Wall Street Executives Background Guide Chair: EagleMUNC Krickett Kazyak Website: Boston College Model [email protected] www.EagleMUNC.org United Nations Conference March 17-19 2017 Wall Street Executives Letters from the Secretariat Delegates, It is my distinct pleasure to welcome you to EagleMUNC V! My name is Kerianne DiBattista, and I am the Secretary-General of EagleMUNC V. I am a senior at Boston College in the Morrissey College of Arts and Sciences majoring in International Studies with a concentration in Economics. I am originally from Long Island, NY, and I have been participating in Model UN conferences since I was in tenth grade, rising to become Head Delegate and Secretary-General of my high school conference. At BC, I travelled to several conferences with our MUN team and I have participated EagleMUNC since my freshman year. As you begin your EagleMUNC V experience, I implore you to explore the conference theme, "The Interplay of Power and Ethics," and make your EagleMUNC experience the best it can be! Thank you, and I'll see you at EagleMUNC! Best Regards, Kerianne DiBattista Secretary-General, EagleMUNC V Dear Delegates, It is my great pleasure to welcome you to EagleMUNC V! My name is Jack Massih and I am the Under Secretary-General of Political Affairs. I am a senior at Boston College studying Political Science and Economics. I began participating in MUN my sophomore year of high school and have been hooked ever since. I joined the EagleMUNC team as a freshman for the first year we moved off BC’s campus and into Boston, and it has been a joy to witness the conference continuously grow and evolve since then. The Political Affairs team has been working incredibly hard to prepare for the most innovative and exciting conference in EagleMUNC history. I am looking forward to seeing all of your creative and thoughtful responses to the diplomatic predicaments and crises you confront over the weekend. Best, Jack Massih Under Secretary-General Political Affairs, EagleMUNC V Wall Street Executives Introduction Message from the Chair Dear Delegates, My name is Krickett Kazyak and I’ll be leading debate in Wall Street Executives this year at EagleMUNC V. I am a junior majoring in Neuroscience, minoring in Chinese and working toward medical school. I am originally from Detroit, MI but grew up in Asia, living in Shanghai for four years and Singapore for a year. I have been participating in Model UN since 6th grade and I look forward to meeting you all, as well as chairing this thrilling committee. Writing this background guide has already gotten me so excited for the conference as this committee holds a very close place in my heart—due to the fall of Wall Street and the economic recession in 2008, my life was uprooted and my family was moved overseas to China. In this fast paced committee we will act as various banking executives, government personnel, and top tier economists starting in the year 2008 trying to manage the entire United States economy under the scrutiny of public eye and federal policy. I look forward to an inspiring debate this spring. Good luck! Sincerely, Krickett Kazyak Wall Street Executives Historical Background A note on the Timeline: The starting date of this Committee is August 29, 2008, all events that have taken place up to that point can be taken as fact, events that transpired after August 29, 2008 may occur differently depending on the actions of this committee. The American Dream The American dream is to become a homeowner and with the explosive growth of the subprime mortgage market just nine years earlier, that dream was a reality. A subprime mortgage is a housing loan that's granted to borrowers with less-than-perfect credit and less-than-adequate savings, often having no credit history whatsoever, making them unable to get a traditional mortgage.12 In 1999, the Federal National Mortgage Association (widely referred to as Fannie Mae) began a concerted effort to make home loans more accessible for those with lower credit to help everyone attain the America dream. 3 According to the Federal Deposit Insurance Corporation (FDIC) 4 , these borrowers are more likely to be bankrupt, delinquent on their payments; have low credit Homeownership: The American Dream scores, and/or low income. These https://gameofroles.files.wordpress.com/2011/12/am erican-dream.jpg 1 “The Fall of the Market”, Investopedia, accessed August 2, 2016 http://www.investopedia.com/articles/economics/09/subprime-market-2008.asp 2 “What is a Subprime Mortgage”, The Balance, accessed July 20, 2016 http://useconomy.about.com/od/glossary/g/subprime_mortg.htm 3 “Fannie Mae Eases Credit To Aid Mortgage Lending”, New York Times, accessed August 7, 2016 http://www.nytimes.com/1999/09/30/business/fannie-mae-eases-credit-to-aid-mortgage-lending.html 4 The FDIC is an independent agency of the Federal government that is not funded by the US congress but is instead funded by premiums from banks. The FDIC insures savings, checking and other deposit accounts and it also examines and supervises about 5,250 banks. It does not insure stocks, bonds, or mutual funds. “Federal Deposit Insurance Corporation”, The Balance, accessed July 20, 2016 http://useconomy.about.com/od/governmentagencies/p/FDIC.htm Wall Street Executives borrowers are considered high-risk and are more likely to default on their loans. Banks, therefore, attached unconventional terms to their mortgages to compensate for the additional risk, including: higher fees, higher interest rates, and variable payment. Generally, the higher interest rates make it too expensive for many subprime borrowers to make monthly payments. The advent of interest-only loans helped to lower monthly payments so subprime borrowers could afford them.5 It increased the risk to borrowers, however, because the initial rates usually reset after one, three or fives years. In 2002, the government-sponsored mortgage lenders Fannie Mae and Freddie Mac had extended more than $3 trillion worth of mortgage credit.6 The role of Fannie and Freddie is to repurchase mortgages from the original lenders and ideally make money when the mortgages are paid. In the up-trending market that existed from 1999 through 2005, these mortgages were virtually risk-free. A borrower, despite the low mortgage payments, had positive equity since the home increased in value since the purchase date and could just sell the home for a profit if they could not afford future higher payments. However, in the event of a housing market downturn, owners would go into a negative equity situation, making it impossible to sell. 7 As the Wall Street Executives, a committee of banking executives, financial gurus and federal regulators, it is your job to put your considerable economic resources and knowledge to work to try and weather the coming storm. However, in the cut- throat world of Wall Street, you always have to be aware of whether or not someone has your best interests at heart, and if you are making the best deal possible for your organization. In the backdrop of this high stakes game, the fate of the American economy may well hang in the balance. Subprime Mortgage Crisis Subprime mortgages were one of the major causes of the subprime mortgage 5 “What caused the Subprime Mortgage Crisis”, US Economy, accessed July 20, 2016 http://useconomy.about.com/od/criticalssues/tp/Subprime-Mortgage-Crisis-Cause.htm 6 “The Fall of the Market” 7 “The Reality of Investment Risk”, Financial Industry Regulatory Authority, accessed August 6, 2016 http://www.finra.org/investors/reality-investment-risk Wall Street Executives crisis. Hedge funds8 found they could make significant money buying and selling mortgage-backed securities (MBS). A MBS is a pool of mortgages grouped into a single security, often bundling subprime mortgages with high-quality conventional mortgages.9 Investors benefit from the premiums and interest payments on the individual mortgages a MBS contains. This market is highly profitable as long as home prices continue to rise and homeowners continues to make their mortgage payments. However, when housing prices begin to plummet and homeowners start to default on their mortgages, the risks become all too real. 10 The hedge-fund traders divided these MBS bundles into different components, called tranches.11 They put all the low-interest payments from the first three years of the Percent of Subprime Mortgages in the Housing Market https://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf 8 A hedge fund is a limited partnership of investors that uses high-risk methods, such as investing with borrowed money, in hopes of realizing large capital gains. ”Hedge Fund”, Oxford Dictionaries Online, accessed August 6, 2016 http://www.oxforddictionaries.com/us/definition/american_english/hedge-fund 9 “The Financial crisis inquiry Report”, United States Government Publishing, accessed August 9, 2016 https://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf 10 “The Fall of the Market” 11 “What caused the Subprime Mortgage Crisis” Wall Street Executives subprime mortgages in with the low-interest payments of conventional loans. The high-interest payments were bundled into tranches that appeared to be riskier because they were high yield. To top it off, they sold insurance against any default, called credit default swaps (CDSs).12 However, unlike the insurance market, the market for credit default swaps was unregulated. Thus, there was no requirement that issuers of CDS contracts maintain enough money in reserve to pay out under worst-case scenarios, such as an economic downturn.13 The popularity of mortgage-backed securities meant hedge fund traders needed more and more actual mortgages to feed the demand.