What led to the worst financial crisis of our time? The Great Recession What led to the worst financial crisis of our time?

Do Now: Watch the following clip: https://www.youtube.com/watch?v=0voHN20ZNeY Do you believe that homeownership is apart of the American Dream? Why is that the case?

Traditional Mortgages Traditional Mortgages are called prime mortgages. Lenders provide borrowers with a prime rate on their mortgage loans prime rate: The interest rate that commercial banks charge their most creditworthy customers

Subprime Mortgages Subprime Mortgages: a type of loan granted to individuals with poor credit histories (often below 600), who, as a result of their deficient credit ratings, would not be able to qualify for conventional mortgages. Because subprime borrowers present a higher risk for lenders, subprime mortgages charge interest rates above the prime lending rate.

Subprime Mortgage Structures Adjustable Rate Mortgages: initially charges a fixed interest rate, and then convert to a floating rate based certain index rates

Long-term problems When their mortgages reset to the higher, variable rate, mortgage payments increase significantly. This is one of the factors that lead to the sharp increase in the number of subprime mortgage foreclosures in August of 2006, and the subprime mortgage meltdown that ensued.

The total number of foreclosures skyrocketed during the housing crisis in 2009-2010.

Subprime Mortgage Meltdown As you view the 60 minutes clip, please generate a list of at least 8-10 reasons how subprime mortgages led to a financial crisis. https://www.youtube.com/watch?v=iUuROWEMjm0

Types of Derivatives futures/ futures contract mortgage-backed securities collateralized debt obligation (comprised of mortgage/ mortgage backed securities) swaps/ credit default swaps

What’s a Derivative? https://www.youtube.com/watch?v=hGh2OzI06o8 Why is it problematic that Wall Street traders and economists can’t explain this term?

Derivatives A derivative's value is based on an asset, but ownership of a derivative doesn't mean ownership of the asset. Financial products with value that stems from an underlying asset or set of assets. These can be stocks, debt issues or almost anything. Warren Buffett once called derivatives, "financial weapons of mass destruction,"

But not all derivatives are bad! Homeowners use lock in rates for oil all the time to reduce prices to heat their homes!

Watch: https://www.youtube.com/watch?v=Q-zp5Mb7FV0

Who bears the blame? the consumers? the banks? the investors? the government?

Do Now: Take your BEST guess on explaining the cartoon on the left. What is the cartoonist’s message?

Are all derivatives bad? Derivatives are actually integrated into our daily financial system and are utilized by farmers to homeowners!

Discuss! Do you believe that derivatives are the root cause of the problem or how they are utilized by the financial community? Why is that the case?

Mortgage Backed Securities Definition: A type of asset-backed security that is secured by a mortgage or collection of mortgages. http://www.investopedia.com/terms/m/mbs.asp

Discuss! Why do banks invest in mortgage backed securities? How can this impact our financial system?

Mortgage backed securities would have been a safe investment had the banks issued mortgages to worthy borrowers and had the ratings agencies evaluated the risk of each investment properly.

But the banks failed to do so and investment firms got even more reckless!

CDOs CDO stands for Collateralized Debt Obligation Similar to mortgage backed securities because the pooled assets are bundled into separate tiers based on risk (the higher the risk the more interest is paid to the investor) The main differences is that CDOs can include mortgages, loans (including student credit card, and auto loans) and bonds into the separate tiers

Watch the clip and make some predictions! CDOs and Mortgages http://www.investopedia.com/terms/c/cdo.asp Watch the clip and make some predictions! Why would investors continue to invest in CDOs (especially knowing the risk involved!)?

Why do people invest in CDOs? According to Bloomberg… The transactions offer the potential for higher returns than buying a typical corporate bond. Yields on corporate debt globally have plunged to 3.3 percent from as high as 9.05 percent at the 2008 peak, according to Bank of America Merrill Lynch index data (remember interest rates were only one percent!)

Problems with CDOs CDOs subsequently exploded in popularity, with CDO sales rising almost 10-fold from $30 billion in 2003 to $225 billion in 2006. CDOs become one of the worst-performing instruments in the broad market meltdown of 2007-09. The bursting of the CDO bubble inflicted losses running into hundreds of billions on some of the biggest financial institutions, resulting in them either going bankrupt or being bailed out through government intervention, and contributing to escalation of the global financial crisis during this period.

Bank of America https://www.youtube.com/watch?v=7adZKCmp3c4 Why did the Dept of Justice sue Bank of America for fraud? How did the DOJ justify their actions?

Credit default swaps insured that the investment banks would continue to profit even as the foreclosures started to skyrocket! Essentially the banks all profited off of the financial pain of the homeowners!