the first place.

Barack Obama has received more campaign donations that any other politician in the past three
years from Fannie Mae and Wall Street. FM&FC have been virtually private piggy banks of
campaign contributions for Democrats for the past 10 years. Yes, a token amount went to some
Republicans.
And there is plenty of blame to go around in this financial crisis, but the reason it happened was
100% caused by a Democrat run government that forced a liberal policy initiated by President
Clinton and reforms primarily blocked by Democrats. One would never know this by watching
the news or reading newspapers.
Until the majority of our citizens understand whom (government liberals) and what
(liberalism/socialism) caused this mess, we will allow our elected officials, through massive
inflation, to lower the standard of living of those of us who are financially prudent and give our
earnings to those who are not prudent. The big excuse for the bailout is that credit markets have
frozen up. But it is not true. There is plenty of credit available for good credit risks.
The only way this can be rectified is to allow the people who made the mistakes to take their
losses. It is called taking personal responsibility for ones actions. Already we see that the bailout
has had virtually no effect on the markets other than to cause huge sell offs because smart
investors see that the U.S. is adopting failed liberal socialist policies. Our government is
following in the footsteps of Hoover and Roosevelt.
We do not need to have another depression, but the government is taking the steps to make it
happen. The taxpayer financed bailout should be reversed immediately as it will only encourage
more irresponsible fraudulent behavior.
Mr. Davis can be contacted at jfd11@cornell.edu
From houses to money markets
When Americas housing market turned, a chain reaction exposed fragilities in the financial
system. Pooling and other clever financial engineering did not provide investors with the
promised protection. Mortgage-backed securities slumped in value, if they could be valued at all.
Supposedly safe CDOs turned out to be worthless, despite the ratings agencies seal of approval.
It became difficult to sell suspect assets at almost any price, or to use them as collateral for the
short-term funding that so many banks relied on. Fire-sale prices, in turn, instantly dented banks
capital thanks to mark-to-market accounting rules, which required them to revalue their assets
at current prices and thus acknowledge losses on paper that might never actually be incurred.
Trust, the ultimate glue of all financial systems, began to dissolve in 2007a year before
Lehmans bankruptcyas banks started questioning the viability of their counterparties. They
and other sources of wholesale funding began to withhold short-term credit, causing those most
reliant on it to founder. Northern Rock, a British mortgage lender, was an early casualty in the
autumn of 2007.

Complex chains of debt between counterparties were vulnerable to just one link breaking.
Financial instruments such as credit-default swaps (in which the seller agrees to compensate the
buyer if a third party defaults on a loan) that were meant to spread risk turned out to concentrate
it. AIG, an American insurance giant buckled within days of the Lehman bankruptcy under the
weight of the expansive credit-risk protection it had sold. The whole system was revealed to have
been built on flimsy foundations: banks had allowed their balance-sheets to bloat (see chart 1),
but set aside too little capital to absorb losses. In effect they had bet on themselves with
borrowed money, a gamble that had paid off in good times but proved catastrophic in bad.
Regulators asleep at the wheel
Failures in finance were at the heart of the crash. But bankers were not the only people to blame.
Central bankers and other regulators bear responsibility too, for mishandling the crisis, for failing
to keep economic imbalances in check and for failing to exercise proper oversight of financial
institutions.
The regulators most dramatic error was to let Lehman Brothers go bankrupt. This multiplied the
panic in markets. Suddenly, nobody trusted anybody, so nobody would lend. Non-financial
companies, unable to rely on being able to borrow to pay suppliers or workers, froze spending in
order to hoard cash, causing a seizure in the real economy. Ironically, the decision to stand back
and allow Lehman to go bankrupt resulted in more government intervention, not less. To stem
the consequent panic, regulators had to rescue scores of other companies.
But the regulators made mistakes long before the Lehman bankruptcy, most notably by tolerating
global current-account imbalances and the housing bubbles that they helped to inflate. Central
bankers had long expressed concerns about Americas big deficit and the offsetting capital
inflows from Asias excess savings. Ben Bernanke highlighted the savings glut in early 2005, a
year before he took over as chairman of the Fed from Alan Greenspan. But the focus on net
capital flows from Asia left a blind spot for the much bigger gross capital flows from European
banks. They bought lots of dodgy American securities, financing their purchases in large part by
borrowing from American money-market funds.
In other words, although Europeans claimed to be innocent victims of Anglo-Saxon excess, their
banks were actually in the thick of things. The creation of the euro prompted an extraordinary
expansion of the financial sector both within the euro area and in nearby banking hubs such as
London and Switzerland. Recent research by Hyun Song Shin, an economist at Princeton
University, has focused on the European role in fomenting the crisis. The glut that caused
Americas loose credit conditions before the crisis, he argues, was in global banking rather than
in world savings.
Moreover, Europe had its own internal imbalances that proved just as significant as those
between America and China. Southern European economies racked up huge current-account
deficits in the first decade of the euro while countries in northern Europe ran offsetting surpluses.
The imbalances were financed by credit flows from the euro-zone core to the overheated housing
markets of countries like Spain and Ireland. The euro crisis has in this respect been a
continuation of the financial crisis by other means, as markets have agonised over the
weaknesses of European banks loaded with bad debts following property busts.
Central banks could have done more to address all this. The Fed made no attempt to stem the
housing bubble. The European Central Bank did nothing to restrain the credit surge on the
periphery, believing (wrongly) that current-account imbalances did not matter in a monetary
union. The Bank of England, having lost control over banking supervision when it was made
independent in 1997, took a mistakenly narrow view of its responsibility to maintain financial
stability.
Central bankers insist that it would have been difficult to temper the housing and credit boom
through higher interest rates. Perhaps so, but they had other regulatory tools at their disposal,
such as lowering maximum loan-to-value ratios for mortgages, or demanding that banks should
set aside more capital.
Lax capital ratios proved the biggest shortcoming. Since 1988 a committee of central bankers
and supervisors meeting in Basel has negotiated international rules for the minimum amount of
capital banks must hold relative to their assets. But these rules did not define capital strictly
enough, which let banks smuggle in forms of debt that did not have the same loss-absorbing
capacity as equity.

Under pressure from shareholders to increase returns, banks operated with minimal equity,
leaving them vulnerable if things went wrong. And from the mid-1990s they were allowed more
and more to use their own internal models to assess riskin effect setting their own capital
requirements. Predictably, they judged their assets to be ever safer, allowing balance-sheets to
balloon without a commensurate rise in capital.
The Basel committee also did not make any rules regarding the share of a banks assets that
should be liquid. And it failed to set up a mechanism to allow a big international bank to go bust
without causing the rest of the system to seize up.


All in it together
The regulatory reforms that have since been pushed through at Basel read as an extendedmea
culpa by central bankers for getting things so grievously wrong before the financial crisis. But
regulators and bankers were not alone in making misjudgments. When economies are doing well
there are powerful political pressures not to rock the boat. With inflation at bay central bankers
could not appeal to their usual rationale for spoiling the party. The long period of economic and
price stability over which they presided encouraged risk-taking. And as so often in the history of
financial crashes, humble consumers also joined in the collective delusion that lasting prosperity
could be built on ever-bigger piles of debt.

Remedies
The origin of the U.S. financial crisis is that commercial banks and investment banks lent vast
sumstrillions of dollarsfor housing purchases and consumer loans to borrowers ill-equipped
to repay. The easy lending pushed up housing prices around the U.S., which then ratcheted still
higher when speculators bought houses on the expectation of yet further price increases. When
the easy lending slowed and then stopped during 2006-07, the housing prices peaked and began
to fall. The housing boom began to unravel and now threatens an economy-wide bust.

The U.S. economy faces four cascading threats: First, the sharp decline in consumer spending on
houses, autos and other durables, following the sharp decline in lending to households, will cause
a recession as construction of new houses and production of consumer durables nosedive.
Second, many homeowners will default on their mortgage payments and consumer loans,
especially as house values fall below the mortgage values. Third, the banking sector will cut
back sharply on its lending in line with the fall in its capital following the write-off of bad
mortgage and consumer loans. Those capital losses will push still more financial institutions into
bankruptcy or forced mergers with stronger banks. Fourth, the retrenchment of lending now
threatens even the shortest-term loans, which banks and other institutions lend to each other for
working capital. Interbank loans and other commercial paper are extremely hard to place.

The gravest risks to the economy come back to front. The fourth threat is by far the worst. If the
short-term commercial paper and money markets were to break down, the economy could go
into a severe collapse because solvent and profitable businesses would be unable to attract
working capital. Unemployment, now at 6 percent of the labor force, could soar to more than 10
percent. That kind of liquidity collapse was the basic reason why Asian national incomes
declined by around 10 percent between 1997 and 1998, and why the U.S. economy fell by
around 25 percent during the Great Depression.

The third threat, the serious impairment of bank capital as banks write off their bad loans, could
cause a severe recession, but not a depression. Unemployment might rise, for example, up to 10
percent, which would create enormous social hardships. The ongoing fall in bank capital as the
housing boom turns to bust is already forcing banks to cut back their outstanding loans
significantly, because they must keep the lending in proportion to their now-shrunken capital
base. Major investment projects, such as acquisition of new buildings and major machinery, are
being scaled back. Some major nonfinancial companies will likely go bankrupt as well.

The second threat, the financial distress of homeowners, will certainly be painful for millions of
households, especially the ones that borrowed heavily in recent years. Many will lose their
homes; some will be pushed into bankruptcy. Some may see their credit terms eased in
renegotiations with their banks. Consumers as a group will start to become net savers again after
years of heavy net borrowing. That trend will not be bad in the long term but will be painful in
the short run.

The first threat, the cutback in sales of housing and other consumer durables, is the Humpty-
Dumpty of the economy that cannot be put back together. The inventory of unsold homes is now
large; housing demand and new construction will be low for many years. Consumer spending on
appliances and autos is also plummeting. All these consequences are largely unavoidable and
will force the U.S. into at least a modest recession, with unemployment likely to rise temporarily
to perhaps 8 percent.
How they control
1. Securitized mortgagesare home loans that have been bundled into large groups and sold to
investors. A group of about 4,000 mortgages can be securitizedand sold just like a stock or bond.
Investors like to buy groups of mortgages because they receive all the monthly house payments.
2. Some groups of securitized mortgages were subdivided into smaller pieces, called
derivatives.However, both of the fancy names refer to mortgage loans.
3. The problem is that many bad loans (with no payments) got mixed in with good loans. That
turned the all the securitized mortgages into bad investments, which are ruining our banks. It is a
huge problem, and the government has to fix it, before our economy will recover.
4. Total securitized mortgage and derivative market is estimated at $1.3 Trillion by a Professor
of Economics at Ohio State University. (Also see the graph from Deutsche Bank at The Death of
Securitized Mortgageshttp://www.nakedcapitalism.com/2008/06/death-of-securitized-
mortgages.html )
5. Government should buy up securitized mortgages and derivatives at the lowest market price,
which is set via a reverse auction. (Google on reverse auction.)
6. Squatters, who sit on their mortgage derivatives, in order to extort big $ from the rest of the
system, can be forced to sell. (Law is analogous to eminent domain, or sales forced on
cybersquatters that registered the domain names of well-established companies.)
7. Government pays mortgage derivative squatters at market price set by previous reverse
auctions, perhaps with a penalty to the squatters.
8. Sellers give up all rights. No new law there.
9. Banks, investors, and insurers now have cash instead of questionable mortgage loans and
derivatives. So, the banking system is healthy with cash to lend.
10. Credit will flow, and the economy will grow.