The Credit Crisis and the Resulting Effects on the Financial World Essay Example for Free

The Credit Crisis and the Resulting Effects on the Financial World Essay All of these events are what has led to what analysts have said to be a recession. This paper will attempt to explain the causes that credit issues had on the financial crisis as well as show how liquidity played a major role in throwing debt markets into panic and in some cases failure. I will also give some insight into how the debt markets became inactive because of these issues. We will also take a look at how interest rates affected this crisis as well as how the stock market and initial public offerings (IPOs) were affected. The Beginnings of the Bubble Burst After the internet bubble burst of 2000 the Federal Reserve Bank was worried about a serious deflationary period. Because of this fear they did not want to counteract the housing bubble. The Federal Reserve Bank actually lowered the federal funds rate from 6. 5% to 1% in the period from 2000 to 2003. This was done in order to soften the blow from the internet bubble and was encouraging people to borrow at faster rates. During this time period, banks also went through a serious transformation period where instead of holding onto debt, they used new financial innovations to bundle them and sell the risk off onto other investors. This process was named originate and distribute. In this banking model loans were put together, tranched and sold via securitization. To tranche means to slice up the pool of debt into say slices of a pie. Each pie slice has a different risk involved, credit rating and thus different amounts of interest paid. Securitization is where these slices are then sold to different investors as bonds or Collaterized Mortgage Obligations (CMOs). The principal and interest on the debt, underlying the security, is paid back to the various investors regularly. These types of new innovations led to new investors and thus access to more liquidity for banks. Banks began to thrive with all the new opportunities for them to create more liquidity. As you can see from this chart, Securitization was being exploited at alarming rates. [pic] This in turn, allowed them to be able to lend more money. The problem was not the increased amounts of loans that banks gave out, the problem lied with whom these banks were lending money. Of course the added pressures growing in the market from the government and financial institutions werent helping matters. As I mentioned earlier, The Federal Reserve Bank was lowering the federal funds rate in the years of 2000 through 2003 which encouraged people to invest in real estate. At the time the real estate market was on a tremendous upswing. However in the years of 2004 through 2006 they started increasing the federal funds rate (FFR) which made 1-5 year adjustable rate mortgages more expensive to reset for homeowners. There was another side effect of the rising FFR, generally when interest rates rise, assets fall in value. This would mean that speculation in real estate would be much riskier for investors, and this may have led to the eventual housing bubble burst. However this did not stop banks from targeting a new market. A new customer target entered the market for banking systems, Sub-prime borrowers. Originally, banks were, for the most part only lending to prime borrowers, a group of borrowers who are considered the most credit-worthy, indicated by a FICO score greater than 720. These prime borrowers were able to borrow money at the markets best interest rate and were also considered safe investments. Sub-prime borrowers on the other hand, were less than desirable potential customers to lend to. Their credit ratings were much lower than prime borrowers, meaning they were more likely to be late with payments on loans or even default all together. Now, initially banks may have strayed away from giving as many loans out to sub-prime borrowers as they did, however added pressures by the government and financial institutions were mounting. When the Securities and Exchange Commission relaxed the net capital rule in 2004, this allowed the five biggest investment banks to dramatically increase the leverage they could use and also allowed them to aggressively expand on their issuance of mortgage backed securities (an asset-backed security or debt obligation that represents a claim on the cash flows from mortgage loans through securitization). This then pressured government entities such as Fannie Mae and Freddie Mac to expand their riskier lending to sub-prime borrowers, and this led as an example for other banks that followed suit. Financial Market Begins to Feel the Pain and the Onslaught of Liquidity Issues Arise The rise of securitized products ultimately led to a flood of cheap credit, and lending standards fell. Now that banks had a way to get rid of the majority of risk involved in lending money, via securitized products being sold to financial institutions, they took an easy going approach to approving and monitoring loans. Banks came up with new ways to give out mortgage loans with no down-payments, jobs and even income! These were called piggyback mortgages (the combination of two loans to take the need of a down payment away) and NINJA (no income, no job or assets). These loans were given on the assumption that people if people needed money they could always refinance and actually horribly wrong and in fact the opposite happened. Loans started to default a domino effect began causing liquidity crisis as well as other issues. The trigger for the liquidity crisis began in early 2007, when sub-prime mortgage defaults started increasing at damageable speeds. Mortgage-backed Securities, CDOs and asset-backed securities (a security whose value and income payments are derived from and collateralized (or backed) by a specified pool of underlying assets) all took a huge hit. This dominoed into the shadow banking system (financial institutions that do not have the same regulations as banks because they do not take deposits like banks do) causing many institutions great problems. The major issue was that a lot of these shadow banks had borrowed from investors in short-term, liquid markets (such as money markets and commercial paper markets) and then took this money and lent it out to corporations or invested in long term investments, less liquid assets. In most cases these long term assets that were purchased were mortgage-backed securities. So as you can see the default on sub-prime mortgages was deeply intertwined with all that shadow banking systems were involved in. Once the mortgages defaulted and investors became weary of investing in mortgage backed securities, these financial institutions that had so heavily depended on short term monetary loans from the investors were finding themselves quickly bankrupt. Because the shadow banks are not regulated such as depository banks they are also not able to use the lender of last resort, the U. S. Central Bank. In short financial institutions were in a serious bind. They needed to sell their long term loans for cents on the dollar to be able to pay off the short term loan payments and in the end many institutions were out of business. Some notable companies in 2008 that closed down shop were Bear Stearns and Lehman Brothers. And the long and short of it is that these financial institutions were also highly leveraged. That coupled with the long term illiquid investments they held were the shadow bankers downfall. The effects of defaulted mortgages did not stop there. The effects of defaulted mortgages continued to snowball into a huge problem for such companies as AIG. AIG is an international insurance company that had heavily invested in credit default swaps. The major problem that started the downfall of AIG was the downgrade of its credit rating. When you have a credit rating of AAA you do not, by industry standards, have to give collateral when entering into credit swaps. When AIG had to start providing collateral with their trading counter parties the problem of liquidity started. This was not just a small problem either; they had backed 100 cents on the dollar to CDSs. They had engaged in over 440 billion dollars worth of CDSs of which almost 60 billion were structured by sub-prime loans. In their first half of 2008 they reported 13. 2 billion in losses. They were on the verge of what could have sent our whole financial system into chaos. Had AIG failed it would have sent a wave of bankruptcy through the financial world that would have collapsed the entire market. Because after all, they were insuring financial institutions, who were holding risk for banks who had defaulted mortgage loans. The bailout by the U. S. Government saved AIG by giving them the biggest bailout in history, 85 billion dollars (of which the US Government got an 80 percent equity stake). That was not even the end of it; AIG was given another 77 billion after that. The buck basically stopped with AIG, as they were too big to fail. They had offered a product that while markets were doing well AIG was successful, but as the market declined they entered into what analysts say was inevitable. They offered to cover all risk when offering 100 cents on the dollar, and once the defaults on prime mortgages made it through the entire financial world they had to back the product they offered in CDSs and obviously they could not. The Financial Market Freezes The collapse of the shadow banking system was an igniter of the market freezing. They had accounted for one third of all U. S. lending mechanisms leading into this crisis. The reasoning was because investors that had been supporting the financial institutions with short term money loans quickly bailed out once things started to go wrong. With this absence of monetary injection into the shadow banking systems they were no longer able to fund mortgage funds, corporations and others in need of their services. This caused banks to have a serious absence of liquidity as well, leading them to start hoarding money. This meant that instead of banks loaning to counter-parties in need they held onto the funds in fear of needing liquidity in the future. This was a serious problem and one that will not be fixed in years to come. A lot of the forms of securitization that were once available are likely gone forever. The reasoning behind them disappearing is that they were designed in a time of very loose credit conditions and that time has gone, at least for now. While banks have raised their lending standards it was the rise and fall of shadow banks that inevitably led to the inactivity of debt markets. The Stock Market Follows As I mentioned earlier, the defaults on sub-prime mortgages spiraled into many liquidity problems in the financial markets. They caused investors to start fearing that markets would continue to drop. Banking institutions bankrupted, and with AIG on the brink of disaster, matters only got worse. Investors caused bank runs (Groups of people all withdrawing money from banking institutions at the same time), Illiquidity, and massive panic in stock markets. As we can see from this table, The S;P 500 index was significantly hit by these defaults. As you can see, during the crisis period volatility was 43. 6% (325% of pre-crisis period). [pic] This table reflects how the average investor was feeling about the market. As you can see in the post-crisis analysis the market volatility is still at 20. 9% and the average is actually lower than the crisis period. This next chart reflects the Dow Jones Industrial Average (DOW). As you can see here, the chart mirrors the information given in the last table. March 2009 was the low point of the market (where the crisis ended), and the market has rebounded. It has not yet returned to its previous high of 14,000 but it has steadily been on the incline since March 2009. This gives us hope in looking to the future, that even in the trenches our economy can rebound. Effects on Initial Public Offerings Initial public offerings are the first sale of stock by a company to the public. This allows companies big and small to raise capital for their firms. With the severe economic downturn in 2008, it sent a wave of negative effects worldwide, which hit the IPO markets hard. IPO markets plummeted by over 60% in both deal numbers and funds raised. Up until 2008, there had been record-setting years with IPOs. The problem lied with the illiquid markets. There was a significantly less money that investors were willing to supply for IPOs. Although IPOs were taking a significant hit, U. S. and China still led the way as far as funds raised from IPOs Companies with strong business plans and innovative products for the economy were still able to realize positive gains in the public markets. Looking towards the future, IPOs will rebound. Analysts say that signs point to new horizons for IPOs, favoring companies that offer innovative and public solutions for the changing environment. Looking Towards the Future In short, our financial world hit a wall when sub-prime mortgages were abused. Securitization multiplied the effects from default mortgages causing financial ripples that destroyed many firms. Other problems such as the relaxing of regulations and the pressures from the U. S government to give out sub-prime mortgages only made things worse. Greed ran wild and should have taught us a lesson on what deregulation and the abuse of sub-prime borrowers can do to markets. We also need to keep banks more regulated and have the government always keeping a watchful eye on the shadow banking system. Congress and the Obama Administration have taken the first step forward to preventing a repeat by putting into law the Dodd-Frank Wall Street Reform and Consumer Protection Act. As regulators begin the rule-making process it is estimated that the act mandates nearly 250 regulations and 70 studies. Just as quickly as it was passed, however, the industry was hard at work lobbying to diminish the protections under the act by intervening as much as possible in the rule-making process that follows any such legislation. Additionally, the industry lobbyist are hard at work in an effort to get the newly elected Republican-controlled House of Representatives to weaken the legislation’s impact through low funding of the various regulatory enforcement provisions. I would hope that in the future we can learn from this crisis and realize that lending to borrowers with good credit, and income that can afford the payments of a loan, are very important aspects in lending. Equally, financial institutions must get back to seriously following their own loan policies, since most policiesthat were ignored allowed for loans to be approved that should not have been. . Works Cited 1. United States. Federal Reserve Bank of St. Louis. The Financial Crisis Timeline. Web 09 Dec. 2010.

The Brink of War :: history

The Brink of War In 1914, there were many things that placed Europe at the brink if war. Nationalism, militarism, imperialism, social darwinism, and Jingoes where five of the main forces that were pushing Europe to the brink of war. Another main force was the development of Alliance systems. These ideas and systems threatened the balance of power which could then cause a major war to break out. In Europe at the time, there were many ideas which were causing friction. Nationalism, which was the desire for a country was causing friction because people in old empires sought to be free. The leaders of these people would not be happy and a war would definitely break out. If they became free they would also need to take land from someone else and this again may cause a war and usually did. Another idea which was contributing to the shifts of power in Europe was Militarism. This was when a country believed its power was reflected in its army. They believed that war was the right thing to do and that all countries needed to be ready for war. If a country felt they had a lot of power they would, no doubt, try to conquer a weaker neighbor or just any other country. Imperialism which was the countries want to build an empire was another reason. For a country to become an empire they would have to colonize and conquer other territories. This would easily start wars and it's not that hard to figure out why. A good example of this is Italy. They wanted to become an empire so they attacked a country which they thought was weaker then them(Abyssinia). This caused a war which in the end was won by Abyssinia. Another cause was the idea of social darwinism. This meant the survival of the fittest. The best would win and the weaker would parish. The stronger country would attack weaker countries and in the end the weaker would usually lose. This caused a lot of tension just like militarism. The last of the ideas, was the idea of jingoes. These were people who lived for war. All they wanted was to go to war. Jingoes where very aggresive talkers and they caused a lot of friction between many countries. These ideas where some of the main reasons Europe was pushed to the brink of war.

Child abduction Essay

Kidnapping is any illegal capture or detention by any strangers for criminal and mischievous purpose. In criminal laws, kidnapping means taking away or asportation of a person against the person’s will. These problems are usually caused by parental child abduction, children abduction for slavery and abduction results from parents to bring up as their own. Now, here are some preventions for these particular circumstance from occur. First of all, parents ought to give guidelines to their children. They should play their very important role to build up a family safety plan. Parents need to educate their kids to think logically, in order to do so, kids must be taught that questioning, reasoning, and criticizing are good requirement to stay safe. They have to stay aware of the surrounding issues and keep alert. For example, teach the kids about stranger and common lures used by kidnapper such as giving sweets to seduce them and many more. Other than that, parents should also listen to their kids’ problem. Ask if they have question, and listen carefully to their answer. Parents have to put themselves into their children’s shoes. Moreover, it is essential to know where the kids are going, who is with them and when they are suppose to return home. Parents can check on the location of their children if they keep a list of acquaintance’s phone numbers. Besides that, an implantable chip touted is another effective solution for child kidnapping. The chip can be surgically planted under a child’s skin, putting it into the fabric of clothes or inserted under the skin by injection. With this chip, parents can easily detect their children’s situation, once they are out of the certain area the special alarms will send out a SOS signal. This is because it has an SOS button, which sends an SMS and position coordinates to a predefined mobile number if the child is in trouble. A parent can call the child back to find out what the problem is. Kidnapping can be controlled if the laws are strong and if you inform your parent or guardian where you are going.

Juvenile Court Vs. Adult - 1452 Words

Nowadays, murders, rapists and other heinous crimes can be committed by anyone. A fourteen-year-old teenager murders someone or does a massacre in school can be often seen from the headline news of newspaper. However, these youth criminals may have much less severe punishment than adults may have who have done the same crime. A criminal is a criminal that must be punished as no difference between adult and youths; especially, the crimes are categorized under murder and rape. A bullet wound just hurt as much when a child as fires the gun as when an adult fires the gun. Therefore, regardless to age, the youths who commit heinous crimes like murder and rape should be charged as adults in a way of the punishment they deserve the same. The difference between juvenile court and adult court have been distinct. The issue has been a controversial one for a long time. The two justice systems, juvenile court and adult court have been long established for decades. Both involve people accused of crimes with the basic individual rights in the court. According to Pacific Juvenile Defender Center, it stated, â€Å"Youth may be held under juvenile court jurisdiction from age 12 until age 21, or until age 25 if he or she is committed to the California division of juvenile justice.† (YLC, 2009) The purpose of juvenile court system was set up for those youths who are not as mature and cannot be held as adults. However, juvenile crimes are becoming more often and heinous, it is necessary to focusShow MoreRelatedJuvenile Vs Juvenile915 Words   |  4 PagesJuvenile v. Adult Corrections Juvenile delinquents use to not face police or a correction system, only the fear and punishment of their families. However, as the juvenile delinquents aged they were faced with harsher punishments, but it was not until the 1800s reformers started looking for ways to teach values and built asylum and training schools. 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