The House Of Cards

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The House of Cards By Garrett Leider Directed Studies Report Professor Charles Ruscher PhD, Southern Methodist University April 25, 2009

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Table of Contents:

I. Introduction. II. A brief history of the subprime mortgage. III. The recent subprime boom (1997-2007). IV. Angelo Mozilo and Countrywide Financial. V. Wall Street’s Role. VI. It is now a truly global economy. VII. Governmental Response. VIII. Prevention Methods. IX. Conclusion. X. Bibliography.

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I. Introduction. Corporate greed? Check. Astronomical upper-management compensation? Check. Massive job losses? Check. Record quarterly losses and bankruptcies? Check. “He said, she said” finger pointing? Check. The use of taxpayer money to attempt to solve the problem and let management off the hook? Check. And still no responsibility taken for the problem? Check. So then what makes the current economic crisis different from ones of the past such as the 1979-1982 recession, the Chrysler bailout of 1979, the S&L crisis of the 1980s and 1990s, and the dot-com implosion? In retrospect, not a whole lot. But the reason why the current economic crisis is on a scale unimaginable to most people, including many renowned economists is due to the interconnectivity of the global economy, primarily achieved over the last fifteen years according to most scholars. In this paper, I intend on laying out the reasons why we are neck deep in this mess today, decipher the government’s actions to prevent the problem from getting worse, and suggest methods to ensure that this never happens again.

II. A brief history of the subprime mortgage. Although the sub-prime mortgage industry really took off after the terrorist attacks of 9/11, enabled by interest-rate cuts championed by then-Federal Reserve Chairman Alan Greenspan and a national economy recovering from a decline in growth, the foundation of the sub-prime mortgage dates back a few decades before that. Subprime mortgages grew out of the second lien mortgage business that was started in the 1960s by “pioneers” of the industry like “Peter Cugno and Beneficial Finance” (1). In the beginning, companies like Beneficial Finance would not extend “credit to a homeowner

4 if the first and second mortgages combined would have an LTV (loan-to-value ratio) above 80 percent” (2), but Beneficial Finance’s niche was making second mortgages to customers who had owned their house for years and seen an increase in its value; with this a relatively conservative new lending industry was born. However, with the S&L industry beginning to fail in the 1980s, large regional banks began looking for ways to expand their business-lending units in order to shore up their balance sheets and continue generating the profits their investors clamored for. With these banks lending to larger consumer finance companies like Beneficial, the smaller companies begin to search out for ways to lend out more money to consumers without paying the fees that large financial banks demanded: wealthy individual investors were the answer they so desired. The rise of the sub-prime mortgage industry was fueled by “rich professionals who were looking to put their extra cash to work, becoming the backbone of the subprime industry in the 1960s, 1970s, and early 1980s” (3). With this investor pool now secured, large financial companies began to take notice, and Prudential Securities jumped in head first, offering Aames Financial, a smaller consumer finance company, a $90 million warehouse line. Yet Prudential was not just lending money to Aames and standing pat while making a profit off their credit line, they began pooling the loans and securitizing them into mortgage bonds and with it came the birth of a new industry and a security instrument: the mortgage-backed security (MBS). With the advent of Prudential’s relationship with Aames Financial, Wall Street firms like Lehman Brothers and Bear Stearns began to rush into the sub-prime mortgage business via the underwriting of these consumer finance companies IPOs, the buying and securitizing of their subprime

5 mortgages, and the lending of money through warehouse lines of credit to these smaller companies: Wall Street had tasted blood and the waters were dark. When the Russian debt crisis began to unfold in 1998, spurned by the Russian government’s devaluing of the ruble, Wall Street firms like Lehman Brothers and Bear Stearns and some newly created hedge funds began to loose their appetite for buying the least risky bonds and subsequently began cutting back the amount of money they would lend to these subprime consumer finance companies. In addition to this, many subprime loans began to refinance faster then consumer finance companies like Aames Financial, Beneficial Financial, The Money Store, and First Plus had ever anticipated. Coupled with the “gain-on-sale (GOS) assumptions that these firms had made turning out to be horribly wrong” (4), investors began to flee from these companies in droves, and it subsequently resulted in many companies filing for bankruptcy. The lack of coverage on this first crisis, according to one analyst, was “due in part to their busy coverage of the Russian debt crisis and the meltdown of Long-Term Capital Management (LTCM)” (5), a massive private hedge fund operated by John Meriwether. Yet an argument could be made that the lack of media coverage on the first subprime crisis was also due to the fact that the subprime industry of the 1990s was still “relatively small, accounting for just 10% of all mortgages funded in the United States” (6), keeping many of the financial behemoths sheltered from the losses felt by the smaller finance companies of the time, and their appetites for new profit sources just as intense.

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With the booming American economy of the 1990s, the American dream of owning a home was never more prevalent. With home prices rising 126% between 1997 and 2006 (source: economist.com), more and more average American consumers believed the owning of a home to be a sound investment opportunity and they came to lenders more then happy to finance them in flocks. With the advent of loan brokers who took customers to smaller consumer finance companies like The Money Store, only requiring to be paid a small fee, larger companies like Countrywide Financial led by Angelo Mozilo, became heavily involved in the lending of money to these new customers, and were happy to assist with their dreams of becoming homeowners. And with industry trade groups creating an “informal political alliance to beat down any type of legislation that might harm their bottom line” (7), you subsequently had the perfect storm brewing for economic catastrophe: lax-government regulations, eager new home owners, and lenders and Wall Street firms with eye balls filled with dollar signs. The business of loan brokering soon became a booming business: according to David Olson, an economist who conducted research on the loan brokerage industry through his firm Wholesale Access of Columbia, Maryland. “In 1998, mortgage lending became a $1 trillion a year business. If loan brokers earned an average one point and accounted for 70 percent of all loan originated each year (Olson’s estimate), that worked out to $7 billion a year in fee income” (8). Due to this large amount of willing new homeowners and lured by the prospect of huge earnings, as of January 2007, there were roughly “200,000 individuals who worked for 53,000 loan brokerage firms and they were

7 earning a lot more than one point per loan, and the fees paid to brokers on subprime loans were a lot higher than the old standard one point” (9). With this profit source only growing larger each year, loan brokers had an enormous incentive to sign anyone with a walking pulse up for a new home and mortgage, regardless of their credit rating, income, and capacity to repay. According to several interviews conducted by National Mortgage News, few brokers were willing to admit they earned $1 million or more per year, but a survey later conducted by the newspaper found that 80% of brokers contacted said they earned north of $400,000 per year. Any person with a simple business sense could understand that the higher the yield on a loan made that particular mortgage even more valuable to wholesalers like Countrywide, Wells Fargo, Washington Mutual, and Wachovia who could in turn sell it to Wall Street at a higher price. Wall Street firms involved in the subprime debacle would then pool these sub-prime loans into bonds and the bond investors couldn’t get their hands on these assets paying a much higher-yielding rate fast enough. With loan brokers, mortgage wholesalers, and Wall Street firms all in on the take, ignoring the risk-aversion strategies they championed so much to the American public, there had to be an underlaying reason for this reckless lending: bring in the US government. The US government’s role in the subprime mortgage collapse lies in various aspects, stretching through three administrations dating back to the Reagan administration. President Reagan’s signing of the Garn-St Germain Depository Institutions Act of 1982 ushered in an era of deregulation for the housing finance business by allowing insured depositories to invest 40% of their assets in nonresidential real estate and by permitting it to have just one stakeholder, attracting developers of all

8 kinds to purchase S&L depositories or start their own and continue the cycle of irresponsible lending. Under the Clinton Administration, the U.S. Department of Housing and Urban Development (HUD) in 1996 directed the Government-Sponsored Enterprises (GSE) of Fannie Mae and Freddie Mac that “at least 42% of the mortgages they purchased should have been issued to borrowers whose household income was below the median in their area” (9), fueling the subprime mortgage boom even more. While the Bush Administration’s role in the current economic crisis and subprime mortgage market’s collapse is still widely debated, this much we know: under the Bush Administration, the HUD mandated that the GSE purchase loans from borrowers whose household income was below the median in their area to “52% of their total purchases in 2005” (10), up 10% from 1996. The Bush Administration was also a vocal supporter of free-market capitalism and relaxed government regulation. This is nowhere more apparent then in former Federal Reserve Chairman Alan Greenspan’s monetary policies, especially in the realm of interest rates, where he championed rate cuts after 9/11 and kept rates historically low for a wartime nation. This led to the spigot of cheap credit continuing to flow, allowing American consumers to continue their debt-fueled spending binge and lowest in the developed world savings rate, aided not only by government policies and decision makers but also by Wall Street’s ongoing gorge with rising profits, regardless of the risks they carried with it.

IV. Angelo Mozilo and Countrywide Financial. Countrywide Financial Corporation, led by Angelo Mozilo until July 1, 2008, is a picture-perfect example of the greed that characterizes financial crises and economic

9 collapses. By effectively tossing modern portfolio theory, diversification, and any riskanalysis measures conceived in the last eighty years completely out the window, Countrywide Financial became the largest lender and servicer of mortgages in the entire world. With Countrywide Financial continuing its love affair with loan brokers as “38,000 of the 44,000 brokers in the U.S. were approved and signed up to do business with Countrywide” (11) and utilizing the new stated-income loan, Countrywide originated “$150 billion in mortgages rated A- to D between 2004 and 2007” (12). Driven by Mozilo’s quest to become the biggest subprime originator in the U.S, Countrywide began to get sloppy; loan brokers would be approved in 72 hours, background checks done on borrowers were outsourced to contractors in India, and due diligence was taken off the back burner and left to rot. Yet Mozilo was hell-bent on keeping Countrywide’s reputation as sterling as possible, and in his quest for growth, Mozilo led Countrywide into the life insurance business. To sell life insurance globally, companies need to maintain a triple-A credit rating, something the company lacked due to its subprime mortgage business: involving Mr. Warren Buffett would soon change this. Yes, the man proclaimed by many in the world to be a financial genius and the world’s smartest investor, the “Oracle” was duped into selling an insurance policy, through Berkshire Hathaway, to Mr. Mozilo and Countrywide Financial. With this insurance policy in hand, Mozilo quest for nationwide financial dominance was complete. Angelo Mozilo is the epitome of corporate greed: his executive compensation during the U.S. housing bubble of 2001-2006 approached $470 million (13). Countrywide’s payment of his annual country club dues at Sherwood Country Club in

10 Sherman Oaks, CA, The Quarry at La Quinta golf club in La Quinta, CA, and Robert Trent Jones Golf Club in Gainesville, VA only validates this point. This point is further exemplified by his selling of company stock even when he was publicly touting the stock and using shareholder funds to support buy back programs in order to support an inflated stock price. The example of Angelo Mozilo’s involvement in the subprime mortgage collapse is sadly not unique; many other CEO’s and top managers of Wall Street firms, mortgage companies, and other financial corporations participated in similar compensation programs, designed to reward reckless risk taking, all in the name of huge annual profits that kept shareholders happy and the governments of the world off their backs.

V. Wall Street’s Role. Wall Street’s role in the subprime mortgage collapse and the subsequent global economic downturn cannot be understated in any shape or means. Like Countrywide Financial, Wall Street firms involved in the subprime mortgage business threw all risk analysis, diversification strategies, and modern portfolio theories into the garbage can; all for the sake of record profits that left top management fat, merry, and content. No Wall Street firms were exempt from exposure to subprime mortgage backed securities and derivatives yet a select group of firms were leading the pack and their lead was lengthy and secured. The firms who led this group now all have one thing in common: either they endured embarrassing and disastrous bankruptcy hearings or were sold at fire sale prices to their competitors, largely at the urging of the U.S. government. Lehman Brothers went

11 up in smoke in September 2008; Bear Stearns and Merrill Lynch were sold later that month, and Morgan Stanley and Goldman Sachs opted to become commercial banks in order to obtain government bailout funds, becoming the subjects of stricter regulation in order to maintain a fiscal solvency that was quickly slipping away. Wall Street’s love affair with subprime mortgages began when Salomon Brothers created a new financial instrument called the mortgage-backed security (MBS) in the mid-1980s. This gooey, romantic affair continued when mortgage traders at First Boston perfected the MBS through the development of the collateralized mortgage obligation (CMO), a more predictable financial instrument. Seeing the profits that these instruments had generated for their founders, many other Wall Street firms took the plunge, eager to expand their companies’ income statements at a breakneck pace. Financing of these mortgage corporations operations, IPOs underwrote by Wall Street firms, and the securitization of these mortgage securities continued this wet and wild love affair. No one fell more head over heals then Lehman Brothers. Lehman Brothers bravado in the subprime mortgage industry led to record profits at the company, $3.26 billion in 2005, $4 billion in 2006, and $4.125 billion in 2007 (14). Yet this arrogance in the company’s financial superiority ultimately led to its downfall. The house of cards they had slapped together without much consideration to situational analysis begin to crumble in 2008 when they reported a $2.8 billion loss in the 2nd quarter, forcing the company to sell $6 billion in assets (15). This loss, coupled with another astronomical loss of $3.9 billion for the 3rd quarter (16) was apparently the result of its large holdings in subprime and other lower-rated mortgage securities, while during the same time securitizing the underlying mortgages of which these securities were sold

12 upon. Former CEO Richard Fuld largely led this reckless quest for profit, and the company under his leadership became the top U.S. underwriter of mortgage bonds in 2006 and 2007 (17), neglecting the massive risks that these bonds carried with them. Yet, there were opportunities according to many Wall Street executives to sell the company before it collapsed; ultimately it was Fuld’s arrogance that caused him to reject these offers, as he believed they did not accurately reflect the value he so greatly championed in the company. And in accordance with other executives involved in this collapse, it did not stop him from accepting ludicrous compensation packages, totaling $480 million over the previous eight years (18). It appears as if they didn’t break the mold when Fuld was born. Bear Stearns, once regarded by Fortune Magazine, as “America’s most admired securities firm” became the litmus test for corporations on the verge of collapse during this crisis. Its exposure to the subprime mortgage markets began in 1997 and though it was shaken somewhat during the initial subprime mortgage collapse of 1998, it became hell bent on dominating the mortgage securitization market through an industry-wide used three-pronged approach whose goal was “sucking as many subprime loans as they could out of nondepositories like Ameriquest, New Century, and others” (19). The 1st prong started with the salespeople, pressuring them relentlessly in the hopes that they would sell you the loans at the cheapest possible price, and by the next day, the loans would be out in the marketplace. Next came the outsourcing firms, whose only job was to reunderwrite the mortgages in order to assure the investment-banking firm that the mortgage can go safely into a security. The icing on the cake was the extending of

13 warehouse loans to nondepositories at no cost in order to get their business. Wash, rinse, dry: repeat as often as possible. Many Wall Street firms believed that “as long as home prices kept going up at a rate of 25 percent a year, there would be nothing to worry about” (20). No one exemplified this better then Bear Stearns; according to Fortune Magazine, Bear Stearns contained a net equity position of $11.1 billion in 2007, supporting $395 billion of assets and revealing a leverage ratio of 35.5 to 1: insane. Carrying with it was $13.4 trillion dollars in derivative financial instruments; with a balance sheet that leveraged, just a small fraction of these instruments failing would break the company in half and it is precisely what happened. With two of its hedge funds collapsing due to its investments in collateralized debt obligations (CDO), investors began to flee the company, and with a rapidly declining stock price, Bear Stearns executives were forced to sign a merger agreement with JP Morgan Chase on March 16th, 2008 in stock swap valued at less then 10% of its market value. When you realize that Bear Stearns once traded at $172 as recently as January 2007 and that it was now being sold in a merger valued at $2 adjusted per share, you realize just how much harm the company had done itself by exhibiting such a reckless abandonment for profit. Perhaps greed is not as good as it once seemed. Hi, I am John Thain and I am the poster boy for corporate greed, excess, and irresponsibility. After our parent company, Bank of America, received $20 billion from the federal government to complete our merger, I decided to refurnish my corporate office at the taxpayers’ expense of $1.22 million; isn’t America great? Though John Thain didn’t take over Merrill Lynch until December of 2007, Merrill Lynch’s place in the dysfunctional corporate world had already been cemented. This position can be

14 summed up by the following quote of a former Bear Stearns managing director when asked about former Merrill Lynch CEO Stan O’Neal and his jealousy of Lehman Brothers and Bear Stearns subprime securitization business: “Oh, it just pissed him off” (21). Furthering the effect of resentment was the fact that according to Bill Dallas, chairman of Ownit Mortgage, that “when the subprime business recovered, Lehman was making money hand over fist; Merrill, was late to the party” (22). Due to Merrill Lynch’s tardiness in the subprime mortgage business, CEO O’Neal decided to jump in head first; be number one was his mandate. First order of business: dump the senior manager of the mortgage department and replace him with Michael Blum, a confident of O’Neal’s who would do anything to garner the praise of his boss. That he did: the purchasing of subprime loans by Merrill Lynch increased exponentially, even paying 3 to 5 cents higher then their next competitor for each subprime loan available. With loan originations in the U.S. reaching “$3.9 trillion in 2003, and subprime loans accounting for $390 billion or 10%” (23), Wall Street’s role in the mortgage business had been cemented and Merrill Lynch began to see the fruits of their labor. Merrill’s operating profit between 2003 and 2006 “averaged $5.2 billion, more than double the $2.1 billion average in the proceeding five years” (24). Merrill’s growing operations in the subprime mortgage market became Stan O’Neal’s #1 priority and he emphasized this at whatever chance he could get; through press releases, internal memos, speaking engagements, and corporate meetings: he wanted in and badly, badly enough to pay upwards of 105 cents on the dollar for every mortgage. Corporate lunacy was operating at full throttle.

15 Through the selling of warehouse financing to subprime originators at nearly next to nothing, Merrill began to pick up market share from other Wall Street firms unwilling to go to such great lengths to secure their business. And by the end of 2005, Merrill had become the “seventh largest issuer of subprime ABSs in the United States, just a few billion dollars behind its archrivals, Bear Stearns and Countrywide” (25). Like Lehman Brothers and Bear Stearns, Merrill Lynch had launched and owned its own mortgage company that enabled it to go directly to the source of the mortgages without having to hassle with other Wall Street firms and intermediaries. With this company set and operating, in 2006 Merrill began sending out feelers to potential companies it was looking to acquire and it settled on First Franklin, a money center bank based in Cleveland, Ohio. Paying $1.3 billion for a company that had sold for four times less in 1999 (26) completed O’Neal’s quest to become a giant amongst dwarfs; Merrill was now able to manufacture loans itself and complete the cycle. By paying top dollar for mortgages and through its institution of a policy that was considered to be the most pro-lender friendly, Merrill’s exposure to the mortgage market, both subprime and jumbo rated was of a prodigious scale. Borrower defaults on their loan on the 61st day? That was Merrill’s problem. The majority of Wall Street firms made the lender buy back delinquent loans up to 90 days; cutting that to 60 days only wetted loan originators appetite for dealing with Merrill more. In Merrill’s quest to become the biggest and baddest of them all, approving as many loans as possible, they began to get lazy, buying loans approved by outsourcers that were rated a three (fail) and always walking a fine line between reputable and fraudulent.

16 With home delinquencies rising rapidly in 2007, dozens of subprime lenders and hundreds of loan brokerage firms began shutting their doors, and with the overseas market for CDOs drying up, Merrill’s “luck” began to change and not for the better. In November of 2007, Merrill disclosed to its investors that it would “write-down $8.4 billion in losses associated with its mortgage business” (27) and remove Stanley O’Neal from the CEO position; it was the only major Wall Street firm to lose money in the third quarter of 2007. And the fourth quarter was even worse; Merrill “posted the largest loss in company history of $8.6 billion, setting aside with it $12 billion to cover expected losses on its subprime CDO bonds” (28). Totaling over $20 billion was the damage Merrill inflicted on itself through its investment in the subprime business, and that is not even including the cost of acquiring First Franklin and Ownit Mortgage Solutions. The cards were beginning to fall and First Franklin was the first to go: Merrill Lynch pulled the plug on it in early March 2008 and the collapse was complete in some regards on September 14, 2008 when Bank of America agreed to purchase Merrill Lynch for almost $50 billion according to the Wall Street Journal. The preceding snap shot of three Wall Street firms heavily involved in the subprime mortgage collapse illustrate just how reckless they were in their quest for profit sources that they believed would never dry up. It appears as if these companies and the executives who led them never learned from mistakes made during previous bubbles and bull markets, though in fairness home prices had gone up every year “from 1890 to 2004 at an inflation-adjusted rate of 0.4%” (29). What is different about this bubble and the subsequent collapse is the effect it has had on the economies of the world, from the

17 rapidly developing nations of Asia to the developed countries of Western Europe. It is to this where I next turn my attention.

VI. It is now a truly global economy. The global bull market of the mid to late 1990s was led by an American economy, which experienced real GDP growth of 36% between 1990 and January 2000 (Source: data360.org, a non-partisan organization), padding the wallets of many Americans and leading to a debt-fueled spending binge that is partially to blame for the crisis we are currently in. Some scholars have pointed to this decade as the truly second coming of globalization; however I believe it would be better classified as an “Americanization” as we were the primary source of many nations economic growth, both developed and developing, through our purchases of their manufactured goods, and most importantly their raw materials. The new dawn of globalization came in the 2000s and in no better way is this illustrated then through the effects that the subprime mortgage collapse has had on all economies of the world, further magnified by the world’s credit markets freezing. Countries thought to be isolated from the U.S. economic decline have defaulted on their debt, had their credit ratings downgraded, and their currencies have been on the verge of collapse as investors flee to safer securities and central banks step in to attempt to stem the tide through the use of their central reserves. When American investors appetites for CDOs and ABSs appeared to be full, Wall Street firms turned to international investors, flush with petrodollars and buoyed by their

18 own country’s economic growth, to continue purchasing the securities that Wall Street firms were churning out by the second and investors located in all corners of the globe were more than happy to oblige. The dangers of purchasing CDOs and ABSs originating in the U.S. was that investors didn’t know one lick about the assets that these securities were based upon, they didn’t know if the homes were palaces fit for a king or shacks that would seem more suited for the slums of Dhaka. They didn’t know what the borrower’s household income was, whether it was a real figure or one made of pixy dust. They didn’t know if the loan was based upon a real appraisal or one pulled from the Internet. These investors just assumed that if a reputable Wall Street firm whose reach stretched worldwide underwrote the securities, that it must be considered a safe investment. With these securities carrying yields several points higher then traditional bonds, investors gobbled up as many securities as they could possibly afford and continued Wall Street’s reckless practices. The global reach of the financial crisis began when CDOs that countries had purchased from Wall Street firms started to default, causing huge losses both within Wall Street and abroad at hedge funds and banks. Just a month after Bear Stearns’ two hedge funds filed for bankruptcy, an Australian hedge fund called Basis Yield Alpha Fund filed for bankruptcy protection in July 2007. Its lenders included who else but “Citigroup, JPMorgan Chase, Lehman Brothers, and Merrill Lynch. In its bankruptcy filing, Basis Yield Alpha Fund cited mounting losses from subprime mortgage assets” (30) sold to them by investment bankers in the U.S. Banks that were once thought to be on a sound economic foundation began to either fail or require capital injections made by their respective governments, all because of their exposure to subprime CDOs. In France, one

19 bank took a $3 billion loss and in Germany, “the government was forced to merge two ailing banks because of their subprime investments” (31). In September of 2008, the Irish Government undertook a two-year guarantee arrangement to safeguard all deposits in six Irish banks; the economic union of Belgium, Luxembourg, and the Netherlands was driven to invest “$16.3 billon in Fortis, a huge banking and finance company that was partially nationalized under the plan” (32) after sustaining record losses and investor confidence having crumbled. Iceland’s economy collapsed after experiencing difficulty in their attempts to refinance short-term debt. Though the fallout continues to this day, this much is known: the national currency has plummeted, foreign currency transactions were literally suspended for weeks, the market capitalization of the Icelandic stock exchange fell by 90% and the government was forced to nationalize Glitnir bank. While scholars and economists debate the causes of Iceland’s collapse, it is readily accepted that due to reckless borrowing by Iceland’s newly deregulated banks, when they were unable to refinance their debt on the interbank lending market, the debts expired, leading to the collapse of the banks. Because these banks were so much larger then the national economy, the hands of the Central Bank of Iceland and the national government were effectively tied, and the damage was done. Developing nations were not isolated from the chaos going on many time zones away. With the world’s developed nations economies in free-fall, consumer demand for the items these nations produced went into a nose-dive, as evident by China’s export total to the U.S. dropping 14% in 2007 (source: The US-China Business Council). Shipping rates, once sky-high due to the growing price of fuel, plummeted and the demand for raw

20 materials crashed as companies were producing less and less manufactured items. The crisis had reached epic proportions and no one was left unaffected. These examples show that it was not only Wall Street firms who were on cloud nine from past profits. Corporate institutions worldwide saw the money that these firms were printing and wanted a piece of the action themselves; what they got was definitely something more then they bargained for. While the blame for the global economic crisis resides predominantly in the United States, it is a fair statement to make that we buried some of our garbage overseas. Nothing exemplifies this better then the following blurb uttered by an investor in Abu Dhabi: “he said to the Wall Street firm that sold him the CDOs: ‘How come I’m losing money? It’s triple-A rated.’ The Street firm just crapped all over him” (33). The preceding six sections of this paper were written to provide the reader with a general conceptual timeline of how the subprime mortgage fiasco unfolded, who the major players were, the results of their reckless actions, and how it has affected companies, governments, and individuals in all corners of the globe. But as I have been writing this over the past ten weeks, the same question continues to pop up inside my head: what started and enabled this reckless subprime mortgage binge that has basically caused the collapse of home prices and subsequently brought the U.S. economy and with it, the global economy on the verge of disintegration? On the surface, it would appear that first-time borrowers, loan brokers, mortgage lenders, Wall Street firms, and investors all bear some responsibility for the subprime collapse and they rightfully do. But who were the facilitators behind the boom of subprime mortgages, who enabled this reckless lending practice to continue to take place even as the foundation was beginning to show

21 signs of cracking? And the answer I keep coming back to is the U.S. government and its regulatory agencies. By cutting interest rates to levels historically low for a wartime nation and by continuing to champion free market monetary policies, the U.S. government, beginning with the Reagan Administration and ending with the Bush Administration in 2008, allowed these lending practices to begin, prosper, and implode, sitting on the sidelines for much of the time and taking action only when it was too late to stem the tide of red ink gushing from American households, Wall Street, and corporations not even involved in the lending business. As evident from the previous section of “A brief history of the subprime mortgage”, the U.S. government became the enabler for lower-income Americans to achieve the American Dream of becoming a homeowner. It is my belief that if it wasn’t for the U.S. Department of Housing and Urban Development (HUD) directive that Fannie Mae and Freddie Mac must purchase a set number of mortgages from borrowers with household incomes below the median in their area, that a majority of these risky borrowers would have never signed on the dotted line for mortgages that enticed them with low initial payments and no money down at closing only to hike up the interest rates a few years down the line. Through this directive and mortgage lenders use of extremely risky income verification tools such as stated income applications and no due diligence required, first-time homeowners were setting themselves up for trouble. This trouble was further inflated by the Federal Reserve efforts to keep interest rates low, allowing the spigot of cheap credit to flood the U.S. economy, and making it more affordable for borrowers to drown themselves in initially cheap debt, rack up credit

22 card bills with no possible way of repayment, and to continue a abysmal savings rate that turned negative in 2005, the only one of the developed world. With the Bush Administration embracing free market capitalism with open arms, the regulatory agencies that were in charge of preventing such a bubble from happening began to implement a “hands off” approach, believing that as long as home prices continued to rise that it was not plausible for the bottom to fall out of the housing industry and consequently the U.S. economy as well. Though it is fair to say that Federal regulatory agencies did not have any laws in place to prevent such reckless lending practices and that lenders were not breaking any laws beyond common sense, there apparently was a culture of “don’t ask questions” within the walls of the SEC and the CFTC, furthering the era of free market capitalism and lack of government intervention within the U.S. economy. Regardless of the roles that borrowers, loan brokers, mortgage lending companies, Wall Street firms, and the investors who purchased these securities played in the subprime mortgage boom and collapse, the U.S. government is where the buck eventually stops. The irresponsible lending practices and securitization of these loans were all facilitated by the U.S. government, hell bent on continuing the impressive economic growth achieved in the late 1990s and into the late 2000s, the terrorist attacks of 9/11 only being a minor speed bump. Yet it was this same government that eventually realized the sheer enormity of the problem that they helped facilitate and unleash. It is the government’s responses to this problem that I now turn to.

VII. Governmental Response.

23 The U.S. Government’s response to the subprime mortgage crisis and consequent global financial crisis has been spotty at best, with a number of the ailments it has prescribed failing to stem the tide of negative economic news that continues to pour through the airwaves. This flow of bad news has spread internationally, as other government’s of the world deal with bank failures, negative GDP growth, currencies plummeting, and defaults on debt issued during the boom times of the early 2000s. The U.S. Federal Reserve’s responses to the subprime mortgage crisis have centered on what Chairman Ben Bernanke called “efforts to support market liquidity and financing and the pursuit of our macroeconomic objectives through monetary policy” (34). The Federal Reserve has lowered its target federal funds rate from 5.25% to 2% and its discount rate from 5.75% to 2.25% ending in April of 2008 in order to encourage lending between banks and to individual borrowers. These rate cuts have increased lately, in fact they are effectively at 0% now, yet the thawing of credit markets has been lethargic at best. With these actions not helping the credit markets, the Federal Reserve increased the monthly amount of loans made to banks, to a cumulative total of “$1.6 trillion of loans made to banks for various types of collateral” (35) by November 2008. The Federal Reserve in November of 2008 announced a “$600 billion program to purchase MBSs of Fannie Mae and Freddie Mac” (36) in an effort to help lower mortgage rates and stabilize Fannie and Freddie’s balance sheets. With these initiatives in place, it soon became apparent that more was needed, especially in the regulatory realm. Congress soon approved an expansion of Federal Reserve regulatory powers, allowing the Federal Reserve to have jurisdiction over nonbank financial institutions and the authority to intervene in financial crises. New

24 regulations have been proposed recently to subject nondepository banks to the same capital requirements as of depository banks and regulation regarding restrictions of the leverage used by financial companies, leading Alan Greenspan to propose that banks should have a 14% capital requirement ratio, much above the historical 7-11% ratio employed by many banks. The underlying problem of these proposed regulations which has led to much debate in the financial world and Congress is the potential for overregulation, retarding future economic growth and profits, the effects of which would be felt by many ordinary households and individuals. These cries of too much government intervention have not squashed the government’s role in this crisis, evident from the proceeding paragraph. The government’s response to this economic crisis has centered on three things: Federal Reserve monetary policy and new regulations, economic stimulus packages, and government-led takeovers of some of the biggest financial institutions of the world. President Bush signed into law a $168 billion economic stimulus package on February 13, 2008 that primarily consisted of income tax rebate checks designed to get consumers spending again. This inflow of government money into consumers’ wallets did little to help the economy as gas and food prices continued to skyrocket, largely negating the gains that consumers had received and renewing calls for more government action to help the economy; that help eventually came in some unexpected places. With the government’s assistance facilitating JPMorgan Chase’s purchase of the beleaguered investment bank Bear Stearns, it began a period of government economic intervention unseen since the Great Depression. The Federal government seized IndyMac Bank’s assets after it collapsed; Fannie Mae and Freddie Mac were placed into federal

25 conservatorship after both banks were on the verge of going bust, and insurance giant AIG received an $85 billion loan from the Federal Reserve in September 2008, giving the Federal government a 80% equity stake in AIG. Since September 2008, AIG has received more money from the government and it has been estimated that it could eventually cost taxpayers “$250 billion due to its critical position insuring toxic assets of many large international financial institution through credit default swaps” (37). Yet the trouble continues: the USA Office of Thrift Supervision (OTS) seized Washington Mutual in September 2008 and its assets were later sold to JPMorgan Chase. For reasons that remain highly debated, the Federal Reserve, in the midst of all these government bailouts, let Lehman Brothers slip into bankruptcy after talks to purchase the company failed with Bank of America and Barclays, citing losses too big to absorb. With losses on MBSs and other assets continuing to skyrocket at a numerous financial institutions and the freezing of the credit markets, the Emergency Economic Stabilization Act of 2008 (EESA or TARP) was signed into law by President Bush on October 3, 2008. This law included $700 billion in funding for TARP, which was intended to purchase financial institutions’ MBSs and CDOs that were backed by now toxic sub-prime mortgages. The U.S. Treasury began to inject funds into financial institutions in exchange for dividend-paying, non-voting preferred stock. Major financial companies that have since received money on multiple occasions include Citigroup, Wells Fargo, JPMorgan Chase, Bank of America, Goldman Sachs, Merrill Lynch, and Morgan Stanley. Yet with write-downs on losses increasing, a hesitancy to lend continues to persist within the banks and it is apparent that more action will be needed. Under President Obama, Treasury Secretary Timothy Geitner has revealed plans that, though

26 details remain murky, aim to increase these financial institutions solvency and get them to begin lending again through the use of more taxpayer money. The U.S. government has not been alone in the realm of government intervention and takeovers: the British government has nationalized and provided bailout money to multiple banks including RBS, the Australian government has approved measures to lend “AU$4 billion to nonbank lenders unable to issue new loans” (38), the Chinese government has approved a stimulus package of roughly $600 billion and various European governments including Ireland, Denmark, France, and Belgium have also approved government bank bailouts and stimulus packages. With the signing into law President Obama’s $787 billion stimulus package that includes large spending increases and tax cuts, it appears that the U.S. government has begun to obtain a grip on the economic crisis, though it remains to be seen just how soon the effects of the stimulus will be felt and unknown when the economy will begin to recover. What is readily apparent though, is that the regulatory agencies of the G-10 countries should be given more power to monitor the types of securities that multinational financial institutions are writing and selling in the market. The calls for caps on executive compensation for companies who receive bailout money should be put into place; it is ludicrous that companies who have received taxpayer money be allowed to issue billions of dollars in bonuses when the company itself is hemorrhaging money at an alarming rate. At any rate, there must be prevention methods put into place that prevents a global economic collapse from happening like this again; economies operate in cycles, this much we know, but it is the duty of citizens and governments of the world to work together to ensure that nothing like this ever happens again.

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VII. Prevention Methods. There have been many prevention methods voiced in the media on how to thwart such an economic meltdown from happening again. Members of Congress, past and present Federal Reserve Chairmen’s, current and former CEOs and CFOs of financial corporations, economists, and academic scholars have all voiced their opinions on how to ensure a economic collapse like this never reoccurs. Yet the only thing these opinions have in common is that no majority of American businesses or consumers agree with their suggestions. The only thing that these suggested solutions have accomplished is creating more public bickering and U.S. government’s continued dragging of their feet on the issue. I believe this is the case because no one in the U.S. Senate or House of Representatives wants to admit that the policies they championed and agencies they had oversight of were to blame for the mess we are in. Until a group of powerful and respected elected officials say, “I don’t care if I am up for reelection, the truth needs to be told in order for us to move on”, we will never have a strong consensus on the matter. The solutions I have devised will not come cheap, nor will they likely be popular among financial corporations and their respected investors. But it is my personal belief that the market forces encoded in our economy’s DNA have failed us and that we must take a more “hands on” and integrated approach to ensure that we do not find ourselves in this situation ever again. Some may call me a Socialist; others perhaps will claim I don’t have any regard for the American Dream. Yet the reality is that we now live in times exponentially different from the ones when the U.S. economy developed its main traits and ideologies; our laws, guidelines, regulations, and principles must change in order to

28 maintain responsible economic growth in the 21st century. Yet, it must be ensured that these integrated measures be of appropriate scale in order to ensure our economy once again becomes an efficient and well-oiled machine, capable of carrying out the innovation and prosperity that it once was known and envied for around the globe.

Solution #1: Tighter Lending Standards.

Yes, Wall Street banks will scream, beg, plead, and lobby their hearts out in Washington D.C. but it is something that must be done to prevent future irresponsible lending. While I do not advocate the elimination of GSEs like Fannie Mae and Freddie Mac, I do believe that the sooner America and its elected officials realize that the American Dream of owning a home is not for everyone, the better off we will be. We should have uniform minimum lending standards implemented across the board that would be clearly defined and void of any loopholes that would enable financial institutions to return to the reckless lending practices that have defined this crisis. These standards should be based on the five C’s of credit, which are capacity (borrower’s legal and economic capacity to borrow), character of the borrower, capital (invested and reinvested cash flows), available collateral, and conditions of the loan (economic climate, state of the industry etc.), with the Federal Reserve in charge of enforcing these standards. For starters, all borrowers should be required to show proof of income verification through multiple sources including tax returns, payroll checks, and bank statements. Loan officers must conduct a credit bureau investigation of the borrower to

29 review his or her current credit rating, past credit history, and other historical financial information to gain an insight into the borrower’s fiscal discipline and history. The practice of loan securitization should not be eliminated; rather lenders who lend to borrowers deemed overtly risky by the bank through the use of credit checks, income verification, employment history etc. should not be allowed to package these loans and sell them to investors across the globe, it negates the lender of any fiscal responsibility and puts an unfair burden on the investors. Instead, lenders who are inclined to making riskier loans to borrowers who fail to meet the minimum requirements or are not up to par in one of the five C’s of credit should be required to retain the loan on their books until its maturity, making them individually responsible for their actions. Most professional money managers agree that a homeowners monthly mortgage payment (principal, interest, insurance, taxes) consist of no more than 30% of their monthly gross income, and because of this, borrowers should be subject to a uniform ratio that would consist of the home price over the borrower’s income: if the ratio is beyond the 30% threshold, the lender may be permitted to make the mortgage but not be able to sell the loan to securitization firms, making them again individually responsible for their actions. Though tighter lending standards are necessary, it doesn’t mean the death of the adjustable-rate mortgage (ARM). Recently the FDIC sought public comments on subprime mortgages and a majority of respondents including Citigroup agreed with the FDIC’s suggestion that tighter lending standards should be put in place. It would be beneficial to both borrowers and lenders if the FDIC enacted a mandatory lifetime and one year maximum cap and floor on interest rate increases. This would provide an incentive structure conducive to lenders desired outcomes as well as enabling borrowers

30 ability to obtain financing and an avoidance of the “bait and switch” pitfall many borrowers find themselves in after the interest rate adjusts. Though the purpose of the ARM is to shift any potential interest rate risk to the respected borrower, I still believe the enactment of a minimum time period for the resetting of the loan’s interest rate would be beneficial to both the borrower and the lender. A minimum time period of six months to one year would give the borrower an ample amount of time to come up with the additional income needed as well as provide default protection for the lender. The instituting of an interest rate cap and floor, and a minimum time period would achieve the desired eradication of “teaser rates” that are obscenely low, protecting both borrowers and lenders. A measure that is sorely needed is for the elimination or reduction of the Housing and Urban Development Department’s mandate that GSEs purchase a certain percentage of their loans from borrowers whose household income is below the median in their area. There is nothing wrong with the purchase of these loans; what must be established is a series of due diligence performed to establish whether or not the borrower has the capacity to repay. If the government insists that GSEs continue to purchase loans from borrowers who meet their requirements, they could possibly set up a program mirroring the government-backed SBA loans that banks currently make. These loans would be guaranteed by the Federal Government up to a 75% level, with the lender responsible for the rest. The program would back loans only for borrowers who were unable to obtain conventional financing and if the lender is not comfortable with carrying 25% of the loan value on its books as the sale of these loans would be banned, then the potential borrower would be rejected and as a result of this, loan defaults would likely decline.

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Solution #2: Creation of new Regulatory Agencies I believe the SEC must be eliminated or dismantled: its inability to even remotely foresee the irresponsible lending and securitization practices of financial corporations during the last ten years suggests to me that it is a government agency that needs to be dissolved. Even the events that the SEC foresaw were not acted upon, primarily because a majority of its agents and officers once worked in the industry that they were in charge of regulating, creating enormous conflicts of interest. Reform is not the answer to solving the SEC’s woes; it has been done in the past and nothing worthwhile or constructive has been the result. Rather, the SEC needs to be broken into two components to eliminate the problems of regulatory forbearance and conflicts of interests in order to be able to correctly perform its regulatory duties. I propose that a specific regulatory agency similar in structure and scope to the Federal Reserve and the FDIC, with oversight being handled by a non-partisan organization be created for the sole purpose of regulating all U.S. based lending activities and the financial securities firms produce. This agency would be in charge of enforcing all lending regulations and have the ability to file charges and prosecute all suspected violators without having to go through any legislative committees or other regulatory agencies. In order for this agency to be run in an effective, efficient, and most importantly, an independent manner free of Congressional officials and budgets, it would obtain its operational funds from mandatory membership fees paid by the financial firms themselves. According to the U.S. Chamber of Commerce, the SEC has oversight of the 17,000 publicly traded companies in the United States, with the SEC’s 2008 fiscal budget

32 containing $906,000,000 dollars (39); annual fees would be based upon a percentage of the company’s total assets as to not unfairly burden smaller corporations with excess fees, yet still ensuring the agency with enough resources to regulate the larger institutions. Though it has been suggested in recent news articles that this responsibility should fall to the Federal Reserve and the FDIC, I do not think this would be immediately beneficial as the Federal Reserve and the FDIC are already bogged down with TARP related activities and the recently announced toxic asset purchase programs. The consolidation of this new agency with the Federal Reserve would give rise to potential conflicts of interest as well as the Federal Reserve’s responsibility is the regulation of financial intermediaries and the government’s monetary policy, it is plausible to believe that powerful financial companies could influence decisions made regarding to changes in the Federal Reserve’s monetary policy or regulations, leading to detrimental decisions. Also, if consolidation were to occur, it is possible that the expanded Federal Reserve would become too large and influential, negating the checks and balances of our government. Nonetheless, I believe this newly created agency would be able to streamline the regulatory process, allow for greater and more efficient oversight, and most importantly reduce the bureaucratic red tape that the SEC finds itself covered in. The second agency that I propose the Obama Administration creates is one solely devoted to the regulation of publicly traded companies in the U.S. This agency would be in charge of monitoring the accuracy of any financial information these companies publish, ensuring corporations follow the accounting rules and methods already established, and protect outside investors from insider trading. To ensure that the agency is run in an efficient manner, I think it is prudent that its top management answer to only

33 one Senate and House committee and the President himself, similar to the way the Federal Reserve is operated. To avoid the “purse-strings” of Congress, a separate fee would be required of all publicly traded companies, again based upon a percentage of a corporation’s total assets, in order to fund this second agency independently. Though I suggested previously that regulatory agencies of the G-10 countries need to be given more oversight over their respected national corporate activities, I do not believe that a jointly developed international agency similar to the U.N. Security Council would be prudent as there would be too much time wasted determining the logistical factors necessary for its creation and too many political games likely played. Rather, an early warning system needs to be created to alert the world’s economies of possible systemic risks facing the global financial system. It has become increasingly evident that the practices of the IMF, World Bank, and the Financial Stability Forum cannot perform the task of fostering stability throughout the world as these institutions also perform lending activities that directly conflict with making unbiased analysis and formal judgments. Rather, a “global risk assessor” (40) should be created unbounded from the influences of the enormous economies of the world. This global risk assessor could be staffed by previous Nobel-prize winning economists or respected senior level policy makers which would ensure that their analysis be independent of his or her country of origin and deliver prudent unbiased policy suggestions designed to ensure action is taken before it is too late.

Solution #3: Overhaul of Executive Compensation

34 The executive compensation of U.S. corporations is in dire need for reform, as evident from the recent public outrage over U.S. Government-owned AIG’s paying of $165 million in bonus money to its top employees. However, it must be said that implementing a 90% federal tax on bonuses, mandatory compensation caps, and restricted stock options are not the right solutions to the problem at hand. Rather, executive compensation should be tied to the long-term value of the corporation, as opposed to profit-related goals, which would not eliminate the potential for executives to select risky projects that guarantee short-term profits yet harm the corporation’s longterm profitability. A possible executive compensation plan could consist of an incentives-based package that would reward long-term value creation in the corporation. If the executive were to meet specific year-end goals based not on numbers that can be manipulated with accounting methods, rather a more independent barometer such as EVA, he would become eligible for compensation that would be based upon a sliding-scale foundation determining the total incentive-based compensation package for each year; this to be preapproved by the corporation’s board of directors. To appease the corporation’s shareholders, the total incentive-based compensation package for each year would be payable over a five-year period. If the specific goals were not met in future years, then the corporation would be allowed to “claw-back” the unpaid balance to be paid for that fiscal year and use it to reimburse shareholders for whatever company value was lost due to the unmet goals. Also, it would be prudent to set a judicial review for complaints of excess compensation; if a lawsuit is filed and the plaintiff is victorious, the company and board of directors would be fined and the compensation returned, similar to Sarbanes-

35 Oxley’s requirement regarding financial statement accuracy. This would ensure that the executive and board of directors would continuously behave and lead in the corporation’s best interests and prevent reckless risk taking that harms the corporation’s sustainability.

What not to do. While the preceding sections offers solutions to ensure that a economic crisis like the current one does not happen again, it must be noted that there are certain solutions that we should not pursue as they would further damage the economy, American consumers and businesses, bloat the government even further then it is already, suppress innovation and technology gains, and retard future economic growth. Calls have been made to tighten Federal monetary policy to prevent the cheap credit spigot from ever being turned on again; this spigot was one of the causes of the borrowing boom and debt-ridden households and companies was its end result. This is not a solution to our economic troubles; rather, the Federal Reserve should pursue responsible and moderate future monetary policy that aims to control inflation, make credit available for responsible borrowers, and most importantly contain incentives for households to save their money for the future through possible tax deductions. It would be shrewd as well if the Federal Reserve were granted the powers to properly deflate any possible economic bubble if it was to occur. To determine if a bubble was forming, the Federal Reserve could measure any price increase, market gains, or lending activity against historical figures that occurred during periods of similar economic growth and then act accordingly with increased capital adequacy requirements for corporations and higher restrictions on the amount of money allowed to be borrowed

36 by investors to purchase stock. The current initial margin requirement for purchasing securities, known as the Regulation T requirement (set by the Federal Reserve), is 50% and most brokerage firms employ maintenance requirements for securities at 30% of market value or $3.00 per share, whichever is greater. If the Federal Reserve, in times of possible bubble formation, increased these requirements to 70% and 50%/$3.60 respectively, it would greatly assist the Federal Reserve’s ability to deflate a possible economic bubble. Furthermore, while I believe the Federal Reserve Chairman should continuously consult with the President and his economic advisors, it is in the country’s best interests if Federal monetary policy remains in the jurisdiction of only the Federal Reserve and not influenced by the members of Congress. In addition, some scholars and Congressional officials have voiced their support for the nationalization of banks and government control and regulation of every financial aspect of the economy. While the nationalization of a select number of banks would result in quicker write-downs of the toxic assets they now carry, the wiping out of management and shareholders that I believe should happen anyways, and a lack of conflicts of interest, it could also result in the government nationalizing the entire financial sector which not only would suppress future economic growth but would also subject firms to government standards made by policy makers that have political motivations for short-term economic growth, rather then the proper economic directives of long-term, sustainable growth. It would be prudent also to separate banks based on a function of overall size and have the largest and likely unhealthiest banks subjected to increased capital adequacy requirements in order to limit the size of these institutions and prevent their possible

37 failure, which would lead to a domino effect bringing the entire financial sector down because of the systemic risks these institutions failure poses. It is in the best financial interests of our economy if a tiered capital adequacy requirement system, based on a sliding scale foundation that increases at a consistent rate were put into place that required larger, more leveraged and less financially solvent banks to hold higher capital levels and have lower leverage ratios. As the size of banks decreased, they would be subjected to lower capital adequacy requirements and the ability to employ higher leverage ratios. The sliding scale could be based upon a hyperbolic function that would increase the capital adequacy requirement of banks, as their total assets grew, similar to the graph below with total asset size representing the x-axis and the required capital adequacy rate representing the y-axis.

This would ensure that financial institutions are solvent and would protect the overall economy from the systemic risks and threats that enormous, under-capitalized banks pose. If a bank is deemed by the Federal Government to be “bad” and unable to continue its operations, the government could take over the institution, “clean” its assets and balance sheet, and later re-introduce it to the market and financial sector as a “good” and healthy bank. This would achieve the desired limitations regarding the size of

38 financial institutions and mitigate the probabilities of banks defaulting and ceasing their operations. Reform is badly needed in the financial sector, as I advocated above. Though I believe we should take an integrated approach between market mechanisms and regulatory oversight to this crisis, we must realize that a complete clampdown on the sector would be a mistake. Newly created laws and regulations should determine the desired behavior we seek; these laws and regulations should reward the desired outcomes and punish the undesirable ones. If the possible punishment were significant enough, then this approach would significantly reduce the reckless behavior that is one of the underlying reasons we find ourselves in an economic crisis. The prosperity of the last 25 years, albeit with some hiccups along the way, was partially enabled by the financial sector, enabling small businesses to thrive, innovation to be made, Silicon Valley to rise etc. Since almost the advent of finance there has always been crisis, it is just the nature of the industry. Evident from the past, whether it is a Socialist, Communist, or Capitalistic government and system, attempts to make finance safe always results in disaster, as clever people work around the rules or bend them. We must find the right balance of economic growth and prosperity built upon state-imposed stability and private innovation.

IX. Conclusion. The consequences of an unhealthy and unsustainable domestic housing market have showed their far-reaching capabilities and the detrimental effects these consequences have had on the U.S. and world economies. From recent news reports,

39 various high-profile corporate bankruptcies, staggering job losses, and the personal tales of greed and lack of financial due diligence performed, the message has become clear and concise: the developed nations of the world, and most importantly the United States, need to return to an era of fiscal conservatism and living within our financial means. By no means am I advocating the dissolving of global financial corporations, the instituting of a Socialist economic structure per se, or a firm cap on the amount of wealth an individual or company can obtain. Rather, I believe the current global economic crisis has served us with the golden opportunity to look into the mirror and see what we have become as well as the rare occasion to take a step back and realize that a life of second and third mortgages, annual housing price increases of 20%, credit card debt that totals more then our yearly income, a minuscule savings rate, and a lack of financial planning for the future is not the life we should lead. The effects of globalization will be debated until the cows come home but one effect can not be overlooked: it has pulled millions of people out of relative poverty and installed them with the ability to lead a better life. The United States plays an enormous role in the affairs of the world and people look to our government and citizens for guidance; that is very unlikely to change in the future. We must use the opportunity that this economic crisis has granted us to return to a more sustainable way of life, a more responsible way of corporate behavior, and most importantly, a more efficient way of governing and regulating to ensure that this type of crisis never occurs again and that we learn from our dramatic mistakes for the sake of the global society.

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X. Bibliography. 1-8: Muolo, Paul & Padilla, Mathew: Chain of Blame: How Wall Street Caused the Mortgage and Credit Crisis. 2008 John Wiley & Sons, Inc. Hoboken, New Jersey. 9: Roberts, Russell; How Government Stoked the Mania. Wall Street Journal, October 3rd, 2008. 10: Buying Subprime Securities. Washington Post. June 10th, 2006. 11-12: Muolo, Paul & Padilla, Mathew: Chain of Blame: How Wall Street Caused the Mortgage and Credit Crisis. 2008 John Wiley & Sons, Inc. Hoboken, New Jersey. 13: Executive Incentives, Wall Street Journal. November 20, 2008 14: YahooFinance.com 15: Anderson, Jenny & Dash, Eric; Struggling Lehman Plans to Lay Off 1,500. New York Times, August 28, 2008 16: White, Ben; Lehman sees $3.9 Billion Loss and Plans to Shed Assets. New York Times, September 9, 2008 17: Plumb, Christian & Wilching, Dan; Lehman CEO Fuld’s Hubris Contributed to Meltdown. Reuters.com, September 14, 2008 18: Clark, Andrew & Schor, Elana; Lehman Brothers Chief Executive Grilled by Congress Over Compensation. Theguardian.co.uk, October 6, 2008

41 19-26: Muolo, Paul & Padilla, Mathew: Chain of Blame: How Wall Street Caused the Mortgage and Credit Crisis. 2008 John Wiley & Sons, Inc. Hoboken, New Jersey. 27: Anderson, Jenny; “NYSE Chief is chosen to lead Merrill Lynch”. November 15, 2007. New York Times 28: Muolo, Paul & Padilla, Mathew: Chain of Blame: How Wall Street Caused the Mortgage and Credit Crisis. 2008 John Wiley & Sons, Inc. Hoboken, New Jersey. 29: Shiller, Robert; “Irrational Exuberance 2nd Edition”. 2005; Princeton University Press, Princeton, NJ 30-31: Muolo, Paul & Padilla, Mathew: Chain of Blame: How Wall Street Caused the Mortgage and Credit Crisis. 2008 John Wiley & Sons, Inc. Hoboken, New Jersey. 32: van der Starre, Martijn & Louis, Meera; “Fortis gets EU11.2 billion rescue from Governments”. September 29, 2008. Bloomberg.com 33: Muolo, Paul & Padilla, Mathew: Chain of Blame: How Wall Street Caused the Mortgage and Credit Crisis. 2008 John Wiley & Sons, Inc. Hoboken, New Jersey. 34: Ben Bernanke speech; January 10, 2008. Federalreserve.gov 35: Goldman, David; “Bailouts: $7 trillion and Rising”. November 28, 2008. CNNMoney.com 36: Press Release; “Fed- GSE MBS Purchases”. November 25, 2008. Federalreserve.gov 37: Fox, Justin; “Why the Government wouldn’t let AIG fail”. September 17, 2008. Time Magazine. 38: “Australian Government to fund Non-Bank Lenders”. February 27, 2009. Homeloanexperts.com.au 39: U.S. Securities and Exchange Commission Fiscal Year 2009 Congressional Justification, February 2008. 40: Stern, Nicholas; “The world needs an unbiased global risk assessor”. March 25, 2009. Financial Times pg. 9.

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