Investment banks provide financial
services for governments, companies, or extremely rich individuals.
They differ from retail banks where you have your savings or your
mortgage. They do not deal in standard consumer debt: credit cards, car
loans, or mortgages.
The Fed
(The Federal Reserve Bank)
a quasi-governmental central bank
responsible for managing the money supply, regulating
commercial banks, and providing loans to commercial banks.
FDIC
(Federal Depositor Insurance Corp.)
provides deposit insurance which
guarantees the safety of checking and savings deposits in member banks,
currently up to $100,000 per depositor per bank.
Treasury
(The United States Treasury)
a Cabinet department of the
executive branch (Presidency) of the US government; responsible for
managing government revenue. The US government borrows money by issuing
and selling bonds through the Treasury (US Treasury Bonds).
SEC (The
Securities and Exchange Commission)
is an independent agency of the US
government responsible for enforcing the federal securities laws and
regulating the securities industry, the nation's stock and options
exchanges, and other electronic securities markets.
Fannie Mae
(Federal National Mortgage Association)
a private government sponsored
enterprise (GSE). It was a stockholder-owned corporation authorized to
make loans and loan guarantees. Fannie Mae was the leading participant
in the U.S. secondary mortgage market, which serves to provide
liquidity to mortgage originators, to enable mortgage companies,
savings and loans, commercial banks, credit unions, and state and local
housing finance agencies have funds to lend to home buyers. As of 2008,
Fannie Mae and the Federal Home Loan Mortgage Corporation (Freddie Mac)
owned or guaranteed about half of the U.S.'s $12 trillion mortgage
market. Along with Freddie Mac it was nationalized on Sept. 7, 2008 by
the US Treasury.
Freddie
Mac (Federal Home Loan Mortgage Corporation)
was a government sponsored
enterprise (GSE) of the United States federal government, authorized to
make loans and loan guarantees. Freddie Mac bought mortgages on the
secondary market, pooled them, and sold them as mortgage-backed
securities to investors on the open market. This secondary mortgage
market increases the supply of money available for mortgage lending and
increases the money available for new home purchases.
Fannie Mae
and Freddie Mac
are owned by private shareholders
but chartered by Congress, they are exempt from state and local taxes
and receive an estimated $6.5 billion-a-year federal subsidy because
they can borrow money more cheaply than other investors. In return,
they are expected to serve "public purposes," including helping to make
home buying more affordable.
The
Transactions
Credit
default swap
Insurance against a credit
default. A bank that owns mortgage debt sells the debt to an
investor for periodic (monthly payments). The bank guarantees that it
will pay-off the investor if the mortgage debt is defaulted. The
problem is that the banks offering these securities never expected the
mortgages to be defaulted and thus never intended to pay out the
insurance.
Derivatives
Derivatives are a way of investing
in a particular product or security without having to own it. The value
can depend on anything from the price of coffee to interest rates or
what the weather is like. Thus, their value is derived from the value of another
asset or security.
Derivatives can be used as
insurance to limit the risk of a particular investment.
Credit derivatives are based on
the risk of borrowers defaulting on their loans, such as mortgages.
Futures
A futures contract is an agreement
to buy or sell a commodity at a predetermined date and price. It could
be used to hedge or to speculate on the price of the commodity.
Hedge Fund
A private investment fund with a
large, unregulated pool of capital. Hedge funds are often used to
provide counter-balancing protection ("a hedge") against the risk of
another security.
Hedge funds use a range of
sophisticated strategies to maximise returns - including hedging,
leveraging and derivatives trading.
Hedging
Making an investment to reduce the
risk of price fluctuations to the value of an asset or security.
For example, if you owned a stock
and then sold a futures contract agreeing to sell your stock on a
particular date at a set price. A fall in price would not harm you -
but nor would you benefit from any rise.
Leveraging
Leveraging, or gearing, means
using debt to supplement investment.
The more you borrow on top of the
funds (or equity) you already have, the more highly leveraged you are.
Leveraging can maximise both gains and losses.
Mark-to-Market
Recording the value of an asset on
a daily basis according to current market prices.
So for a futures contract, what it
would be worth if sold today rather than at the specified future date.
Also marked-to-market.
NINJA loans
Sub-prime mortgage loans approved
for borrowers with no income, no job, and no collateral. NINJA = No
Income - No Job Approval.
Non-banks
Financial institutions that are
not banks by the legal definition, and therefore may not be regulated
as banks, but that provide banking services usually at the commercial
or investment level. Becasue they are often integrated into the
securities, hedge, or insurance markets they link these less regulated
or unregulated industries with the more regulated banking industry.
Securitization
Turning something into a security.
For example, taking the debt from a number of mortgages and combining
them to make a financial product which can then be traded.
Banks who buy these securities
receive income when the original home-buyers make their mortgage
payments.
Security
Essentially, a contract that can
be assigned a value and traded. It could be a stock, bond, or mortgage
debt, for example.
Short
selling
A technique used by investors who
think the price of an asset, such as shares, currencies or oil
contracts, will fall. They borrow the asset from another investor and
then sell it in the relevant market.
The aim is to buy back the asset
at a lower price and return it to its owner, pocketing the difference.
Also shorting.
Sub-prime
mortgage
Home loans to high risk borrowers
who pay higher interest rates (i.e. sub-prime = low quality). The
majority of these loans were made to lower income borrowers with little
or no down payment, collateral, or other assets. Originally introduced
to help low income families gain access to home ownership. They usually
had very low or zero interest rates for a short period of time (3 to 5
years) when the interest payments increased rapidly or when large
payments were due. Over-selling of these loans, banks’
detachment from
the risk of failing to ensure re-payment ability of borrowers,
de-regulation of the oversight on these loans, and irresponsible and
possibly illegal manipulation of these loans all contributed to the
massive default on these loans by the borrowers.
Toxic loans
The sub-prime loans that cannot be
re-paid. They are toxic because they have be bundled and repackaged
in derivative securities and thus, cannot be easily separated or
discharged individually. When they are defaulted they bring down the
value of the entire security or cause the security to be defaulted
although they are only a portion of the security. Thus, they "poison"
the entire security.
Write-down
Reducing the book value of an
asset to reflect a fall in its market value. For example, the
write-down of a company's value after a big fall in share prices.
Zombie Banks
Banks that have failed but won't
die, nor recover, and feed on an endless supply of fresh government
money. They won't die primarily becasue they are "too big to fail" meaning that the
government believes their failure would bring down some many other
institutions that it would cause the economy to crash so low that it
may not recover for a decade. Consequently, the government finds it
necessary to try to revive them with various government funding,
lending, or subsidy programs. However, the banks losses are so large
and the government programs are so cautious that the banks never appear
to recover, but simply require more funds to avoid collapsing.
(*Compiled from
multiple free, open access sources, including: BBC, WSJ, NYT, Wikipedia)