Anna Toronova's List: Research for Economics ISP

• • Derivatives are like a bet: (one bets against and one bets for)
    During financial crisis: bets on whether lenders would be able to pay off their mortgages and loans; 
    historically banks owned loans, but now banks sell off loans so people can invest in them
    

• Actus Reus can be a physical act (hitting someone), a failure to act (watching someone being hit), or a state of being (having stolen property in your possession).  It must be shown that a person committed an act prohibited by law.
• Mens Rea is the mental element of a crime. It includes motive, intent, knowledge, and recklessness/carelessness.
• due diligence; meaning that the accused made every effort to avoid committing the crime.

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• While he says that Wall Street was not blameless in this system, as bankers lobbied for polices that created the problem, it was the government’s track record of riding to the rescue of investors that allowed them to take far greater risks than they normally would have if they thought they could lose nearly everything.
• In the end, Mr. Roberts argues that financial regulatory overhaul will fail to prevent future crises, with investors — homeowners, bondholders or Wall Street bankers — continuing to count on the government to bail them out if anything goes wrong.

• They are both shareholder-owned companies mandated by the US Congress to provide funding to the housing market.
• Fannie Mae is short for Federal National Mortgage Association, Freddie Mac short for Federal Home Loan Mortgage Corporation.
• The two firms do not lend directly to homebuyers, instead buying mortgages from approved lenders and then selling them on to investors.
• Almost all US mortgage lenders, from huge financial institutions like Citigroup to small, local banks, rely on Fannie Mae and Freddie Mac.
• By linking mortgage lenders with investors, the two firms keep the supply of money widely available and at a lower cost

•  <!-- S IIMA -->   

  Foreclosure rates have soared

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  In this scenario, the government will guarantee the firms' debts, bring in new management and provide fresh liquidity to make the business less vulnerable to the declining market.

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• Outwardly, Fannie and Freddie wrapped themselves in the American flag and the dream of homeownership. But internally, they were relentless in their pursuit of profits from partners in the mortgage boom. One of their biggest and most steadfast collaborators was Countrywide, the subprime lending machine run by Angelo R. Mozilo.
• ountrywide was the biggest supplier of loans to Fannie during the mania; in 2004, it sold 26 percent of the loans Fannie bought. Three years later, it was selling 28 percent. What Countrywide got out of the relationship was clear — a buyer for its dubious loans. Now the taxpayer is on the hook for those losses.
• Nine bullet points fall under the heading “Fannie Mae’s Top Strategic Business Objectives With Lender.” The first: “Deepen relationship at all levels throughout CHL and Fannie Mae to foster alignment and collaboration between our companies at every opportunity.” (CHL refers to Countrywide Home Loans.) No. 2: “Create barriers to exit partnership.” Next: “Disciplined Risk/Servicing Management” and “Achieve Fannie Mae Profitability Goals.”

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• one clear culprit was the failure of regulators and market participants alike to fully appreciate the strength of the amplifying mechanisms that were built into our financial system
• shadow banking system was often credited with better distributing risk and improving the overall efficiency of the financial system, this system ultimately proved to be much more fragile than we had anticipate
• The hands-off regulatory approach was a mistake.
• Fixing these incentive problems is certainly a start, as is bringing the shadow banking system under the same regulatory umbrella as the traditional system
• Along these lines, I would be in favor of limiting leverage ratios (through higher capital requirements), a key factor in how much damage a particular shock can do. The ratios we saw prior to the crisis of 30-1 or more leave the system far too vulnerable.
• But there are some types of financial products, e.g. naked CDS’s that amount to an insurance contract between parties with no stake whatsoever in the outcome of the bet they are making, that need close scrutiny before allowing their continued use.

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• Policymakers should recognise that each domestic financial sector is integrated with the rest of the world. As such, policy actions in a financial system may positively or adversely affect the entire global financial system. For example, rising bond yields in the United States due to deteriorating budget deficit and sovereign debt rating may perturb not only the financial sector in the United States, but also throw the world financial sector into chaos. Accordingly, national regulators should adopt prudent financial policies consistent with financial stability, long-term economic growth and welfare improvement.
• regulators should promulgate proper procedures for the listing, trading, and rating of various securities. Market participants should be given thorough understanding of hybrid securities and their associated risks.
• The scope of existing laws and regulations should be enlarged to encompass the operations of all types of financial intermediaries. By doing so, regulators can monitor the activities of the entire financial system more effectively and thereby minimise the effects of any financial contagion.
• Financial authorities commonly believe that capital injected into large banks will somehow find its way into the rest of the under-capitalised banking system. However, this may not necessarily be the case since large financial conglomerates may exert their market power over smaller, less influential banks. This may be happening in the United States now.
• Finally, it is crucial that whenever a financial crisis emerges, the private sector does not recourse to the public sector to resolve the problem. Preferably, the private sector should create a mechanism to confront the issue as well as to bear the full cost of the financial turmoil.
• In addition, taxpayers also should not be required to bear any cost of a financial meltdown. Some researchers have suggested that both enterprises and financial intermediaries subscribe to some form of capital insurance.
• By paying regular premiums, firms and banks can fall back on this insurance whenever a financial crisis evolves. Funds from the capital insurance can be used to ameliorate the repercussions of the financial turbulence.

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• The crisis, the worst since the Great Depression of the 1930s, has already brought down a half-dozen major banks and other financial companies. But at its core, the debacle was caused by the fairly recent practice of selling to more and more homebuyers larger loans than they could afford.
• Mark Tenhundfeld of the American Bankers Association expects Congress to pass laws against so-called predatory lending. Additionally, he said, it may require a federal license for mortgage lenders. “But enforcement will probably be left to the states,” he said.

• Mark Perlow, a securities attorney with the law firm K&L Gates LLP, thinks the government will require companies to keep a financial stake in all the mortgages, credit cards and similar consumer products they sell. “The originators of debt will have to keep some skin in the game,” he said.

   
• The market in credit-default swaps and other complex instruments known collectively as derivatives has become huge and lucrative in recent years, but is unregulated. Observers expect Congress and the regulators to make the field more transparent and to introduce new regulations.

• Reserve requirements could be established. Commercial banks, for example, are generally required to keep on hand $1 of cash for every $10 they owe to account holders or they loan out. (Investment banks typically have no such requirements, and keep only $1 for every $30 or more they borrow to invest. They have made fortunes. But when investments go bad, they have few reserves to cover their losses.)

   

  Perlow, the attorney, expects Congress to debate amending the Commodity Futures Modernization Act of 2000, which kept derivatives unregulated

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• Furthermore, even if those controlling financial firms knew the probability of a severe shock, and the large losses that would result from it, it is not in their interest to hold the capital needed to meet those losses. Because they don't know when the shock will occur, playing it safe would mean reduced earnings for the firm and reduced personal income for them for what could be a very long time. Better to realize the higher income as long as possible, because if they stay within the law, the money won't be taken from them when the firm becomes insolvent. 

   

• This appears to lead logically to the conclusion that government ought to impose capital requirements on financial firms. Capital requirements stipulate the amount of capital firms must have, based largely on the amounts and types of assets and liabilities they have. 

   

• Because Wall Street didn't like the idea, what got dropped from the proposed changes were rules to create different structures for rating different products. And the most egregious of the dropped rules was a proposal that ratings firms make public all underlying information they use in making their ratings. Which is exactly the transparency needed.
• There is an overwhelming heaviness to the credit crisis that bears on our economic future. It is the inordinate weight of established, self-serving power brokers driving dump trucks full of ill-gotten gains over any clarion call for transparency. The underlying currency of capital markets must be clearly and objectively rated instruments, whose value is determined by free market

• many central bankers want to raise capital requirements—at least during good times. Had banks been forced to hold more capital, the boom might have been more constrained, and there would be less of a bust.

   
• mpelling banks to hold more capital—typically, equity—goes against shareholders’ interests, because it results in a lower return on equity
• This ultimately hurts economic growth because capital is diverted from projects that might have higher returns. In addition, worthy borrowers are denied loans. It may also be counterproductive, by encouraging banks to game the system.
• “capital insurance”: push banks to buy policies in normal times that deliver an infusion of fresh equity during crises.

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