Still confused about what happened?

1. The Current State of the US. Financial Market

3. What Caused the Current Financial Situation?

8. What Happened Next?

9. Trouble in the Markets: Sept 2008 Sept 14 Sept 15 Sept 16 Sept 17 Sept 18 Sept 20 Sept 29 Sept 7 Govt. takeover: Fannie Mae and Freddie Mac (1)* Lehman Brothers declare bankruptcy (3) Bank of America acquires Merrill Lynch (2) Stocks fall. Worst drop (504.5 pts) on Dow Jones since 9/11 terrorist attacks (4) Govt. Rescue AIG (5) Dow Jones fall 450 more pts. Markets around the world share confidence crisis. Russia shuts down its market (6) US Federal Reserve pumps $180 billion into money markets to combat seizing up of lending between banks (7) Govt. proposes Emergency Economic Stabilization Act: Purchase up to $700 billion in mortgage-related assets (8) Proposal rejected by the House. Dow Jones falls by 778 pts. (Biggest point-drop in history) (11) *See numbered corresponding explanations for each event on following page Sep 22 Sep 25 Morgan Stanley and Goldman Sachs become bank holding companies (9) Washington Mutual is taken over by JP Morgan Chase (10)

10. Trouble in the Markets: Oct 2008 Oct 1 Oct 3 Senate passes revised proposal (12) House approves revised proposal. President signs into law (13) *See numbered corresponding explanations for each event on following page Oct 8 Oct 10 Dow continued to fall to 8451.49 (15) Stocks rally (17) Oct 13 Oct 28 Oct 29 Oct 31 Oct 12 The Fed cut the Fed Funds rate by ½ a percentage point to 1.5% (14) The Dow Jones climbed by 889 points – its 2 nd biggest daily point surge ever (18) The Fed cut the Fed Funds rate to 1% in hopes of stimulating the economy (19) The end of October culminates the stock market’s worst month in 21 years (20) Wachovia acquired by Wells Fargo (16)

11. Trouble in the Markets: Nov 2008 Nov 10 Nov 12 Nov 13 Nov 18 Nov 20 Nov 25 Nov 4 President-elect Barak Obama elected to the White House (21) American Express received permission to become commercial bank (24) AIG rescue plan restructured (23) Continuation of oversight hearings scheduled for the House Financial Services Committee. Big Three Automakers attend congressional hearing for rescue funds (27) Henry Paulson announced change in rescue program allocations (25) New plan unveiled to pump $800 billion into financial system to unfreeze consumer credit (29) Oversight hearings scheduled for the House Financial Services Committee (26) Dow Jones Industrial Average plunged 445 points to close at 7552 (28) *See numbered corresponding explanations for each event on following page Circuit City declared bankruptcy (22)

12. Trouble in the Markets: Sept-Nov 2008 (Cont.) On September 18, the US Federal Reserve along with the European Central Bank, the Bank of England, the Bank of Canada, the Bank of Japan, and the Swiss National Bank authorized $180 billion to be pumped into money markets in order to pump more short-term liquidity into the financial system. In doing so, the Fed expanded its temporary reciprocal currency arrangements, known as swap lines, to allow banks to borrow at lower rates in money markets. (7) On September 17, the Dow Jones fell 450 more points. In addition, proving that markets around the world have been affected by the US financial crisis, Russia shut down its market after its stocks dropped to their lowest points in almost three years. (6) On September 16, the government rescued AIG by injecting $85 billion into the company for an 80% ownership stake. AIG needed this money to work through problems it had due to investments in mortgage-backed securities and credit default swaps. As AIG was deemed by the federal government to be too big to fail, this rescue was done to avert a collapse of the company, which would have likely caused further failures in the financial industry. (5) On September 15, the Dow Jones experienced its worst one-day loss (504.5 points) since the 9/11 terrorist attacks as investors reacted negatively to the news relating to Lehman Brothers and Merrill Lynch. (4) When possible buyouts by Bank of America and Barclays fell through, Lehman Brothers was forced to declare bankruptcy on September 15 as a result of its exposure to risky real estate related investments and inadequate capital. This bankruptcy was the largest bankruptcy in US history. (3) On September 14, Bank of America acquired Merrill Lynch for approximately $50 billion in an all-stock transaction. Leading up to this acquisition, Merrill Lynch had been experiencing many financial struggles due to billions of dollars of its assets being tied to mortgages that had decreased tremendously in value. (2) On September 7, the government seized control of Fannie Mae and Freddie Mac in order to protect the mortgage market from the failure of the two companies and to prevent their problems from negatively impacting the global markets. (1) Explanation Event

13. Trouble in the Markets: Sept-Nov 2008 (Cont.) On September 25, Washington Mutual was taken over by JP Morgan Chase in a deal brokered by the FDIC, making it the largest bank seizure made by the government in US history. JP Morgan Chase paid $1.9 billion for WaMu’s deposits and branches. (10) On September 22, Morgan Stanley and Goldman Sachs became bank holding companies, abandoned investment bank status, and submitted to supervision by the Federal Reserve. (9) On October 8, the Fed cut the Fed Funds rate by ½ a percentage point to 1.5% in a coordinated move with foreign central banks. (14) On October 10, after Wall Street’s worst week ever, the Dow Jones closed at 845.19, down 128.00 from the previous day. Paulsen also announced the plan to buy stocks in banks on this day. (15) On October 3, the House of Representatives approved the revised proposal in a 263-171 vote. The President signed this bill into law the same day. However, uncertainty remained in the stock markets, as the Dow Jones closed down 157 points and finished its worst week in 6 years. (13) On October 1, the Senate passed the revised proposal in a 74-25 vote. The proposal was amended to include several provisions aimed at helping individuals and businesses. These revisions to the proposal were seen as a way to “sweeten the deal” and encourage the bill’s passage. (12) On September 29, the initial Emergency Economic Stabilization Act proposal was rejected by the House of Representatives in a 205-228 vote. It needed 218 votes to pass. In reaction to the failed proposal, the Dow Jones fell by 778 points, the biggest point-drop in history. (11) On September 20, the government proposed the Emergency Economic Stabilization Act. The purpose of this act, which authorized the US Treasury to spend up to $700 billion to purchase distressed assets, was to purchase bad assets, reduce uncertainty regarding the worth of remaining assets and restore confidence in the credit markets. (8) Explanation Event

14. Trouble in the Markets: Sept-Nov 2008 (Cont.) On October 12, Wachovia was acquired by Wells Fargo in a $15.1 billion all-stock deal. This deal was done without the need for government assistance and government assistance was not part of the deal’s terms. (16) On October 13, the stock market rallied after a series of global initiatives were announced over the past few days to lessen the credit crisis. The Federal Reserve removed currency swap limits with the Bank of England, the European Central Bank, and the Swiss National Bank so that it could supply an unlimited amount of dollar liquidity to these central banks. The Dow Jones closed 936 points higher at 9,387.61. This was the Dow’s largest ever point-gain during a session and was equal to an increase of 11.1%, the best one-day percentage gain since 1932. (17) On November 4, democratic President-elect Barak Obama was elected to the White House with 365 electoral votes and 53% of the popular vote (21) October concluded as the worst month for the Standard & Poor’s index of 500 stocks in 21 years, down 16.9% for the month. The Dow Jones Industrial Average and Nasdaq both also experienced a volatile month, decreasing 14.1% and 17.4%, respectively, through October 31. However, the final week of October was the best week for the market in 34 years. Additionally, the oil market experienced its worst month since oil futures began trading in 1983, falling 33 percent. (20) On October 29, the Fed cut the Fed Funds bank rate to 1% in hopes of stimulating the economy. This rate is the interest that banks charge on overnight loans. A rate this low was last seen in 2003-2004. The rate has not been lower since 1958. The Fed also cut its discount rate, the rate is charges banks for short term loans, to 1.25% (19) On October 28, the Dow Jones experienced its 2 nd biggest daily point surge ever. The Dow Jones climbed by 889 points in anticipation of the Fed’s upcoming rate actions. (18) Explanation Event

15. Trouble in the Markets: Sept-Nov 2008 (Cont.) On November 10, Circuit City declared bankruptcy and filed for Chapter 11. Its need for bankruptcy protection was due to several reasons, including the difficult competitive landscape, backlash from its decision last year to fire higher-paid sales staff and replace them with lower-paid sales staff, and the impact of the economic downturn which left its consumers with less money to shop. (22) On November 10, AIG received a reworked $152.5 billion deal from the federal government, with significant changes made to its initial rescue plan. The Fed reduced AIG’s original $85 million bridge loan to $60 billion, cut the interest rate by 5.5 percentage points, and agreed to provide $52.5 billion to set up two investment pools with AIG, replacing the additional Fed loans made to AIG in October. The Treasury will also purchase $40 billion in preferred stock. (23) At the November 13 hearings, the banking committee heard testimony from executives of Bank of America, Goldman Sachs, JP Morgan Chase, and Wells Fargo on how the companies are using the funds they received as part of the rescue plan. (26) On November 10, the Federal Reserve bypassed the normal 30-day waiting period and approved American Express’ request to become a commercial bank. This new status gives both American Express and its affiliate American Express Travel Related Services access to the Federal Reserve’s emergency-lending facilities. (24) On November 12, Treasury Secretary Henry Paulson announced that the rescue plan’s $700 billion would not be used to purchase troubled assets as originally planned. Instead, he said the plan would continue to use $250 billion to purchase stock in banks to encourage them to resume normal lending. Paulson also said that the program should support financial markets which supply consumer credit in areas such as credit card debt, student loans and auto loans. (25) Explanation Event

16. Trouble in the Markets: Sept-Nov 2008 (Cont.) At the November 18 hearings, the House Financial Services Committee continued to discuss oversight of the $700 billion rescue plan. At the congressional hearings involving the Big Three automakers, congress abandoned its vote on the $25 million in government loans that the automakers were seeking in order to help them survive the worst sales environment in more than 25 years. Instead, congress has required the Big Three to have restructuring plans ready to present by December 2 in order to help determine the aid to be provided. (27) On November 25, Treasury Secretary unveiled new programs to pump $800 billion into the US financial system to unfreeze the markets for consumer debt, such as credit cards, auto loans, and student loans. (29) On November 20, the Dow Jones Industrial Average plunged 445 points (5.6%) to close at 7,552, down 43% from its high in October 2007. This was the first time that the Dow closed below 8,000 since March 2003. (28) Explanation Event

17. The Rescue of Fannie Mae and Freddie Mac

27. The Rescue of the US Financial System

32. A Simple Way to Look at It: The Making of the Current Situation (cont.) Investment banks (in addition to the GSEs, Fannie and Freddie) created investments called mortgage-backed securities (MBS), which are a collection of individual mortgages that are bought from mortgage lenders and bundled together. The Collateralized Debt Obligation (CDO) market also utilized mortgage-backed securities by “slicing” collections of these MBS into tranches to be sold to investors. Shares of MBSs and CDOs were sold to investors so that they could receive a portion of the monthly mortgage income. Fannie Mae and Freddie Mac functioned in the secondary mortgage market by purchasing mortgages from lenders. In purchasing these mortgages, Fannie and Freddie provided lenders with both the funds to lend to home buyers and to originate more mortgages. However, as home prices fell, foreclosures went up and, like lenders, Fannie and Freddie ran into trouble. Loans that the GSEs had backed went bad, capital became harder to come by and it was harder for Fannie and Freddie to sell their loan packages. In order to remain increase revenue and remain competitive, mortgage brokers needed to acquire more customers. So, they began to offer loans to people who were not qualified. In addition, because banks could sell their mortgages on the secondary market to Fannie Mae and Freddie Mac, they were not particularly concerned with the credit-worthiness of potential homebuyers. Buyer demand increased as underwriting standards loosened (in 1999), interest rates decreased, and the home values rapidly appreciated. As a result, the pool of potential homebuyers expanded from normal qualified homebuyers and investors to include those people who would have previously not qualified for mortgages (subprime potential homebuyers) and speculative investors.

33. A Simple Way to Look at It: The Making of the Current Situation (cont.) When the subprime market began to collapse, home mortgage borrowers began to default on their payments, and the value of the mortgage portfolio investments began to decline. As a result, investors began to accumulate huge losses. Financial institutions began to be afraid to deal with one another because they did not know who was able to make good on debt obligations and who wasn’t. As a result, investors reduced their purchasing of short-term bonds (commercial paper) and instead began investing in stable Treasury bills. The lack of commercial paper being purchased began to freeze the credit market. Everyone will be impacted by the frozen credit markets if banks continue to not lend to one another. If the credit market remains frozen, there will not be enough credit available for businesses and individual consumers. Businesses will need to begin to cut costs back to avoid bankruptcy if they don’t have access to short-term borrowing. Day-to-day expenses such as projects and payroll will be affected. Individual consumers will experience difficulty in receiving loans necessary for purchasing homes, cars, college, and other items. The major credit-rating agencies , Moody’s, Standard and Poor’s and Fitch, assign credit ratings for debt obligations, such as the mortgage-backed securities (MBS). They gave the majority of MBS investments AAA ratings, which indicated that the investments were safe, even though they contained high-risk, subprime mortgages. There are a couple of reasons that these MBS investments incorrectly received excellent ratings from the rating agencies. First, rating agencies are paid by the firms that organize and sell the debt being rated to investors, which critics say created a conflict of interest. Second, the rating agencies were using historical data on subprime mortgages to rate the MBSs, which was, in fact, irrelevant data because it didn’t take the current relaxed qualification standards and unqualified borrowers into consideration.

34. What do the Experts Think of the Current Financial Situation?

42. Foreshadowing: What did the Experts Think of the Economy Before the Current Financial Situation?

49. "The budget should be balanced, the Treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands should be curtailed, lest Rome become bankrupt..." -- Cicero , 55 BC

50. Appendix

51. Glossary of Terms This term describes how easily an asset is converted into cash. Liquidity This term describes those loans that are lent to high-risk borrowers: those borrowers with weak credit or who cannot prove their income. Subprime An instrument representing financial value. Securities can take the form of ownership (stocks), a debt agreement (bonds), or the right to ownership (derivatives). Both stocks and bonds are securities. Security National accounting standards that mandate that publicly traded financial companies must report some of their assets (ex. mortgage-backed securities) and liabilities (ex. money that they’ve borrowed from other institutions) at marked-to-market values. This means that companies assigning values to held assets must value them at current market value levels rather than at book value. Mark-to-Market Accounting Rules An unregulated type of asset-backed security and structured credit product. A CDO is constructed from a portfolio of fixed-income assets and is meant to create tiered cash flows from mortgages and other debt obligations that ultimately make the entire cost of lending cheaper for the aggregate economy. Collateralized Debt Obligation (CDO) A swap designed to transfer the credit exposure of fixed income products between parties so that the risk of default is transferred from the holder of the security to the seller of the swap. The buyer of the credit swap receives credit protection; the seller of the swap guarantees the product’s credit worthiness. Credit Default Swap (CDS) A financial indicator that assesses the credit worthiness of risk of debt securities (such as bonds) for potential investors. The ratings are assigned by credit rating agencies (such as Standard & Poor’s, Moody’s, and Fitch) and have letter designations such as AAA, B, CC. Credit Rating A long-term debt sold to investors with the purpose of raising capital by borrowing. A bond is a promise to repay the principal along with interest on a specified date. Bonds can be issued by the federal government, states, cities, corporations, and other types of institutions. Bond Definition Term

52. Wall Street's stock has dropped in world's eyes September 30, 2008 By Adam Shell NEW YORK — Wall Street didn't just lose hundreds of billions of dollars in the current financial crisis. It lost its good name, too. It has long been viewed as the triple-A-rated center of the financial world, a trusted place to invest, and a role model for emerging financial centers around the globe. But that was before Wall Street banks emerged as the central villains in the biggest financial crisis since the Great Depression. Before the exotic securities backed by risky mortgages that they created — and peddled around the world to investors — plunged sharply in value, causing economic mayhem. Before banks, insurers and mortgage companies started to fail at an alarming rate. And, most important, before the Bush administration sought — and so far has failed to get — a $700 billion Wall Street bailout to avoid a 1930s-style economic collapse. As a result, Wall Street's image has taken a major hit. People don't think as highly about Wall Street as they once did. "People have long looked up to the U.S. financial system as a paragon of sophistication and efficiency, but now they realize that it is a false illusion," says Michael Panzner, author of Financial Armageddon and an upcoming book, When Giants Fall: An Economic Roadmap for the End of the American Era . "Wall Street as the center of finance is losing its place in the world.“ Wall Street's reputation has suffered "a big black eye" that is not likely to fade from world view anytime soon, says Vanguard Group founder and ex-CEO John Bogle. "This is a financial crisis brought on by Wall Street greed," says Bogle, who in November will release a book, Enough , which takes aim at Wall Street. "This has been the most speculative period in financial market history." This isn't the first time in recent history that Wall Street, driven in large part by greed and multimillion-dollar paydays, has acted badly and put its reputation at risk. In the late 1990s analysts were slapping buy ratings on Internet stocks while badmouthing the companies in private. Earlier this decade, accountants and top executives at some Fortune 500 companies were caught cooking the books, and several mutual funds were caught profiting at the expense of their shareholders.

53. Wall Street's stock has dropped in world's eyes (cont.) September 30, 2008 By Adam Shell But the public relations fallout this time is far more serious: Wall Street's misdeeds have rocked the foundation of the U.S. and global financial system to its core. U.S. financial markets have been put on the brink of failure, shining an unflattering light on our free-market system. Fear of a systemic meltdown has wiped out $3.6 trillion in stock market value this year and knocked the Dow Jones industrials down 18.2%. Customers leave when trust is lost It's one thing to have tech stocks crash. Or put a crooked CEO behind bars for fraud. Or kick an unsavory analyst out of the business for hyping stocks. It's quite another to put the entire system at risk, says Axel Merk, president and portfolio manager at Merk Investments. "In the tech-stock bust, the system worked as it was designed," he says. "Checks and balances were in place. You had some business failures, but the financial system did not fail.“ Sydney Finkelstein, a professor of management at the Tuck School of Business at Dartmouth College, says the shocking failure of once-vaunted investment banks Bear Stearns and Lehman Bros. shows just how important reputation, image and confidence is to the healthy functioning of financial markets. Both firms were undone by customers who stopped doing business with them after losing faith in the firms' ability to make good on trades and debts. "What are these companies? Their assets are their people, reputation and expertise. And these are not things you can sell in times of trouble," Finkelstein says. Finkelstein thinks the current mess tops all other Wall Street crises of recent vintage, including the dot-com meltdown and the savings-and-loan crisis of the late 1980s. The reason: Wall Street's massive losing trade on real estate loans has created a level of uncertainty and economic instability that is unparalleled in modern financial history. It also put Main Street at risk. "Nobody expected it, and nobody knows what is going to happen next," Finkelstein says.

54. Wall Street's stock has dropped in world's eyes (cont.) September 30, 2008 By Adam Shell When controlled, greed is good Main Street investors are livid with Wall Street for putting their financial lives in peril. "Wall Street knew what the risk was but did not care," says Lindsey McMahon, a Florida-based real estate agent. "I have lost faith. We need to take the bull by the horns and fix the situation, fire all the people in position of authority, eliminate golden handshakes. It will take a lot of real work to earn back respect.“ Adds Matt Korol, a 53-year-old information technology manager from Seattle: "The financial system is more closely related to a Ponzi scheme than to something that is inherently trustworthy. Greed is ultimately what makes markets work. We can't legislate greed out of existence, but we can put appropriate controls in place to make sure that markets do not get too skewed by the excesses.“ But Wall Street isn't the only villain, says former Securities and Exchange Commission chairman Arthur Levitt. Regulators, lawmakers, the Federal Reserve and the Treasury Department all share blame for not keeping a closer eye on banks and brokerages and for allowing the proliferation of opaque and complex credit instruments brandishing exotic acronyms like CDOs, CMOs and CDSs. "Our system has been badly regulated and poorly overseen," Levitt says. "The U.S. regulatory system has got to change dramatically. People tend to fear what they don't understand and what is hidden from them, and a vast portion of the market is totally hidden from public investors. We have to know what the derivatives markets are doing, who owns what positions, what the hedge funds are doing.“ Wall Street's global standing suffers A big repercussion of Wall Street's fall from grace is its tainted prestige with foreign investors. Foreigners who once looked up to Wall Street and mimicked its investment principles and techniques now question whether that is a wise approach, says Sung Won Sohn, an economics professor at California State University. "Now they are saying, 'What can we do different? We don't want to be another Wall Street.' “

55. Wall Street's stock has dropped in world's eyes (cont.) September 30, 2008 By Adam Shell Wall Street's global standing suffers A big repercussion of Wall Street's fall from grace is its tainted prestige with foreign investors. Foreigners who once looked up to Wall Street and mimicked its investment principles and techniques now question whether that is a wise approach, says Sung Won Sohn, an economics professor at California State University. "Now they are saying, 'What can we do different? We don't want to be another Wall Street.' “ Many think Wall Street has lost the power and prestige it used to command. "It is going to be many years before international investors regain their confidence in Wall Street," Sohn says. Adds veteran Wall Street strategist Barton Biggs of hedge fund Traxis Partners, currently in Europe meeting with investors: "It is shocking the level of disillusionment with Wall Street." He says it could take five to 10 years to restore trust. If investors around the world no longer see the U.S. model as the only way to run markets, it could foster a new era of more independent thinking and speed the rise of new financial capitals around the globe, says Peter Schiff, president of Euro Pacific Capital. "Wall Street risks losing its prominence to foreigners just like the auto and textile industries did," Schiff says. "More deals will take place … in places like Hong Kong, Dubai, Shanghai and London. More and more companies will list their shares on other stock markets.“ Despite its black eye, there is still hope that Wall Street can repair its tattered image. Earning back the trust of investors at home and around the world can be done, but it takes time, says Muriel Siebert, the first woman to own a seat on the New York Stock Exchange and president of brokerage Muriel Siebert & Co. "There will be a period where we have to go out and prove ourselves. And after the sale of Merrill Lynch to Bank of America, and Lehman going broke, that will take time. You just can't change a name on a firm's door and have everybody say, 'New name, new firm. I trust them.' “

56. Wall Street's stock has dropped in world's eyes (cont.) September 30, 2008 By Adam Shell Bogle rattles off three quick fixes: "We need more simplicity and less complexity. We need more investing and less speculation. We need more value and less cost.“ Byron Wien, a veteran Wall Street strategist and current chief investment strategist at hedge fund Pequot Capital Management, also believes confidence in Wall Street will be restored. We'll get through this mess Sure taxpayers and Main Street feel offended that Congress will have to bail out "Wall Street's so-called fat cats," he says. But the sense of crisis will pass if Congress passes a rescue plan that stabilizes markets and restores a sense of financial well-being to Main Street, Wien says. Wall Street survived the '87 crash, the near meltdown of hedge fund Long Term Capital Management in 1998, the tech stock crash and 9/11, Wien says. "Memories are short. We have recovered from every previous calamity. This is a serious situation, but not life-threatening.“ A successful bailout package is key, Wien says. In addition, excessive use of debt must continue to come down, and the economy must skirt a serious recession. "If all those things happen, we are on the road to re-establishing our prestige." Betting aggressively against a resurgence of U.S. economic might is a bad idea, says Scott Black, president of Delphi Management. "We are still the lynchpin of the free-enterprise system around the world. Everyone has an inherent vested interest in the U.S. doing well.“ Don't count out the American people, either, he says. "This country was built by people who said, 'I can,' not 'I can't.' Our entrepreneurial spirit has not been extinguished by this latest crisis."

57. Fannie Mae Eases Credit To Aid Mortgage Lending In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders. The action, which will begin as a pilot program involving 24 banks in 15 markets -- including the New York metropolitan region -- will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring. Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits. In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans. ''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.'' Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market. In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's. ''From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison a resident fellow at the American Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.'' (Continued on following page) September 30, 1999 By Steven A. Holmes

58. Fannie Mae Eases Credit To Aid Mortgage Lending (Continued) Under Fannie Mae's pilot program, consumers who qualify can secure a mortgage with an interest rate one percentage point above that of a conventional, 30-year fixed rate mortgage of less than $240,000 -- a rate that currently averages about 7.76 per cent. If the borrower makes his or her monthly payments on time for two years, the one percentage point premium is dropped. Fannie Mae, the nation's biggest underwriter of home mortgages, does not lend money directly to consumers. Instead, it purchases loans that banks make on what is called the secondary market. By expanding the type of loans that it will buy, Fannie Mae is hoping to spur banks to make more loans to people with less-than-stellar credit ratings. Fannie Mae officials stress that the new mortgages will be extended to all potential borrowers who can qualify for a mortgage. But they add that the move is intended in part to increase the number of minority and low income home owners who tend to have worse credit ratings than non-Hispanic whites. Home ownership has, in fact, exploded among minorities during the economic boom of the 1990's. The number of mortgages extended to Hispanic applicants jumped by 87.2 per cent from 1993 to 1998, according to Harvard University's Joint Center for Housing Studies. During that same period the number of African Americans who got mortgages to buy a home increased by 71.9 per cent and the number of Asian Americans by 46.3 per cent. In contrast, the number of non-Hispanic whites who received loans for homes increased by 31.2 per cent. Despite these gains, home ownership rates for minorities continue to lag behind non-Hispanic whites, in part because blacks and Hispanics in particular tend to have on average worse credit ratings. In July, the Department of Housing and Urban Development proposed that by the year 2001, 50 percent of Fannie Mae's and Freddie Mac's portfolio be made up of loans to low and moderate-income borrowers. Last year, 44 percent of the loans Fannie Mae purchased were from these groups. The change in policy also comes at the same time that HUD is investigating allegations of racial discrimination in the automated underwriting systems used by Fannie Mae and Freddie Mac to determine the credit-worthiness of credit applicants. September 30, 1999 By Steven A. Holmes

59. Can’t Grasp Credit Crisis? Join the Club March 19, 2008 By David Leonhardt Raise your hand if you don’t quite understand this whole financial crisis. It has been going on for seven months now, and many people probably feel as if they should understand it. But they don’t, not really. The part about the housing crash seems simple enough. With banks whispering sweet encouragement, people bought homes they couldn’t afford, and now they are falling behind on their mortgages. But the overwhelming majority of homeowners are doing just fine. So how is it that a mess concentrated in one part of the mortgage business — subprime loans — has frozen the credit markets, sent stock markets gyrating, caused the collapse of Bear Stearns, left the economy on the brink of the worst recession in a generation and forced the Federal Reserve to take its boldest action since the Depression? I’m here to urge you not to feel sheepish. This may not be entirely comforting, but your confusion is shared by many people who are in the middle of the crisis. “ We’re exposing parts of the capital markets that most of us had never heard of,” Ethan Harris, a top Lehman Brothers economist, said last week. Robert Rubin, the former Treasury secretary and current Citigroup executive, has said that he hadn’t heard of “liquidity puts,” an obscure kind of financial contract, until they started causing big problems for Citigroup. I spent a good part of the last few days calling people on Wall Street and in the government to ask one question, “Can you try to explain this to me?” When they finished, I often had a highly sophisticated follow-up question: “Can you try again?” I emerged thinking that all the uncertainty has created a panic that is partly unfounded. That said, the crisis isn’t close to ending, either. Ben Bernanke, the Federal Reserve chairman, won’t be able to wave a magic wand and make everything better, no matter how many more times he cuts rates. As Mr. Bernanke himself has suggested, the only thing that will end the crisis is the end of the housing bust. So let’s go back to the beginning of the boom. It really started in 1998, when large numbers of people decided that real estate, which still hadn’t recovered from the early 1990s slump, had become a bargain. At the same time, Wall Street was making it easier for buyers to get loans. It was transforming the mortgage business from a local one, centered around banks, to a global one, in which investors from almost anywhere could pool money to lend.

60. Can’t Grasp Credit Crisis? Join the Club (cont.) March 19, 2008 By David Leonhardt The new competition brought down mortgage fees and spurred some useful innovation. Why, after all, should someone who knows that she’s going to move after just a few years have no choice but to take out a 30-year fixed-rate mortgage? As is often the case with innovations, though, there was soon too much of a good thing. Those same global investors, flush with cash from Asia’s boom or rising oil prices, demanded good returns. Wall Street had an answer: subprime mortgages. Because these loans go to people stretching to afford a house, they come with higher interest rates — even if they’re disguised by low initial rates — and thus higher returns. The mortgages were then sliced into pieces and bundled into investments, often known as collateralized debt obligations, or C.D.O.’s (a term that appeared in this newspaper only three times before 2005, but almost every week since last summer). Once bundled, different types of mortgages could be sold to different groups of investors. Investors then goosed their returns through leverage, the oldest strategy around. They made $100 million bets with only $1 million of their own money and $99 million in debt. If the value of the investment rose to just $101 million, the investors would double their money. Home buyers did the same thing, by putting little money down on new houses, notes Mark Zandi of Moody’s Economy.com. The Fed under Alan Greenspan helped make it all possible, sharply reducing interest rates, to prevent a double-dip recession after the technology bust of 2000, and then keeping them low for several years. All these investments, of course, were highly risky. Higher returns almost always come with greater risk. But people — by “people,” I’m referring here to Mr. Greenspan, Mr. Bernanke, the top executives of almost every Wall Street firm and a majority of American homeowners — decided that the usual rules didn’t apply because home prices nationwide had never fallen before. Based on that idea, prices rose ever higher — so high, says Robert Barbera of ITG, an investment firm, that they were destined to fall. It was a self-defeating prophecy. And it largely explains why the mortgage mess has had such ripple effects. The American home seemed like such a sure bet that a huge portion of the global financial system ended up owning a piece of it. Last summer, many policy makers were hoping that the crisis wouldn’t spread to traditional banks, like Citibank, because they had sold off the underlying mortgages to investors. But it turned out that many banks had also sold complex insurance policies on the mortgage debt. That left them on the hook when homeowners who had taken out a wishful-thinking mortgage could no longer get out of it by flipping their house for a profit.

61. Can’t Grasp Credit Crisis? Join the Club (cont.) March 19, 2008 By David Leonhardt Many of these bets were not huge, but were so highly leveraged that any losses became magnified. If that $100 million investment I described above were to lose just $1 million of its value, the investor who put up only $1 million would lose everything. That’s why a hedge fund associated with the prestigious Carlyle Group collapsed last week. “ If anything goes awry, these dominos fall very fast,” said Charles R. Morris, a former banker who tells the story of the crisis in a new book, “The Trillion Dollar Meltdown.” This toxic combination — the ubiquity of bad investments and their potential to mushroom — has shocked Wall Street into a state of deep conservatism. The soundness of any investment firm depends largely on other firms having confidence that it has real assets standing behind its bets. So firms are now hoarding cash instead of lending it, until they understand how bad the housing crash will become and how exposed to it they are. Any institution that seems to have a high-risk portfolio, regardless of whether it has enough assets to support the portfolio, faces the double whammy of investors demanding their money back and lenders shutting the door in their face. Goodbye, Bear Stearns. The conservatism has gone so far that it’s affecting many solid would-be borrowers, which, in turn, is hurting the broader economy and aggravating Wall Streets fears. A recession could cause credit card loans and other forms of debt, some of which were also based on overexuberance, to start going bad as well. Many economists, on the right and the left, now argue that the only solution is for the federal government to step in and buy some of the unwanted debt, as the Fed began doing last weekend. This is called a bailout, and there is no doubt that giving a handout to Wall Street lenders or foolish home buyers — as opposed to, say, laid-off factory workers — is deeply distasteful. At this point, though, the alternative may be worse. Bubbles lead to busts. Busts lead to panics. And panics can lead to long, deep economic downturns, which is why the Fed has been taking unprecedented actions to restore confidence. “ You say, my goodness, how could subprime mortgage loans take out the whole global financial system?” Mr. Zandi said. “That’s how.”

62. Subprime and Alt A Mortgages Increased Dramatically