Chapter 6- The financial crisis Flashcards
Securitization
*The process through which an issuer creates a financial instrument by combining contractual debts and then selling different tiers of the repackaged instruments to investors.
*The process can encompass any type of financial asset and promotes liquidity in the marketplace.
Mortgage backed securities is a very good example: individual retail investors are able to purchase portions of a mortgage as a type of bond. Without the securitization of mortgages, retail investors may not be able to afford to buy into a large pool of mortgages.
What is a credit default swap?
A credit default swap is an agreement between two parties that work like a side bet on a football game. Swap sellers promise swap buyers a big payment if a company’s bonds or loans default. In return for the promise they get quarterly payments. Neither needs to hold the underlying debt when entering into a swap.
A kind of insurance against credit risk: bankruptcy
The process of a credit default swap
1) Party A buys credit default insurance from Part B to protect against default on a bond, or to bet on a company’s health.
2) In the case of a default, Party B would pay the bonds full value to Party A.
3) The problem: Party B can assign the insurance contract to another party, who can sign it to another, and another ++ In the case of default Party A may have to track down the final party in the insurance agreement. However, this party may or may not be in a position to pay the bond´s full value.
Basel 2 –> Basel 3
Strengthening the rules
- massive impact on the banking sector
Basel 1
Was not linked to ratings yet
Basel II
strengthening the rules
Basel III
- what they have in Belgium today
- banks do not link Basel III → emphasize on risk management and banks want freedom
- its because of Basel we have a relatively safe banking system, we can´´ have banks doing whatever they want
