Exam #3

Question 1

What is the main difference between Fannie and Freddie?

Answer 1

Fannie = big major retail and commercial mortgages
Freddie = smaller banks that serve local/regional communities mortgages

Question 2

Who regulates Fannie and Freddie?

Answer 2

The U.S. Government - specifically the Federal Housing Finance Agency (FHFA)

Question 3

What does GSE imply?

Answer 3

Operating with some sort of tie to the U.S. Government that includes all of the sorts of financial backstop in the event of a financial crisis

Question 4

What benefits did Fannie and Freddie receive that may give them a competitive funding advantage?

Answer 4

1. Do not need to pay state taxes
2. Investors in Fannie and Freddie do not need to pay state taxes on the interest that accrued/is paid to them
3. Fannie and Freddie bonds are effectively guaranteed by the U.S. government
4. Benefit from their massive scale (center of gravity argument)
5. Permitted to employ much greater leverage than “regular” banks

Question 5

Why do Fannie’s and Freddie’s mortgage securitization have only one class of debtors (mortgage bonds), while private subprime mortgage securitization may have multiple classes?

Answer 5

Fannie and Freddie have historically securitized only prime, conforming loans that meet specific underwriting and eligibility criteria (considered low risk). The risk of underlying loans is relatively low and cash flow is predictable.

Private subprime mortgage securitization often involves pooling loans with varying credit quality and risk characteristics.

Question 6

What happened to Fannie and Freddie during the financial crisis?

Answer 6

In 2008, the Bush Administration sees the control of Fannie and Freddie + places the government in control.
1. Extended $200B in U.S. Treasury support
2. Received outright ownership of 79.9% of both F + F

Question 7

Why did the U.S. Treasury opt to take 79.9% of the equity instead of more?

Answer 7

A weird accounting rule. If it is over 80%, the government would need to be able to consolidate this onto its own balance sheet. They did not want to put F+F debt on their balance sheet.

Supplementary reasons:
1. Prevent moral hazards
2. Could encourage better management practices
3. Maintain some degree of market discipline by leaving private shareholders

Question 8

How did the conservatorship of Fannie in Sept. 2008 affect its subordinate (unsecured) bond holders? How did it affect its preferred equity?

Answer 8

Subordinate bondholders were fine because they were guaranteed by the U.S. government and did pretty well under conservatorship.

Preferred equity holders were not good because they were no longer able to receive equity. Their value plunged substantially.

Question 9

What does FDIC insurance protection actually entail?

Answer 9

Insures up to $250,000 across checking, savings, money market accounts, certificates of deposit, and cashiers checks.

Question 10

What does FDIC insurance NOT cover?

Answer 10

Investments in stocks, bonds, mutual funds, and CRYPTO.

Question 11

What were FDIC’s actions during the financial crisis?

Answer 11

1. FDIC insurance limited to $250,000
2. Granted FDIC insurance for all deposits in non-interest-bearing accounts
3. Making special assessment on banks in order to recapitalize the deposit insurance fund (DIF)
4. Granted newly-issued bonds of U.S. financial companies

Question 12

Why are bank runs no longer obsolete?

Answer 12

Crypto, start-ups, and poor decision-making.

Question 13

SVB: How did we get here?

Answer 13

Facts:
1. Over 95% of SVB’s deposits were uninsured

2. SVB invested much of its customer deposits in Treasuries/gov. bonds with fixed interest rates
3. JPowell raised interest rates and these bonds lost their value
4. The group chat with 200+ SVB tech depositors decided to pull their money from the bank and caused a bank run that they were “shocked” by
5. A lot of SVB customers are start-ups (these are the people who are getting hit pretty badly - More likely to ask for their money back)
6. Significant spillover affects onto regional banks

Question 14

SVB: How did we get here?

Answer 14

Facts:
1. Over 95% of SVB’s deposits were uninsured

2. SVB invested much of its customer deposits in Treasuries/gov. bonds with fixed interest rates
3. JPowell raised interest rates and these bonds lost their value
4. The group chat with 200+ SVB tech depositors decided to pull their money from the bank and caused a bank run that they were “shocked” by
5. A lot of SVB customers are start-ups (these are the people who are getting hit pretty badly - More likely to ask for their money back)
6. Significant spillover affects onto regional banks

Question 15

What risk did SVB have?

Answer 15

Interest Rate Risk!

Assets and Liabilities were both highly correlated with interest rate.

Question 16

What are the implications for federal policy?

Answer 16

JPowell needs to:
1. Balance mitigating the banking crisis
2. Fight inflation

Political tension:
1. calls for smaller bps increase or even a pause in interest rates
2. calls for aggressive interest rate hikes

Question 17

What are the implications for federal policy?

Answer 17

JPowell needs to:
1. Balance mitigating the banking crisis
2. Fight inflation

Political tension:
1. calls for smaller bps increase or even a pause in interest rates
2. calls for aggressive interest rate hikes

Question 18

What was the main purpose of the McFadden Act (1927)?

Answer 18

Congress sought to strengthen the financial stability of the banking system by limiting the ability of national banks to branch across state lines. [to protect smaller / regional banks]

1. prohibited national banks from branching into multiple states
2. restricted their ability to open new branches within their home state

Question 19

What are the 2 important components of Dodd-Frank (2010)?

Answer 19

1. The “Hotel California” Provision
2. The Volcker Rule

Question 20

What is the main purpose of Dodd-Frank (2010)?

Answer 20

Overhauled the financial system in an effort to promote greater financial stability [and avoid another crisis].

Increase:
- transparency
- accountability
- stability

Question 21

Who qualifies for the “Hotel California” Provision?

Answer 21

1. Bank holding companies that have more than $50B in assets
   +
2. Received assistance during the financial crisis (gave them access to funding by the FED)

CANNOT avoid regulations by removing their bank holding company status

[Targeted towards Goldman Sachs and IBs who converted to big holding companies during the crisis]

Question 22

What is the Volcker Rule?

Answer 22

Section 619 restricts banks from engaging in certain classes of speculative investments. Have to prove that any trades are done for legitimate customer-related purposes (moneymaking or hedging risks).

• Engaging in proprietary trading with their own funds
• restricts investments in certain hedge funds and private equity funds

Question 23

What is the main purpose of the Community Reinvestment Act (1977)?

Answer 23

Requires all banks that receive FDIC protection to be subjected to oversight by federal banking regulatory agencies to ensure that they are extending credit/loans in a non-discriminatory manner

Question 24

What is the main purpose of the Investment Act (1940)?

Answer 24

Requires investment companies with 100+ investors to register with the SEC and adhere to other disclosure requirements. [to increase public confidence/interest]

Also requires mutual funds to limit the amount of leverage and keep a certain amount of money, sufficient to cover investors, on hand.

Question 25

What is the main purpose of the Securities Act (1933)?

Answer 25

Requires all sales and offers of securities to be registered with and regulated by the SEC

Question 26

What is the SEC?

Answer 26

The U.S. Securities and Exchange Commission (SEC) is responsible for regulating the securities industry and enforcing federal securities laws. Main goal is to protect investors.

Question 27

What is the main purpose of the Glass-Steagall (Banking) Act (1933)?

Answer 27

Create a distinct division between investment banks and commercial banks. Created the FDIC.