Global History of the Great Recession

Automatic stabilizers

Automatic stabilizers offset fluctuations in economic activity without direct intervention by policymakers. When incomes are high, tax liabilities rise and eligibility for government benefits falls, without any change in the tax code or other legislation. Conversely, when incomes slip, the tax liabilities drop and more families become eligible for government transfer programs, such as food stamps and unemployment insurance that help buttress their income.

Mortgage backed security (MBS)

A collection of mortgaged pooled and packaged into derivatives (unsecured, mezzanine, secured). They can be issued with "private labels" by investment banks, or by government agency such as Fannie Mae and Freddic Mac. The structure is "pass-through", meaning the interest and principle payment pass through it to the MBS holder. The shares of subprime MBSs issued are not identical but in tranches, *different in priority and quality*, giving them different levels of risk and reward. The lower priority, higher-interest tranches are often repackaged and resold as collateralized debt obligations (CDO). It can be residential (single-family) or commercial (multi-family). The value of MBS decrease over time, valued by "factor", the percentage of the original "face" that is to be repaid. Started issuing in the 70s and 80s, which is also why defaults peaked in early 2000s when interest rate peaked.

The impossible Trinity (trilemma)

A concept in international economics that it is impossible to have all three: 1) fixed exchange rate 2) free capital flow 3) sovereign monetary policy. Before 2008 crisis, U.S had a fixed exchange rate and free capital flow, which meant they could not have sovereign monetary policy to control their trade deficit and dollar currency. It was too widely used for their fiscal policy to actually show an effect within the country.

Haircut

A haircut is a premium that a lender deducts from the value of collateral in order to account for the risk of a fall in the collateral's value. Haircuts are an important concept in understanding banks' short-term funding from repo markets. In a repo funding transaction, a bank lends out an asset in exchange for cash funding, with a promise to repurchase the asset at a later date. The asset serves as collateral in case the bank does not repay the counterparty. The counterparty deducts a haircut from the amount of cash it extends to the bank. This haircut provides the counterparty a financial cushion to protect against the risk that the collateral's value will decline. During the financial crisis, investment banks relied heavily on repo markets for short-term funding. Banks such as Lehman used the short-term funds to purchase longer-term investments, profiting off of the spread between assets of shorter and longer-term maturity. With mortgage-backed securities (MBS) and other securitized products frequently used as collateral in such repo markets, investors began to demand larger haircuts as stress in MBS became increasingly evident. The result is that average repo haircut rates for securitized products skyrocketed from nearly 0% to about 45% between July 2007 and November 2008. By raising borrowing costs sufficiently that banks had difficulty servicing their liabilities, the spike in haircuts was integral to bringing investments banks to (or over) the edge of bankruptcy during the crisis. A thorough overview of repo markets and the role elevated haircuts played in exacerbating the crisis can be found in the Gorton and Metrick paper (Section 2 readings).

Special Purpose Vehicle (SPV) `

A legal entity created to fulfill specific, narrow or temporary objectives. Usually used by firms to isolate the company from financial risks.

Twin deficit anomoly

A macroeconomic proposition that there is a strong link between a national economy's current account balance(trade deficit) and its government budget imbalance. In the early stages before the crisis, people were overly worried about the twin deficit going up. The Cold War mentality generates a lot of fear towards the Chinese holding of U.S. debt and the trade deficit. Although later it turned out to be a different crisis.

Commercial Paper

A money market security issued by large corporations to obtain funds to meet short term obligations such as payrolls. Because it is not backed by asset, only large company with excellent credit ratings are able to issue these papers. It is a promise to pay back money in the future, usually no longer than 6 months. They are usually sold at a discount from face value.

Great Moderation

A reduction in the volatility of business cycle fluctuations starting in the mid-1980s, believed at that time to be permanent, and to have been caused by institutional and structural changes in developed nations in the later part of the twentieth century.

Asset-backed Security (ABS)

A security whose value is derived from and thus collateralized (backed) by its underlying assets. Usually the assets are iliquid and small to be sold individually (student loans, auto loans, credit card loans etc.). By pooling them together diversifies and lowers the risk, also make it more attractive to general investors. Usually carried out by SPVs.

Collateralized Debt Obligations (CDO)

A type of ABS. Can be thought of as a promise to pay investors in a prescribed sequence, based on the tranches. *when the CDO market expands in late 2006 and 2007, the collateral become not mortgages, but recycled lower tranches from other MBS, whose asset is mostly subprime loans.

Collateralized Mortgage Obligation (CMO)

A type of securities that repackages and directs the payment of principal and interest from a collateral pool to different types and maturities of securities. CMO is not owned by the institution creating and operating the entity. The entity is an independent legal owner of mortgages called a pool. Investors in CMOs are usually banks, hedge funds, insurance agencies, pension funds, central banks etc.

ABCP

Asset backed commercial papers, issued by investment banks such as Lehmann and Deutchbank using SIVs that keep the illiquid long-term asset such as mortgages off their balance sheet and borrow money short term to make money off the difference between long-term and short-term interest rate. This keeps the European involvement in the US market invisible and creates the illusion that the subprime loan crisis is an American crisis when it is really a global one.

AIG - American International Group.

AIG is an insurance corporation that got caught up in the financial crisis and had to be bailed out. Before the crisis AIG realized that it could make a lot of money by insuring the CDOs through a CDS (Credit Default Swap). They believed that a CDO was never going to default and so they would not have to cover the losses. They essentially were taking the risk that the housing market was only going to go up. Therefore when other companies - like Goldman Sachs- were buying CDOs, they also got CDSs in order to maintain a certain level of balance, AIG was only being the one's to insure. They never had a way to counteract their losses. But, they were making so much money so they kept doing this. When the financial crisis hit, AIG suffered huge losses and were at risk of insolvency. Therefore, the government bailed them out. Why? Because AIG was considered too big to fail. They were invested in and insured by too many pension funds, hedge funds and banks to be allowed to fail. So many banks had their CDOs insured by AIG that those banks would lose millions causing even more problems.

Bretton Woods system

After the 1944 Bretton-Woods agreement, U.S., Canada, Western Europe, Australia and Japan agree to tie their currency to the gold standard and the ability of the IMF to bridge temporary imbalance of payments. Cancelled by Nixon in 1971. It means that the global currency system which uses dollar as the reserve currency suddenly become free-floating, creating problems of power balance in the Europe which eventually will lead to the establishment of EU.

Other national leaders during the Crisis

Angela Merkel: German Chancellor, Nicolas Sarkorzy: French president

Counter-cyclical Stimulus

Government should expand when the ecnomy is in recession.

global savings glut

Before the crisis, even though Fed raised short-term interest rate a lot, long term U.S. treasury interest rate was still going down. Because usually mortgage IR is slightly higher but connected to the Treasuring IR, this has a huge booming effect on the housing market. Bernanke explained this phenonmenon as a global savings glut, in which emerging countries like China has a lot of incentives to put their money in the U.S., because it is the most powerful and stable economy which is obligated to pay back their debt by law, and have good interest rate, and are headed by people like Rubin who is really concerned with balance their deficit.

Gordon Brown

British Prime minister 2007-2010.

Paul Volcker

Chairman of Economic Recovery

Ben Bernanke

Chairman of Federal Reserve from 2006-2014. Ben Bernanke is an American economist who was Chairman of the Federal Reserve from 2006 to 2014 during which he oversaw the Fed's response to the crisis. He oversaw unorthodox measures, the Fed lowered its interest rate from 5.25% to 0% within a year. The Fed also initiated Quantitative Easing, creating 1.3 billion USD which was used to buy financial assets from banks and from the government. He proposed "global savings glut" The larger significance of his role in crisis relates to the moral hazard of bailing as well as the extent of government involvemen

Christina Romer

Christina Romer is the former Chairwoman of the Council of Economic Advisors early in the administration of Barack Obama. Romer's deep body of work on the Great Depression prompted the Obama transition team to offer her the position of CEA Chair in November 2008. In late 2008, Romer, National Economic Council Chair Larry Summers, and Office of Management and Budget Director Peter Orszag presented President-elect Obama with a stimulus package that would address financial institutions, major automakers, and the foreclosure crisis. Ultimately, in mid-December 2008, Obama and his economic team settled on a proposed stimulus package of around $800 billion. What initially went undocumented however, was Romer's frustration at her inability to include an even larger stimulus option of $1.7 - to - $1.8 trillion in the final memo that the team presented to Obama. Though Summers agreed with Romer's conclusion that a larger stimulus package would only be beneficial in filling the output gap, he also knew that Congress would never pass a stimulus package north of $1 trillion and that such a proposal would only make the economists appear out of touch in the eyes of Obama and his top political advisors. In a purely political move, Summers blocked the inclusion of any proposal above $1 trillion, leading Obama to believe he was choosing the "larger" package of $800 billion (compared to the other basic choice of $600 billion), despite Romer's calculation that the final package should have been at least $1 trillion larger.

International Monetary Fund

Created during the Bretton Woods conference in 1944, the IMF is an international organization dedicated to monitoring the global financial system, providing assistance to governments through loans, and developing new infrastructure for banking and governing. During the subprime mortgage crisis, Eastern European countries were subject to IMF assistance because of their inability to secure further lending. For whatever reason, no swap lines were extended to the Eastern European countries and they received no help from the EU nor the ECB. The IMF also provided over 110 billion euros in bailout money for Greece in 2010.

CDS

Credit-default Swap. Companies like AIG with high credit rating write credit default swaps, basically insuring the debt in exchange for a small premium. People who buy those CDS are often pension funds, charity etc. to lend lend to corporations (buy securities). AIG had high ratings, so when they insure a lower grade security/bond (MBS) for example, pension funds and public funds could invest in those. **it draws another big company into the crisis** In the years leading up to the crisis insurance issuers such as AIG began selling credit default swaps on many of the mortgage backed securities that would ultimately play such a large role in the crisis. In September of 2008, as the MBS market continued to decline, investors recognized that as the MBSs failed, AIG would fail as well since it was insuring them, and began making collateral calls. In the wake of these events, AIG would ultimately need to be one of the institutions bailed out by the federal government.

Dodd-Frank Act

Dodd-Frank Wall Street Reform and Consumer Protection introduced by Barney Frank and Chris Dodd in the Treasury. It made changes in the American financial regulatory environment that affected all federal financial regulatory agencies and almost every part of the nation's financial services industry.

Financial Services Modernization Act of 1999

Ends the Glass-Steagall Act of banking regulations from the New Deal. Regulatory arbitrage between London and Wall Street is key. It is basically an act to compete for the financial center with London.

Swap lines

European banks can give U.S bank euros in exchange for dollars, and trade back their currency after a designated amount of time. It is a measure little-known by the public to counter the European shortage of dollars for the Fed to protect more fire sale in the U.S by European banks.

Maiden Lane II

Fed creates an SPV that purchase residential MBS from AIG's securities lending protfolio.

TALF (Term Asset-Backed Securities Loan Facility)

Fed provide nonrecourse loans to eligible borrowers posting eligible collateral, for terms of five years.

Term Action Facility(TAF)

Fed's program during the recession that distribute 40 billion by the end of the year in two auctions. Forcing money out the door. Most of the takers are U.S affiliates of European banks.

SIV

Structured Investment Vehicle used by Lehmann, Deutchebank etc investment banks. A non-bank financial institution established to earn a credit spread between the long-term asset held in its portfolio and the shorter term liabilities it issued with high leverage. They invest in various securitization and finance through issuing ABCP (Asset-backed commercial paper). They are not exposed to interest or currency rate risk and is usually rated at AAA until the financial crisis. Banks set up SIVs to keep asset off their balance sheet therefore evade regulation and do a higher leverage.

Glass-Steagall Act

Four provisions of U.S. Banking Act of 1933 separating commercial and investment banking. Under the clause, investment banks cannot take deposits, and commercial banks cannot invest or underwrite non-governmental securities. 1990s wave of free market movement and capitalistic power attempt to repeal the act, and gradually removing regulations between banking and securities.

G20

G20, or literally, Group of Twenty, is a forum of leaders (usually finance ministers) from the world's most industrial and emerging economies. The first G20 meeting took place in the late 1990s in effort to manage the complex and emerging financial and social world. This G20 meeting followed the framework of the G8, a similar style forum that ended after the dissolution of the Soviet Union. The G20, as a response to WWII and Cold War politics, aimed to better manage and communicate the current global financial affairs while including the world's foremost economies. In the fall of 2008, following the September collapse of Lehman and the election of President-elect Obama, the G20 summit was redesigned and reinstated. By the spring of 2009, the first annual G20 took place in Washington, D.C. This meeting marketed itself as the new Bretton Woods given it provided a space for the world's Western leaders to communicate and argue for political and financial solutions. The 2009 G20 meeting focused on highlighting the emergence of Eastern economies, most notably China, and discussing how the economic growth in China would shift and influence the Western world. Since this inaugural G20 meeting, the forum has become annual. The presence of the G20 currently allows for economic/financial leaders to be in constant communication and discuss world issues before they become crises. The G20 website refers to its conferences as "shaping an interconnected world."

Government Sponsored Enterprises (GSEs)

GSE's were created during the New Deal as a form of Government housing subsidy meant to offer stable mortgage finance to a wider group. They are privately owned but backed by the US treasury: this allowed GSEs to buy risky mortgages but continue to sell safe debt. In order to spread out risk, GSEs pioneered securitization in the early 2000s, selling tranched and repackaged mortgages. This arguably opened the door to the housing crisis as private financial institutions not backed by the US government began mimicking these strategies. Key examples of GSEs are Fannie Mae and Freddie Mac. Refer to Powerpoint 4 for a more detailed timeline.

Angela Merkel

German Minister 2005-2015. She refuses to help the banks and cause the coordination failure in the eurozone crisis.

Nixon shock

In 1971, Nixon took a series of drastic economic measures to counter the Great Depression, including terminating Bretton Woods and taking U.S. off the gold standard and issue a 90-day executive order to freeze wage and prices. This is a drastic measure to counter the issue of U.S. dollar overvalue and stagflation within the country. But also created the problem of free-floating currencies. (Same significance as Bretton Woods)

Transfer Purchases

It is a form of governmental stimulus that provides wealth redistribution. This takes in the form of food stamps, social security, medicare, unemployment insurance, and medicaid. These programs target low income individuals because they have more propensity to spend. Also, some of these programs such as the unemployment insurance were to help individuals secure better jobs. *Transfer payments are known as automatic stimulators, which were used to force an economic recovery by increasing consumption.* The Obama administration desired to employ these methods because they would have stopped the decrease in consumption and help boost the economy. This is one form of fiscal stimulus, which governments employ.

LOLR

Lender of Last Resort: when there is a liquidity crisis, lends to banks that are solvant but not illiquid. (Bagehot).

LIBOR

London Interbank Exchange Rate. An estimated interest rate estimated by major banks in Europe. It is a benchmark for global short term interest rate. * If LIBOR goes up, there is either a lot of demand for credit, or a short supply of credit* It is the benchmark rate for the exchange of currencies between Leading banks. 18 Banks release their rates daily, and from this a figure is generated. It acts as a global marker of the exchange rate, operating in five different currencies in seven maturities. Within the relevance of the course, the most important rate is the 3 month USD rate, since it allows for Cross Currency Basis Spread swaps, which shields against fluctuations in the Exchange rate since it is a guaranteed rate. This allows banks and governments to borrow in USD against their own currency to offset their dollar liabilities. LIBOR is also used as the rate for future contracts, mortgages, student loans, and even corporate funding since it is less fixed than the USD official rate. Essentially the rate shows the level of liquidity in the market, and reflects risk and tension in the international banking system. It's important in our studies because it was the benchmark for the European Banks, like Deutsche and UBS, for attaining Dollars to lever up and acquire dollar assets, since it is far easier for them to fund their dollar liability in Euro liability and therefore can, even when US entities are less willing to lend dollars, acquire the currency they need. Its unregulated nature is very much a product of the race to the bottom between New York and London following the end of the Bretton Woods system. They then use this LIBOR exchange to swap for ABCPs and Financial securities. The problem here is that most of the ARMs were indexed to LIBOR, and so when the market began to show stress, banks became far less willing to lend, and liquidity of dollars in the market crashed. In addition, since it was unregulated, there was no way to directly influence it. The US solution was to use swap lines to weaken the dollar, thus keeping LIBOR down, and therefore improving liquidity.

wholesale dollar market

MMMF, ABCP, Repo

Subprime Mortgages

Making loans to people who may have difficulty maintaining the repayment schedule. These loans have high interest rates, poor quality collateral which defaulted in MBS.

Monetarism

Monetarism is a school of thought in monetary economics that emphasizes the role of governments in controlling the amount of money in circulation. Though he opposed the existence of the Federal Reserve, Friedman advocated, given its existence, a central bank policy aimed at keeping the supply and demand for money at equilibrium, as measured by growth in productivity and demand.

Collateral

Mortgages themselves in a security/CMO

1970s Oil Crisis

Oil price surged as petroleum production peaked and started to decline. Part of it is the perception of crisis, and the supply problem itself. Which led to economic stagnation and inflation in many countries - stagflation. The central cause that leads to the termination of Bretton-Woods.

Volcker Rule

Part of Dodd-Frank Act that is often referred to as a ban on proprietary trading by commercial banks, whereby deposits are used to trade on the bank's own accounts. But it is very vague that no one can tell you what you can do.

Volcker Shock

Paul Volcker was the chairman of Fed from 79 to 87, he countered 10% inflation rate by drastically raising interest rate to 20%.

Automatic Stabilizers

Policies and regulations that automatically offsets economic fluctuations in the market without active government intervention. For instance, more people apply for unemployment benefits when economy goes down. Tax revenue decreases because people make less money.

Timothy Geithner

President of New York Fed froom 2003-2009. Secretary of the Treasury 2009-2013 under Obama Ministration.

Stress Test

Proposed by Geithner, the stress test is a mechanism to evaluate the risks of banks in a simulated financial crisis. The Fed uses stress testing as a guideline for the injection of TARP fund into these banks. Most significantly, only 19 banks with assets totaling more than $100 billion are selected for the test and become target for TARP funds, implying that the Fed would take action to relieve these specific 19 banks. As a result, stress testing boosted the market's confidence in these banks as they received help from the American government. In its essence, the stress test runs a simulated crisis scenario less severe than the actual one, thereby injecting less capital for the banks. The banks would need to search for private funds to fill in the gaps.

Classes

Refers to groups of mortgages issued to borrowers of roughly similar credit worthiness.

Round Tripping

Round tripping describes the flow of funds between Europe and the United States in the lead up to the crisis. European banks would borrow from the wholesale money markets in the US to get dollar liquidity and then reinvest the money in the United States dollar-denominated assets, which often took the form of MBS and other real estate assets. Importantly, this exemplifies maturity transformation by banks and the consequent liquidity mismatch: short term funding from liabilities is used to purchase long term assets. As Tooze explains in the second reading packet, the largest inflow of funds in the United States came not from the Chinese trade surplus but rather the reinvestment by European borrowing. This comes back to haunt the Europeans as dollar scarcity erupts and home prices fall. Unable to pay back their short term funding, many banks nearly become insolvent. A major consequence is that the private debt is transformed into public debt as European governments are forced to provide guarantees to their toxic banks in order to quell the panic.

Shadow Banking

Shadow banking system refers to the financial intermediaries involved in facilitating the creation of credit across the global financial system but whose members are not subject to regulatory oversight. Shadow banking can refer to not only institutional agents, like hedge funds, but also to any practices and products that allow investment banks to expand their leverage. Since the late 1990s an increasingly important part of this side of shadow banking has been the 'over-the-counter' credit derivatives market, notably collateralized debt obligations (CDOs) and credit default swaps (CDSs). The most obvious attraction of these lay in the regulatory arbitrage they offered, enabling banks to expand leverage. In "Crisis in the Heartland: Consequences of the New Wall Street System," Peter Gowan explores the rise of the shadow banking system and how they changed the dynamic in Wall Street in the mid-1980s to the financial crisis in 2008. Subsequent to the financial crisis in 2008, the activities of the shadow banking system came under increasing scrutiny and regulations.

Liberal Market Economies (LMEs)

Shareholder. Countries like the U.S, UK and Ireland, good at creative destruction. Heavily rely on the private sector. Financed by the market, have a fluid labor market with wages set by individuals. Limited Social Welfare. It is a variety of capitalism different from most of continental Europe.

trilemma

Sovereign monetary policy, fixed exchange rates (because most of things are denominated in dollars), and free capital flow (global integrated economy, vertical supply chains).

Tranches

Specified slices of securities' risk. Usually classfied into AAA, AA, A, BBB, C etc. It catches the cash flow of interest rates and principle payments by tranches, in sequence according to seniorities. If a loan default, the most junior claim suffers loss first and goes up.

Coordinated Market Economics (CMEs)

Stakeholder. Countries like Germany, Switzerland. Good at skilled production of capital intensive products. Mostly financed by government and the bank. Labor market is more rigid and negotiated with unions. Have more social welfare.

FDIC

Stands for Federal Deposit Insurance Corporation. Provides deposit insurance to prevent bank runs by reassuring people that they'll always be able to get their money back. But FDIC support comes with premiums and restrictions, so investment banks and mortgage lenders didn't have it. (Because FDIC support lessens the risks they can take, and so lessens their potential profit.) In the crisis of 2008, the head of the FDIC, Sheila Bair, clashed with Geithner over the best way to deal with the crisis. Her priority was protecting taxpayer money, while his was ensuring that the banks didn't fail.

Basel Accords

The Basel accords were international global "rules" put into place in the 1980's. They come from the Basel Committee on Banking Supervision and are not in any way actually binding or backed up by regulatory force. Rather, they were guidelines to encourage the world's most advanced economies to have a more common standard by which to approach banking supervision. Basel II superseded Basel I and was the protocol in place at the time of the 2008 financial crisis. The guidelines of the Basel Accords were primarily concerned with what banks had to do to mitigate the risk of insolvency. This is where the guidance that banks should have 8% capital on a risk-weighted balance sheet, with high-risk assets disincentivized, in order to be in compliance with these standards. These standards played a big role in motivating banks to move things off of balance sheets in order to seem better leveraged than they actually were, and in motivating banks to purchase and retain more and more high-rated securities that would hardly count against them on their balance sheets such as the toxic mortgage backed securities, even though the ratings of these securities turned out to be inaccurate.

The Great Moderation

The Great Moderation is the period of time from the mid-1980's to the crisis in 2007. During this period, the Fed was under the chairmanships of Volcker, Greenspan, and Bernanke. The era is characterized by macroeconomic stability. The stability was a result of changes in the structure of the economy, good luck, and good policy. The structure of the economy was changed first through the shift from a manufacturing based economy to a service based one, and also through deregulation, which allowed for smoother adjustments to shocks and improvements in technology also allowed for more accuracy in production thus reducing volatility in production. More open international trade has also contributed to the stabilization of the economy during they period. Although the period's stability was partially attributed to good luck, the shocks during the period were mostly minor in scale, it was much more significantly impacted by good monetary policy. After the very high (~12%) inflation rates in the 1970's, Volcker brought it down and refocused on price stability, beginning the Great Moderation. Some argue that the Great Recession ended the Great Moderation, but the stability now is comparable to that of the Great Moderation, leading others to believe that the Great Recession was an interruption in the Great Moderation.

Milton Freedman & Anna Schwaltz

The greatest problem in the Depression is the dollar deflation.

Freshwater vs. Saltwater Economists

The term freshwater economists is associated with an approach of thinking about economics that was centered in the faculties of US universities such as the University of Chicago, Carnegie Mellon, Cornell, or Rochester. Its name stems from the fact that these universities are located near to the North American Great Lakes. Economists that belong to the freshwater school usually believe that the economy is always in equilibrium, which implies that there is no involuntary unemployment. They also believe that government spending to stabilize the economy over the business cycle is not effective. In fact, they argue that it has even detrimental effects because it crowds-out private investments and because people are rational and change their consumption plans as a reaction to a change in government spending, because they foresee that the debt the government has issued in order to pay for its additional spending has to be paid back in the future (an effect known as the Ricardian equivalence). Therefore, the multiplier of public spending is negative. Saltwater economists, on the other hand, are associated with an economic approach centered in the faculties of institutions near the east and west coast, namely Columbia, Yale, Harvard, Penn, Brown, and UC Berkeley. Freshwater economists reject the theory of rational expectations and do not believe that the economy is always in equilibrium. In their opinion, the economy is sometimes operating significantly below (and sometimes above) potential output. In their view, the government should actively intervene in the economy through changes in public spending in order to close the output gap. The multiplier of government spending is positive and thus, in their view, the government is able to successfully stabilize the economy over the business cycle.

SRM - shared responsibility mortgage

This concept was brought up throughout our readings for week 3 in the studies by Atif Mian and Amir Sufi and Larry Summers' response to them. SRM is a proposed solution for the negative externalities of foreclosures and fire sales in housing crises. Since fire sales bring down the neighborhood's real estate value, homeowners are essentially losing money on their housing investment, thus by decreasing their asset values, more people in the neighborhood will be pushed into foreclosure. As a result, there will be more saving, less spending, and a decrease in aggregate demand, which will bring down the economy in a vicious cycle of market contraction. With SRM, the burden of foreclosure as a result of housing crashes like in 2007-2008 is not fully placed on the vulnerable homeowner, but also on the lender. Middle to lower class home owners' are less able to bear these loss since their wealth is heavily dependent on their house's value, especially when compared to financial investors, creating even greater financial inequality in society. The government should push for these types of mortgages by securitizing them through Fannie Mae and Freddie Mac, because our mortgage model, especially in recessions, is bad for homeowners and the overall economy. Summers criticizes this argument by claiming that this policy could actually end up taking more money out of economy, since people who don't actually need relief could take advantage of this.

Tri-party Repo

Tri-party repo is related to Lehman's illiquidity crisis, which was the fatal part of Lehman's financial vicious cycle. Repo is an effective short-term financing vehicles with securities as collateral. A tri-party repo consists security dealer, cash investor, and a clearing bank. Lehman's illiquidity issue was largely due to its possession of huge amount of repos, which were proven to be unreliable and enticed the cash investors to cut off the funding. Losses of repos were disastrous for Lehman and Bear Stearns. Lehman's loss of repos caused its loss of short-term funding and illiquidity issues. Lehman's illiquidity exacerbates during July and August of 2008; on September 12, Lehman had almost no cash and would go on default without question on Monday, September 15. And we know the rest part of the story.

TARP

Troubled Asset Relief Program: 700 billion initially buying bad assets from banks and then directly inject money into banks.

sovereign default/bankruptcy

When a government declares bankruptcy. For example, Greece delay their default to protect their status as a developed country even though their accumulated public debt and deficit has put them into insolvency.

optimum currency area

a geographical region in which it would maximize economic efficiency by having a single currency. (Through price and wage flexibility, easy displacements of capital/workers between regions, or private/government transfers between countries)

The American Recovery and Reinvestment Act

a stimulus bill passed by Congress in the aftermath of the Great Recession by the Obama Administration in 2009. While it was part of a bipartisan effort on behalf of the Obama Administration, it only earned the votes of three Republicans in the Senate. It was the first priority of the Obama Administration and promised approximately 787$ billion in stimulus (Romer 2009) amidst a contentious debate among Obama's economic team (comprised of Larry Summers who led the National Economic Council, Peter Orstag who was the Budget Director, and Timothy Geithner of Treasury). While Romer had advocated for a larger package, Summers warned that it would come at too much of a political cost (Lecture #12 10/16/17). The package included tax relief, aid for states, investment for infrastructure and green science (Plotz 2012), healthcare expansion, unemployment protections, and education. It is a classic example of Keynesian economics fiscal expansion. As government spending increases, consumption increases, which has an underlying multiplier effect on the growth of the economy. While many on the left of the political spectrum wanted it to be bigger (Romer wanted it to be 1.8 trillion), the stimulus has the effect of mobilizing the right wing of the Republican Party (so called Tea Party) in reaction to "big government." The stimulus is largely considered a reason for the subsequent tempering of the recession.

Discount Window

an instrument of monetary policy (usually controlled by central banks) that allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions.

Jean-Claude Trichet

ean-Claude Trichet was a president of European Central Bank( ECB) from 2003-2011. He was named "Person of the Year" by the Financial Times (2007), "Policymaker of the Year" due to his contributions to the crisis. Trichet was educated at top institutions in France and worked in the ministry of France as well as being Governor of Bank of France and president of Bank of France. During 2007/8 crisis he is known for working closely with Mervyn King of Bank of England, whom he was studied together at Cambridge and Ben Bernanke. In particular, he was one of the leading participants in the December 2007 was "Bank of Canada, Bank of England and European Central Bank, the FED and Swiss National Bank" swap currencies between each other. Therefore, ECB would take dollars in exchange for euros, and ECB would eventually lend dollars out to the banks in the Eurozone that were of a shortage of dollars. Then, two central banks would return each other money "He was determined to keep the ECB;s attempts to prop up the European banking system separate from monetary policies." ( page 88, reading 5 ) He saw rising inflation as a danger and greatest risk on the horizon, which he announced at the public press conference on June 8, where he said that there is "heightening alertness" of high-interest rates, which didn't commit to that decision but gave high after that that was likely to happen.

Senior-subordinate structure

efers to tranched debt structures after they have been divided, with certain slices of debt holding claims to the underlying cash flows that legally come prior to other slices. Because different cash flows on the same debt asset have differing likelihoods of being paid (the first $100 is more likely than the last $100), the practice of dividing debt into senior and subordinate claims to these cash flows allows for the construction of AAA assets from what otherwise would have been considered a junk loan. This type of financial instrument is significant because of the role it played in the onset of the financial crisis. To create good assets by tranching you also necessarily create bad assets from what's left over--people buy those worse assets for the promise of a higher interest rate to compensate them for their risk. In the financial crisis large institutions held lots of these assets in SPVs because they were deemed to be relatively safe. Mortgage foreclosures made the assets with weak claims to the mortgage cash flows close to worthless, driving down the collateral value institutions could use in overnight repo markets to obtain funding, and creating risk of default because of maturity mismatch.

periphery countries

refers to the problematic countries in the eurozone crisis: spain, ireland, greek, italy.

SDR

special drawing rights. A form same as gold or US dollars created and held by the IMF that must be converted to other currencies to be traded but still holds real values. It was created at the end of Bretton Woods b/c of the shortage of dollars and gold reserves for trade demands. G20 leaders increased SDR in 2009 to fight the crisis.

money market mutual fund

take investors' money and invest in safe short-term investments such as commerical papers issued by GE

Bond Vigilantte

the fear that China will sell off all of its treasuary bonds.

bond vigilantes

the fear that countries like China will suddenly sell off all of their US treasury debt and thus lead to a devaluation of the dollars. Part of the Rubinites concern that anticipated the wrong crisis.

Basal agreements

the international regulation for banking to stop competition. Basal One: 1. 8% of your asset should be backed by capital. 2. risk-rate the asset (put securitized asset as very low rate) at 20% to avoid perverse incentive to only put into the riskiest stuff 3. loans off the balance sheet count much less degree against capital. (asset held in SIV to issue ABCP). Basal One allowed huge expansion of balance sheets with European leading the way. The leverage ratio of the banks shots up.

Pre-provision Net Revenue (PPNR)

very closely related to profit.

Robert Rubin

• Secretary Treasury under Clinton administration. • Steered through the repeal of Glass-Steagall act in the 1990s and encouraged bank deregulation and enabled the development and sale of MBS. • He helped Clinton reduce the deficit, only that Bush piled it up again with his "right wing class war" • Rubin's view of economics would have led to the crisis the U.S. was anticipating -- the decline of the dollar and a bond sell off from the Chinese. He enumerated the "panic of debt" crisis, which never actually happened. But this line of thinking is influential in both the U.S. and Europe. The Germans adopt the same view of "fiscal responsibility' in dealing with the Euro Crisis (Lecture 15). • Former chairman and director of Citigroup during the bailout, which received bailout and gave out huge bonuses. He was also tied to many of Obama's economic advisors.