financial basics and crisis explained

1. Created by: Parshwadeep Lahane Financial crisis 2008

3. Let’s start with Basics

18. Mortgage Backed Security (MBS) Source: http://www.urbandigs.com/2007/08/how_mortgage_backed_securities.html STEP 1 - A pool of mortgages are owned by a bank or lender. They are grouped into categories by credit risk including subprime, alt-a (between subprime and prime), and prime. STEP 2 - The pool of mortgages are packaged into a mortgage backed security. STEP 3 - The mortgage backed security is then sliced and diced into different classes with varying maturities (called tranches). Each tranche offers varying degrees of risk to the investor. The first loan to default will be placed into the Junk tranche while the strongest loans receive the highest credit rating of 'AAA' and are placed at the top of the tranche division. As with any asset associated with risk, the highest risk tranche receives the highest rate of return or yield while the lowest risk (AAA rated) will receive the lowest yield. STEP 4 - The tranches are then resold to investors who are willing to take on the varying degrees of risk and maturities.

21. Now we are ready to look into the mess !

26. Details : Private Sub-prime mortgage process 1. Brokers identify borrowers 2. Originator and broker identify a loan for borrower after looking at his credit rating 3. Formal application for loan by borrower 4. Originator transfers the loan to the subsidiary of an investment banking firm ( Seller) 5. Seller(Investment bank) collects a pool of loans and call it as SPE/SIV/SPV. Off balance sheet instrument 6. SPV can be a corporation, partnership or limited liability company. Most often a Trust. It has nothing else except mortgage loans 7. Underwriter purchases all the securities (derivative income streams) 8. In designing SPV and its tranches underwriter works with credit rating agencies 9. Underwriter then sells the securities to the investors 10. High rated tranches might be guaranteed by a 3rd party insurance company 11. Seller also arranges to sell the rights to service the loan pool to a company or sometimes Originator takes these rights 12. MERS – document custodian. Company to keep track of mountains of paper work on loans in the pool. At National level. Source : Subprime Mortgage Market Turmoil , testimony by Christopher L. Peterson

27. Possible inter linkage in the US subprime mortgage market Source: http://www.norges-bank.no/templates/article____66901.aspx

34. Those good old days were gone now!!

40. Subprime losses by Big Banks Worldwide :US$ 586.2 billion and still counting Source: Financial Times

42. Investments devalued across the Globe Source: BBC News, http://news.bbc.co.uk/2/hi/talking_point/7644574.stm

43. Subprime impact across globe Source: Financial Times

44. Impact of Financial crisis-felt across the globe Source: Reuters, http://www.reuters.com/news/globalcoverage/creditcrisis

45. Thanks

50. High Banks leverage ratio’s to fund MBS/CDO

51. Building up of the housing bubble

53. Starting 2006 housing bubble busted

54. LIBOR rate

55. Credit rating of complex financial instruments Source: IMF and WSJ

56. Speedy Foreclosures

57. Top 10 Bankruptcies

58. The American way of debt Source: http://www.nytimes.com/interactive/2008/07/20/business/20debt-trap.html?ei=5070

59. Average debt of American in 2004 Source: http://www.nytimes.com/interactive/2008/07/20/business/20debt-trap.html?ei=5070