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fin360thefinancialcrisisof2008-2.pptxInvestments: Background and Issues
Bodie, Kane, and Marcus
Essentials of Investments
Ninth Edition
1
Chapter
FIN 360: The Financial Crisis of 2008
Discussion – “The Big Short”
1) Who is the character Luis Rayneri and why is he important?
2) Define a sub-prime mortgage?
3) Define a credit default swap (CDS)?
4) Who is the character Dr. Michael Burry, what was his investment thesis and approximately how big was his initial investment?
5) Who is the character Mr. Mark Baum, how did he come to his investment thesis and approximately how big was his investment?
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FIN 360: The Financial Crisis of 2008
Discussion “The Big Short”
6) Who are the characters Charlie & Jamie and how did their investment thesis differ from Michael & Mark’s?
7) Explain how the movie explains a “sub-prime” mortgage?
8) What is a “short” trade, what outcome are you expecting, & what is a credit default swap (CDS)?
9) Name some of the NYC investment banks that sold Michael Credit default swaps (CDS)?
10) Who is Mr. Jared Vennent what was his role at his investment firm? Explain his selling “prop”?
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FIN 360: The Financial Crisis of 2008
Discussion – “The Big Short
11) What was Jared’s thesis on the housing market?
12) What is a Collateral Debt Obligation (CDO) and how does it relate to seafood stew?
13)Why does Mark’s coworkers go to Miami Florida? What is a NINJA loan?
14) What’s so important about January 11, 2007?
15) What was in Vegas and why did Mark’s team and Charlie & Jamie attend?
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Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
FIN 360: The Financial Crisis of 2008
Discussion – “The Big Short
11) Was there a housing bubble and how exposed were the investment banks?
12) Why does Mark’s coworkers go to Miami Florida? What did they uncover?
13)What was in Vegas and why did Mark’s team and Charlie & Jamie attend?
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Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
FIN 360: The Financial Crisis of 2008
Discussion – “The Big Short
16) What was the key date in history that each of the players’ investments paid off big? What was the event?
17) Who was on the other side of Mark’s CDS trade and why was this ironic and important?
18) What bold move did Michael Burry do while managing his hedge fund that angered several of his investors?
19) Eventually what did Michael Burry hedge fund make from from their investments in CDS because of the sub-prime mortgage crisis?
20) Who was the author of the book The Big Short?
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FIN 360: The Financial Crisis of 2008 Case-Shiller Index of U.S. Housing
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Index (January 2000 = 100)
FIN 360: The Financial Crisis of 2008
Changes in Housing Finance
1970s: Fannie Mae and Freddie Mac bundle mortgage loans into tradable pools (securitization)
Subprime loans: Loans above 80% of home value, no underwriting criteria, higher default risk. Introduced in 1994 and assets grew rapidly by 2005 had $665 billion…
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8
FIN 360: The Financial Crisis of 2008
Mortgage Derivatives
Collateralized Debt Obligations (CDOs: Consolidated default risk of loans onto one class of investor, divided payment into tranches
Ratings agencies paid by issuers; pressured to give high ratings
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9
FIN 360: The Financial Crisis of 2008
Credit Default Swaps (CDS)
Insurance contract against the default of borrowers
Issuers ramped up risk to unsupportable levels
AIG sold $400 billion in CDS contracts
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10
FIN 360: The Financial Crisis of 2008
Systemic Risk
Risk of breakdown in financial system — spillover effects from one market into others
Banks highly leveraged; assets less liquid
Rating Agencies (i.e. S&P and Moody’s) not performing their due dilligence
Poor regulation
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11
FIN 360: The Financial Crisis of 2008
The Shoe Drops
September 15, 2008: Lehman Brothers files for bankruptcy (largest in U.S. history)
September 17: Government lends $85 billion to AIG (biggest swap underwriter)
Money market panic freezes short-term financing market
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12
FIN 360: The Financial Crisis of 2008
Dodd-Frank Reform Act
Called for stricter rules for bank capital, liquidity, risk management
Mandated increased transparency
Clarified regulatory system
Volcker Rule: Limited banks’ ability to trade for own account
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13
FIN 360: The Financial Crisis of 2008
CONCEPT CHECK -- When Freddie Mac and Fannie Mae pooled conforming mortgages into securities, they guaranteed the underlying mortgages loans against homeowner defaults. In contrast, there were no guarantees on the mortgages pooled into subprime mortgage-backed securities, so investors would bear the risk. With this information what was one of the primary reasons for the Financial Crisis of 2008?
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Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
FIN 360: The Financial Crisis of 2008
CONCEPT CHECK -- When Freddie Mac and Fannie Mae pooled conforming mortgages into securities, they guaranteed the underlying mortgages loans against homeowner defaults. In contrast, there were no guarantees on the mortgages pooled into subprime mortgage-backed securities, so investors would bear the risk. What was one of the primary reasons for the Financial Crisis of 2008?
Answer – One of the primary reasons for the Financial Crisis of 2008 was subprime mortgage loans or mortgage loans that were non conforming – i.e. “JUNK”. Subprime mortgage were borrowers with low credit scores, some with no documentation and even some with no income verification. When the default rate hit 8% the house of cards came tumbling down.
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