Financial Crisis Term Paper

4200 words - 17 pages

Domenick Luongo

Fin 635: Dr. Wong

5/4/15

The Great Recession: The Financial Crisis of 2008

Table of Contents:

I. Introduction......................................3
II. Cause & Effect of the Housing Bubble..............3
III. Financial Industry................................5
IV. Global Contagion..................................6
a. European Sovereign Debt Crisis of 2007-2008.....7
V. LIBOR.............................................8
b. LIBOR & the Crisis in Lending...................8

VI. Unemployment......................................9
VII. United States Stock Market.......................10
VIII. Laws & ...view middle of the document...

(See table of contents)

Cause & Effect of the Housing Bubble

In 2006, the housing market peaked and began to decline in 2007. The reason that it had peaked in 2006 was because of low interest rates from 1999 to 2004. Low interest rates make mortgages appear attractive to prospective buyers. “The Fed – and many of the world’s other leading central banks – continued to pump liquidity into credit markets to ensure credit would continue to flow at low rates of interest (Marshall 2009).” It had begun when the Federal Home Loan Mortgage Corporation, also known as Freddie Mac, proclaimed that it would no longer buy the most risky subprime loans. This led to private label mortgage backed securities being the main source of mortgage originators. Due to the influx of mortgages being backed by private companies, government sponsored enterprise (GSE) was not able to see and control mortgage originators. This situation set the pace for the decline in underwriting standards where almost anyone was able to invest in a home. This lack of regulation put the market in jeopardy with supplying mortgage loans to people with low credit. As people are not able to pay their mortgages, the number of foreclosures would have an increase. As foreclosures were occurring, it was just adding to the already high supply of homes. Using the basic analytical tool of supply and demand, with a very high inventory of homes, the price of these homes were decreasing and not being applied to for mortgage loans from possible homebuyers. The depreciation of home prices led to losses to the government-sponsor enterprises (which were backing the bulk of United States mortgages).

After government sponsored enterprises were overshadowed by private organizations, the private companies began to get overwhelmed with the loans they had given out. Starting with New Century Financial filing for Chapter 11 bankruptcy. “Chapter 11 bankruptcy is a form of bankruptcy reorganization available to individuals, corporations, and partnerships. It has no limits on the amount of debt. It is the usual choice for a large business seeking to restructure their debt (Moran Law Group 2008)” New Century Financial had more than $100 million of listed liabilities. This resulted in them terminating more than half of their employees.

The next major firm to be affected was Bear Stearns. What started out as a rumor turned into the truth in that Bear had massive investments in subprime mortgages, otherwise known as toxic assets. They were also involved with selling credit default swaps, which ensured payment for failed bonds. Investors immediately pulled out and the stock price plummeted from what was once $170 to $30. Bear was left on the edge of bankruptcy but they were too connected with the other major firms on Wall Street to let them completely go under. After analyzing the systemic risk, the Federal Reserve lent to JP Morgan who would then pass on the money to Bear Stearns as a bailout. Hank Paulson,...

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