AFF5230 L 11 Sub Prime

AFF 5230
Lecture 11
Learning Objectives
• By the conclusion of the lecture:
– Students should understand the structure of sub prime crisis:
> Sub prime housing loans;
> Mortgage & bond insurers ( Monoline);
> Collaterised debt obligations;
> Credit Default swaps;
> Structured Investment Vehicles.
• Have defined some of the causes of the crisis.
• Have noted the attitude of financial institutions & regulators.
Department of Accounting and Finance Slide 2

References
• Reader : pp. 285-289.

• Text: Chapter 32-pages 629-639,641-642.
• Handouts.

Sub Prime crisis
• This lecture is a natural extension of the securitisation lecture.
• In Chapter 2 of our text, Fabozzi and Modigliani state:
• “ The major financial innovations are discussed throughout this
book; however, we conclude this chapter with a key innovation
in the 1980’s that dramatically influenced the role of financial
intermediaries-asset securitisation”.
• In its simple form, asset securitisation was a valuable source of
alternative finance for banks, and increased their financial
flexibility.

(2)
The concept was extended to cover:
HOMOGENEOUS STRUCTURE
 Mortgages-residential, industrial, commercial;
 Loan receivables.
 Cash flow receivables-credit card, debtors, specific loans,
film revenues.
NON HOMOGENEOUS STRUCTURES
 Collaterised debt obligations- effectively “a cocktail “of
assets.
Further, financial engineering was employed to create
synthetic financial instruments which in many cases
had no specific asset backing.
(3)
• Financial Engineering definition: *

– “ Financial Engineering is the successful
implementation of the investor banker’s
creativity in security design. The application of
mathematical and statistical modeling, together
with advances in computer technology provides
the necessary infrastructure for financial
engineering”.
– * “The Business of Investment Banking”, K Thomas Liaw

(4)
 As previously advised, there are a range of parties
involved in the securitisation process:
 Mortgage originators;
 Mortgage brokers;
 Mortgage insurers;
 Mortgage servicers;
 Investment banks;
 Rating agencies;
 Investors- seeking to maximise their income return within their
preferred risk profiles.
 Each of theses parties ( other than investors) receives a
fee in part related to value of transactions- so the
inducement to increase volume was significant.

A driving principle behind the sub prime
crisis
• “GREED IS GOOD”
• (SOURCE:Gordon Geko- “Wall Street” and
“Wall Street : Money Never Sleeps”.)

Structure of sub prime crisis
• The US sub prime housing market;

– Associated difficulties for related parties-
mortgage insurers; rating agencies.
• The Collaterised Debt Obligation market
(CDO’s);
• The Credit Default Swap market (CDS’s).
• Structured Investment Vehicles (SIV’s)
and CLO’s.
Summary of structure

Sub prime housing crisis
• Sub prime lending is a general term that refers to the

practice of making loans to borrowers who do not qualify
for market interest rates of traditional housing mortgages
because of problems with their credit history or the
inability to prove that they have enough income to
support the monthly payment on the loan for which they
are applying.
• Effectively NIJA’s:
– No income;
– No job;
– No ability to repay.
Community Reinvestment Act
• The original Act was passed by the 95th United States Congress and signed into law
by President Jimmy Carter in 1977 (Pub.L. 95-128, 12 U.S.C. ch.30).[38] Several
legislative and regulatory revisions have since been enacted.
• is a United States federal law designed to encourage commercial banks and
savings associations to meet the needs of borrowers in all segments of their
communities, including low- and moderate-income neighborhoods.[1][2][3] Congress
passed the Act in 1977 to reduce discriminatory credit practices against low-income
neighborhoods, a practice known as redlining.[4][5] The Act requires the appropriate
federal financial supervisory agencies to encourage regulated financial institutions to
meet the credit needs of the local communities in which they are chartered, consistent
with safe and sound operation. (See full text of Act and current regulations.[1
• ] The same Federal banking agencies that are responsible for supervising depository
institutions are also the agencies that conduct examinations for CRA compliance.[10]
These agencies are the Federal Reserve System (FRB), the
Federal Deposit Insurance Corporation (FDIC), the
Office of the Comptroller of the Currency (OCC), and the Office of Thrift Supervision
(OTS).

(2)
• The law, however, emphasizes that an institution's CRA activities should be
undertaken in a safe and sound manner, and does not require institutions to make
high-risk loans that may bring losses to the institution. [3][4] An institution's CRA
compliance record is taken into account by the banking regulatory agencies when
the institution seeks to expand through merger, acquisition or branching. The law
does not mandate any other penalties for non-compliance with the CRA.
• Before the Act was passed, there were severe shortages of credit available to low-
and moderate-income neighborhoods. In their 1961 report, the
U.S. Commission on Civil Rights found that African-American borrowers were
often required to make higher downpayments and adopt faster repayment
schedules. The commission also documented blanket refusals to lend in
particular areas.
• Contributory factors in the shortage of direct lending in low- and moderate-
income communities were a limited secondary market for mortgages,
informational problems to do with the lack of credit evaluations for lower-income
borrowers, and lack of coordination among credit agencies.

(3)
• Although not part of the CRA, in order to achieve similar aims the
Federal Housing Enterprises Financial Safety and Soundness Act of 1992 required
Fannie Mae and Freddie Mac, the two government sponsored enterprises that
purchase and securitize mortgages, to devote a percentage of their lending to
support affordable housing.
• In July 1993, President Bill Clinton asked regulators to reform the CRA in order to
make examinations more consistent, clarify performance standards, and reduce
cost and compliance burden.[52] Robert Rubin, the Assistant to the President for
Economic Policy, under President Clinton, explained that this was in line with
President Clinton's strategy to "deal with the problems of the inner city and
distressed rural communities"

(4)
• Some economists, politicians and other commentators have charged
that the CRA contributed in part to the 2008 financial crisis by
encouraging banks to make unsafe loans. Others however, including the
economists from the Federal Reserve and the FDIC, dispute this
contention. The Federal Reserve and the FDIC holds that empirical
research has not validated any relationship between the CRA and the
2008 financial crisis.[97][98]
• Economist Stan Liebowitz wrote in the New York Post that a
strengthening of the CRA in the 1990s encouraged a loosening of
lending standards throughout the banking industry. He also charges the
Federal Reserve with ignoring the negative impact of the CRA. [92] In a
commentary for CNN, Congressman Ron Paul, who serves on the
United States House Committee on Financial Services, charged the CRA
with "forcing banks to lend to people who normally would be rejected as bad
credit risks."[99]
(5)
• The conclusions on the effects of this

Act are variable.

Background
• Prior to 2005 subprime mortgage loans accounted for approximately
10% of outstanding mortgage loans. By the end of 2006 the originations
of subprime totalled $650b, which was 20% of new residential mortgage
loans.
• The growth in the market can be attributed to a number of factors:
– Borrower friendly underwriting criteria;
– Favourable conditions for the residential housing market that
applied from 2002 to 2005:
> During this period, home price appreciation gave borrowers
an equity cushion, so that sub prime borrowers who
experienced financial hardship could refinance their loans or
pull equity out of their properties . As a result the loss ratio
was low.

(3)
• The increase in securitisation of subprime loans-typically as asset

backed securities (ABS) in which senior and subordinate tranches were
created:
– S&P estimated that in 2006 subprime ABS constituted more than
70% of the collateral in rated mezzanine structured finance CDO’s.
– The tremendous demand for these high yielding securities greatly
increased the volume of credit available to subprime borrowers.
• Technological advances in mortgage lending, such as automated
underwriting systems, have allowed originators to make rapid decisions
based on credit scores & other available credit information of
prospective borrowers- man vs. machine!

Use of risk layering
• Definition: risk layering is a procedure for reducing the lending
standards as market conditions worsen. It is designed to
maintain the level of loans (& hence the fee income earned by the
respective parties)..
• The increase in risk layering occurred in response to the problem
of maintain housing affordability. Rapid price appreciation from
2003 to 2005 made home buying less affordable. To address this
issue, and maintain volume of home loans:
– lenders developed subprime mortgage loans which
combined the lowest possible down payments, with
– relaxed underwriting standards. Mortgage brokers &
mortgage bankers were principal lenders-why?
(2)
• Example of the risk layering positions used in subprime mortgages are:
– A typical subprime borrower with a credit score of between 450 & 680
could obtain a loan :
> With little or no down payment:
– Two mortgages arranged-one for 80%, the other a “piggybank” loan so
that the borrower made no down payments. A higher interest rate
applied on the second loan.
– Provide little or no documented proof of income or assets;
> Extended beyond original concept of self employed professionals
(Alt A loans) who could not readily substantiate earnings to persons
with impaired credit histories & first time borrowers. The extension
to stated income loans, whereby limited evidence was
provided-“liar loans” was a rising sub class of these loans.
• .

(3)
• Obtain a loan with a low initial “teaser” interest rate that reset to a new
higher rate after 2/3 years, or obtain a loan with a term beyond 30 years
with associated lower monthly payments
• Further definition:
– Alt-A mortgages are similar to low documentation loans that are
marketed to borrowers in Australia by lenders such as St George,
Bluestone and Westpac.
– Alt-A loans often require less proof of the applicant's income and are
often targeted at self-employed individuals and other potential borrowers
who cannot provide standard documentation.
– According to Standard & Poor's, Alt-A borrowers may also be able to
secure other features that fall outside standard underwriting guidelines,
including higher loan to value ratios. The Alt-A loan category on the
credit risk spectrum sits between prime and sub prime mortgages.
Other Parties Involved

Mortgage brokers.
• A party which has received some criticism is the mortgage
broker.
– Mortgage brokers don’t lend their own money, there is
not a direct correlation between loan performance and
compensation.
– Accordingly, in 2004 mortgage brokers originated 68%
of all residential loans in the US , with subprime and
Alt A loans accounting for 42.7% of brokerages total
production volume.
• It has been claimed that brokers profited from a home loan
boom, but were not concerned to examine whether
borrowers could repay.
Role of mortgage insurers/Monoline
insurance/rating agencies
• Mortgage/bond insurance:
– A process whereby issuers of bonds can pay a premium to a third
party, who will provide interest and capital repayments as
specified in bond in the event of the failure of the issuer to do so.
– Berkshire Hathaway acts as a mortgage insurer.
– Companies whose sole business is to provide bond insurance
services to one industry are termed monoline insurers.
• No monoline insurer had been rating downgraded or defaulted
until 2007:
– In November 2007 ACA, the only single A rated insurer reported a
US$1bn loss:
(2)
> ACA advised that if it was downgraded below A-, collateral
would have to be provided;
> In December, it was downgraded to CCC.
–Credit rating agencies placed other monoline insurers under review.
–Berkshire Hathaway was forced to unwind 26,000 undesirable swaps
at loss of US$400m.*
–This year many municipal and institutional bonds have traded at
prices as if they were uninsured-effectively making the monoline
insurance effectively worthless.

(3)
• Rating agencies have been criticised on many

counts:
– Monoline insurers were not downgraded
promptly;
– Rating agencies may failed to fully understand
the complexities of structured finance
instruments.
– Rating agencies failed to acknowledge the
problems of lack of market liquidity.
Housing market slowdown
• In 2006, the rate of annualised increase in US housing prices slowed-

meaning the credit risk could not be masked by rising property prices.
– By March 2007, 13% of sub prime borrowers were delinquent on
their payments by 60 days or more.
• Prior to 2006 many loan sale agreements between subprime lenders &
loan purchasers who packaged the loans into Asset Backed Securities,
provided for little recourse on sale.
– The credit risks associated with the subprime loans were largely
passed to the purchasers of the loans.
• However, with the weakening of the housing market in 2006, many
investment banks & other investors in sub prime loans recognised the
additional risk characteristics and required lenders to assume the risk
of default occurring within the first few months of origination- early
payment defaults.
(2)
• A large increase occurred in early 2007 of early payment defaults, the
most frequent occurring in a stated income or limited documentation
loan for a first time borrower, together with a “piggyback” loan.
• Under the terms of many recent loan sale agreements, investors have
right to require loan sellers to purchase early payment default loans.
• Many specialty finance lenders have lacked the funding liquidity, capital
or earnings to meet their repurchase obligations.
– Hence loan sellers have had the limited option of a forced sale,
filing for bankruptcy or gone out of business. In most cases, these
institutions were not covered by federally insured deposits.
– Therefore, the inability to enforce early payment default clauses,
led to the occurrence of significant loan losses by banks.


The problem (reasons for fall of sub
prime market)- as summarised.
• Loans sourced by brokers
• Warehoused by thinly capitalised mortgage bankers
• Insurance or CDS’s arranged- in some cases by parties which
lacked financial worth.
• Sold to investment banks, who manufactured CDO’s
• Rated by rating agencies
• Sold to institutional investors
• All income- from original sourcing to final placing was fee
income-bigger volume- the bigger the income.
• Market dealt with inexperienced & uninformed investors.

Impact of the sub prime meltdown
– Market reaction-
> Consolidation has occurred in US subprime mortgage
market as large financial institutions and investment
banks have acquired subprime mortgage originators
and servicers.
> Underwriting standards have been tightened.
> Purchasers are examining the loans more critically.
– Sub prime originations dropped by more than 30%
in first quarter of 2007.

(2)
• Impact on individual borrowers:
– Resets on variable interest rate mortgages has resulted in
greater financial hardships for borrowers when rates rose.
Tighter lending standards & a slump in housing prices have
restricted refinancing opportunities.
– If defaults occur, the sale or foreclosure of properties is
likely to result in losses due to drop in house prices.
– Property investors have often walked away from their
obligations.

(3) Impact on regulators
• Numerous hearings & enquiries but no

specific regulatory and legislative
responses to date.

The combined consequence of these
factors was:
• The higher demand resulted in a steady increase in the risk
characteristics of subprime loans;
• Incentive structures that tied lender revenue to the number of
subprime loans written made origination volume the primary
objective of some lenders;
• Subprime loans were originated and sold into the secondary
market as long as lenders could record profits from the sale of
such loans or funding from securitisation.
• As downturn in the US market combined with a rise in interest
rates reduced the number of loans written- but the demand
among mortgage lenders remained high- leading to a loosening
of underwriting standards.

Collaterised debt obligations
• CDO’s are pools of diversified assets, bonds, loans, residential

mortgages which are parceled up by investment banks and then
split into tranches of varying risk and sold on to investors.
Because the different tranches have varying credit ratings and
durations, investors choose the tranche they prefer, depending
on their risk/reward requirements.
• Effectively, it is a “fruit salad” of various forms of assets.

Example of a CDO
Overview of CDO problem
• Banks sold off their riskiest mortgages by repackaging them
into securities called collaterised debt obligations.
• The tiers were structured according to different investors
tastes. The top tier tranches which comprised 80% of bonds
would have first call on underlying cash flows and could be
sold with an AAA rating. The low tiers absorbed first dollar risks
but carried higher yields.
• This form of securitisation actually increased risks- by
transferring ownership of mortgages from bankers who knew
their customers to investors who did not.

Use of financial engineering
• Let’s construct financial instruments which appeal to a range of
investors-meeting their various risk & return demands.
• The senior slice, the AAA-rated tranche, tends to appeal to
banks and financial institutions.
– Lower down the credit rating scale, say BBB-rated
tranches and below, it is insurance companies and hedge
funds that are the major buyers, since they can pick up
increased yield compared to similarly rated bonds.

(2)
• “You buy a AA-rated corporate bond you get paid Libor plus 20
basis points; you buy a AA rated CDO and you get Libor plus
110 basis points,” says Mr O’Carroll at Fortis.
• Hedge funds have taken a more active interest in the unrated
subordinated or equity portion where the greater returns are to
be had.
• “Hedge funds are more comfortable with leverage and can be
more sophisticated in their analysis of these products. They
have the ability to hedge certain risks out, because of the level
of sophistication they have,” says Mr Powell. (in retrospect- this
represents an optimistic claim).

In Summary
• Collateralised debt obligations (CDO’s) are about yield
enhancement, and in low yielding times investors are going to
be tempted to consider new ways of increasing their fixed
income returns. CDO’s come in a range of different guises.
– CDO’s can be cash-based, where the underlying is a
portfolio of bonds, or more recently synthetic CDO’s have
emerged, which refer to a pool of derivatives, usually credit
default swaps.
– Other forms are CLO’s with reference to loans, and CBO’s
with reference to bonds.

(2)
• Starting around 2005, securitisation, enhanced by financial
engineering, became a mania. It was easy and fast to create
“synthetic securities” that mimicked the risks of real securities
but did not carry the expense of buying and assembling actual
loans.
• Risky paper could be multiplied well beyond the actual supply
in the market. Investment banks could slice up CDO’S and
repackage them into CDO’s of CDO’s, or CDO’s squared or even
CDO’s in triplicate.
• In this way , more AAA liabilities were created than there were
AAA assets. Towards the end, synthetic products accounted for
more than half the trading volume.

How CDO’s can multiply – CDO squared

How CDO’s can multiply- CDO cubed

Goldman Sach’s problems with CDO’s
• Problem one:
– Selling a CDO (Timber Wolf) which their
own managers said (as recorded on tape)
was a “sh---ty” investment.
• Problem 2:
– Alleged involvement in fraud with a hedge
fund over CDO’s sold to clients- Abacus
CDO.
Timberwolf
• Australian investors were adversely affected:

– Basis Capital, a hedge fund lost at least $56m;
– Local Government Financial Services, an
investment manager in NSW purchased triple A
rated debt for $42m & double A rated debt for
$38.6m.
> Paid $11.25m, with balance financed by
margin calls.

(2)
– Sales were structured as credit default

swaps between fund and Goldman Sachs,
with Timberwolf as referenced entity.
– The basic facts are that Goldman sold
BYAFM a bunch of AAA and AA rated CDOs
in Timberwolf. They were worthless, like
other CDOs that turned out to be fancy
names for home loans made to Americans
with no hope of repaying them.
(3)
• Meanwhile, Goldman, which had seen

problems but had not informed
investors, decided to bet against the
market by taking short positions.
• http://www.youtube.com/watch?
v=VVfGB_jvz2s&feature=related

Goldman Sachs and Abacus problems
• SEC charged Goldman Sachs with fraud

in structuring & marketing of CDO’s tied
to sub prime mortgages.
• Ultimately settled for fine of $633m.
• Goldman Sachs structured and marketed
a synthetic collaterised debt obligation
that hinged on the performance of
subprime mortgage backed securities.
(2)
• Paulson & Co hedge fund provided advice on

which securities should be included in the
portfolio. Paulson then shorted the RMBS
portfolio it had helped to create (logic/interest
conflict?) by creating credit default swaps with
Goldman Sachs to buy protection on layers of
Abacus capital structure.
• Hence, Paulson had an economic incentive to
select RMBS that it expected to experience
credit events in the future.
(3)
• These details were not advised to investors.

• Further:
– VP Fabrice Tourre mislead investors by indicating the Pauson
had invested $200m in equity (namely, they expected the fund
to grow financially) in Abascus, whereas their interest was the
opposite.
– Deal closed on 26 April 2007 & Paulson paid Goldman $15m for
structuring & marketing Abacus.
– By October 2007, 83% of portfolio had been down graded &
17% was on negative watch.
– By 29 January 2008, 99% of portfolio had been down graded.

(4)
– Investors lost more than $1b.

• The SEC case:
– The SEC is claiming Goldman Sachs made
“materially misleading statements and omissions” in
its marketing of Abacus to investors, failing to inform
them that Paulson’s hedge fund had “played a
significant role” in choosing the subprime mortgage-
backed securities underlying this CDO and that
Paulson had an incentive to pick securities that
would probably decline in value.
• ]
(5)
v=5bS6UsWKMuk
v=n9uipRLT0e4

Credit Default Swaps (CDS’s)
• The synthetic mania was not confined to mortgages and spread
to other forms of credit. By far the largest synthetic market is
constituted by credit default swaps. Early CDS’s were
customised agreements between two banks
– Bank A the swap seller agreed to pay an annual fee for a set
period to Bank B , the swap buyer, with respect to a
specific portfolio of loans.
– Bank B would commit to making good Bank A’s losses on
portfolio defaults

(2)
• In terms of volume:
– Nominal value of CDS contract
outstanding is US$42.6 trillion
• By comparison:
– US household wealth is $18.5 trillion;
– Capitalisation of US stock market is
$18.5 trillion
– US treasuries market is $4.5 trillion.
(3)
• The combination of a bond from a lesser rated company, with a
CDS from a bank or insurance company can raise the rating of
the bond.
• Hence if we wish to invest in an A rated bond, we have two
choices:
– Invest in an A rated company, or
– Invest in a lower rated company which has a supporting
CDS from at least an A rated organisation.
• This latter investment combination is termed a synthetic bond.

So what is the problem?
• How valuable is insurance-
– Writers of swaps include:
> unlicensed parties such as credit hedge funds;
> Contracts could be transferred without notification to
counterparties.
• So were synthetic bonds of value?
• Could they be marked to market to provide a liquid market?
• If the market value could not be readily determined:
– How could investors deal with values ?;
– How could quarterly profit returns be calculated?

Further
• CDS’s had allegedly been used by hedge funds to scare market
investors. The swaps are meant to be a form of insurance, so
the higher the price- the more the market thinks it is likely that
the seller will be unable to meet its side of the deal (due to pay
out probability).
• If you drive up the price of CDS’s as high as possible (1000 bp-
in case of Macquarie Bank) you are indicating to the market that
there is no trust in the company. This aids shorts!


Structured Investment Vehicles
(SIV’s).
• Investment banks carried large positions of CDO’s off balance
sheet in structured investment vehicles (SIV’s).
– The SIV’s financed their positions by issuing asset backed
commercial paper:
> This provided liquidity;
> Benefited capital adequacy ratios..
– As the value of CDO’s were questioned, the asset backed
commercial paper market dried up, & the investment banks
were forced to bail out their SIV’s. Most investment banks
took the SIV’s into their balance sheets & were forced to
recognise large losses (due in part to low value assets &
valuation problems),

(2)
• Banks had to transfer off balance sheet items on balance

sheet. They had difficulty in calculating their own
exposure to securitised instruments and even greater
difficulty in estimating the exposure of their
counterparts.
• Hence, they were reluctant to lend to each other,
preferring to hoard their liquidity.
• This explains the action of central banks in providing
liquidity to the financial system.


Freddie Mac/Fannie Mae
• These GSE’s hold or guarantee almost half of America’s US$11
trillion mortgage market.
• They also facilitated much of the MBS market as investors
believed they carried an implicit government guarantee. In fact
since 2007, the US government has used Fannie & Freddie to
increase mortgage lending to help ameliorate the effects of the
sub-prime mortgage crisis.
• Bail out proposal:
– Government to purchase US$100 billion in 10% coupon preferred
stocks in the company.
– Government will also provide funding to Fannie & Freddie
secured against MBS issued by GSEs & Federal Home Loan
Banks.
(2)
• Foreign investors began to question the credibility of Federal Reserve &
US Treasury:
– Foreign investors, including more than 60 global central banks, hold
over US$ 1,400 billion in securities in US agencies including Fannie
Mae & Freddie Mac:
> Chinese investors had US$500b of GSE debt;
> Kuwait Investment Authority (6th largest soverign wealth fund) had
recently confirmed soundness;
> “ if US government allows Fannie & Freddie to fail without
compensation------ it’s not the end of the world, it is the end of the
current financial system”.
• US$100 billion commitment equates to < 2% of US$5.4 trillion GSE
portfolio of mortgages and guarantees.

American International Group
• US government has taken 80% ownership of company.
• AIL had massive CDS exposure on its balance sheet-market
value of US$62 trillion in face value .
• AIG will pay interest at a steep 8.5 percentage points above the
three-month London Interbank Offered Rate, equal to about 11.4
per cent. That gives AIG a big incentive to embark on a massive
asset sale programme to pay back the loan quickly.
• Insurance rivals are set to jostle to pick up attractive parts of
the AIG empire, assets which include profitable aircraft leasing
arm International Lease Finance Corp (ILFC).

Next week’s test
• Incorporates “effectively” tutorial

questions from:
– Lecture 7-Capital raisings in equity markets.
– Lecture 8- International Equity Markets.
– Lecture 9- US Securities Law.
– Lecture 10- Securitisation.

Tutorial questions (to be discussed in
Week 13)
1 Define the technique of financial engineering.
2 Define the four interlinked components of the US sub prime financial crisis.
3 In terms of the sub prime crisis:
- What were the contributing factors leading to the growth in the market?
- Discuss the Community Reinvestment Act
- Describe the process of risk layering.
4 Discuss the roles of the following parties in the sub prime housing
markets, and comment on whether they may have been a contributing
factor to the problem:
- Mortgage originators;
- Mortgage brokers;
- Mortgage insurers.
- Rating agencies.
(2)
5 Explain the effects of rising home loan mortgage rates and the housing
market price slowdown on the sub prime mortgage market.
6 Define a collaterised debt obligation;
- What was the linkage between CDO’s and the sub prime housing
market?
- How did this linkage contribute to the financial crisis?
7 Define a Credit Default Swap;
8 What was the linkage between CDS’s and the sub prime housing market?
- How did this linkage contribute to the financial crisis?
9 Define a Structured Investment Vehicle.
-What was the linkage between SIV’s and the financial crisis ?

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AFF 5230

Department of Accounting and Finance Slide 2

• Reader : pp. 285-289.

Department of Accounting and Finance Slide 3

Department of Accounting and Finance Slide 4

• Financial Engineering definition: *

– * “The Business of Investment Banking”, K Thomas Liaw

Department of Accounting and Finance Slide 7

Department of Accounting and Finance Slide 8

• The US sub prime housing market;

Department of Accounting and Finance Slide 10

• Sub prime lending is a general term that refers to the

Department of Accounting and Finance Slide 12

Department of Accounting and Finance Slide 13

Department of Accounting and Finance Slide 14

• The conclusions on the effects of this

Department of Accounting and Finance Slide 16

Department of Accounting and Finance Slide 17

• The increase in securitisation of subprime loans-typically as asset

Department of Accounting and Finance Slide 18

Department of Accounting and Finance Slide 22

Department of Accounting and Finance Slide 25

• Rating agencies have been criticised on many

• In 2006, the rate of annualised increase in US housing prices slowed-

Department of Accounting and Finance Slide 28

Department of Accounting and Finance Slide 29

Department of Accounting and Finance Slide 30

Department of Accounting and Finance Slide 31

• Numerous hearings & enquiries but no

Department of Accounting and Finance Slide 32

Department of Accounting and Finance Slide 34

• CDO’s are pools of diversified assets, bonds, loans, residential

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• Australian investors were adversely affected:

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– Sales were structured as credit default

• Meanwhile, Goldman, which had seen

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• SEC charged Goldman Sachs with fraud

• Paulson & Co hedge fund provided advice on

• These details were not advised to investors.

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– Investors lost more than $1b.

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• Banks had to transfer off balance sheet items on balance

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• Incorporates “effectively” tutorial

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