How did the banks make money in the financial crisis

Why are bank profits so high? We will go through a few reasons: higher interest rates, better loan performance and higher non-interest related charges. As we explain in our recent blogbank basically makes money by borrowing from you via deposits and lending to those that need a mortgage or another type of loan. As Fed has been increasing short term interest rates sincethe rate at which banks lend has gone up, while banks have not increased your deposit rate. We explain why that happens in our other recent blog. However, the result of that is that banks can pick up a greater difference in rates between hwo they borrow and at what rate they lend. The second contributor to better bank profits is better loan performance.

What Really Caused the Crisis?

Over the short term, the financial crisis of affected the banking sector by causing banks to lose money on mortgage defaults, interbank lending to freeze, and credit to consumers and businesses to dry up. Before the financial crisis hit in , regulations passed in the U. Starting in , Fannie Mae and Freddie Mac purchased huge numbers of mortgage assets including risky Alt-A mortgages. They charged large fees and received high margins from these subprime mortgages, also using the mortgages as collateral for obtaining private-label mortgage-based securities. Many foreign banks bought collateralized U. When increasing numbers of U. Banks stopped lending to each other, and it became tougher for consumers and businesses to get credit. With the U. In hopes of averting another financial crisis, in December of , the international Basel Committee introduced a set of proposals for new capital and liquidity standards for the global banking sector. The reforms, known as Basel III, were passed by the G in November , but the committee left it to member nations to implement the standards in their own countries. In the U. The legislation also created the Financial Stability Oversight Council, to include the Federal Reserve Bank and other agencies for the purpose of coordinating the regulation of larger, «systemically important» banks. The council can break up large banks that might present risk because of their sizes.

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Ten years ago, the economy broke, and today America is a much different place. For the past year, Marketplace has been reporting on how the financial crisis changed the country. The crisis led to an unprecedented wave of consolidation in an already coalescing industry, as floundering institutions like Bear Stearns and Merrill Lynch were gobbled up by giants like Bank of America and JPMorgan Chase. Do you like the convenience of being able to take out money at an ATM overseas or even over state lines? You can thank bank consolidation for that. Do you like being able to deposit a check by taking a photo on your smartphone? You can thank bank consolidation for that, too. Once banks were allowed to operate over state lines, they began to gobble each other up. Bigger banks now offer more perks and conveniences because they have to fight for your business. How do we know? Because the Dodd-Frank Law makes future bailouts illegal. Former Sen. Chris Dodd and former Rep. Barney Frank told us themselves:. Barney Frank: Not only politically could you not get away with what we were able to do in , but legally you cannot do it.

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They created interest-only loans that became affordable to subprime borrowers. Housing prices started falling as supply outpaced demand. That trapped homeowners who couldn’t afford the payments, but couldn’t sell their house.

When the values of the derivatives crumbled, banks stopped lending to each. The repeal allowed banks to use deposits to invest in derivatives. Bank lobbyists said they needed this change to compete with foreign firms. They promised to only invest in low-risk securities to protect their customers.

It specifically exempted trading in energy derivatives. Who wrote and advocated for passage of both bills? He listened to lobbyists from the energy company, Enron. His wife, who had formerly held the post of Chairwoman of the Commodities Future Trading Commission, was an Enron board member. Big banks had the resources to become sophisticated at the use of these complicated derivatives.

The banks with the most complicated financial products made the most money. That enabled them to buy out smaller, safer banks. How did securitization work? First, hedge funds and others sold mortgage-backed securitiescollateralized debt obligationsand other derivatives. The hedge fund then bundles your mortgage with a lot of other similar mortgages.

They used computer models to figure out what the bundle is worth based on several factors. The hedge fund then sells the mortgage-backed security to investors. Since the bank sold your mortgage, it can make new loans with the money it received. It may still collect your payments, but it sends them along to the hedge fund, who sends it to their investors. Of course, everyone takes a cut along the way, which is one reason they were so popular.

It was basically risk-free for the bank and the hedge fund. Thanks to this insurance, investors snapped up the derivatives. As the demand for these derivatives grew, so did the banks’ demand for more and more mortgages to back the securities.

To meet this demand, banks and mortgage brokers offered home loans to just about. Banks how did the banks make money in the financial crisis subprime mortgages because they made so much money from the derivatives, rather than the loans themselves. Banks hit hard by the recession welcomed the new derivative products. The payments were cheaper because their interest rates were based on short-term Treasury bill yields, which are based on the fed funds rate.

But, that lowered banks’ incomes, which are based on loan interest rates. With such cheap loans, many people bought homes as investments to sell as prices kept rising. Many of those with adjustable-rate loans didn’t realize the rates would reset in three to five years.

Inthe Fed started raising rates. By the end of the year, the fed funds rate was 2. By the end ofit was 4. By Junethe rate was 5. Homeowners were hit with payments they couldn’t afford. Housing prices started falling after they reached a peak in October That was enough to prevent mortgage-holders from selling homes they could no longer make payments on. The Fed’s rate increase couldn’t have come at a worse time for these new homeowners.

Deregulation in the financial industry was the primary cause of the financial crash. It allowed speculation on derivatives backed by cheap, wantonly-issued mortgages, available to even those with questionable creditworthiness.

Rising property values and easy mortgages attracted a lot of people to avail of home loans. This created the housing market bubble. This burst the bubble in Since home loans were intimately tied to hedge funds, derivatives, and credit default swaps, the resounding crash in the housing industry drove the U.

With its global reach, the U. To prevent this, the U. The financial crisis has similarities to the stock market crash. The New York Times. Markets Stock Market. By Kimberly Amadeo. Article Table of Contents Skip to section Expand. The Growth of Subprime Mortgages. Raised Rates on Subprime Borrowers. The Bottom Line. Article Sources. Continue Reading.

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They created interest-only loans that became affordable to subprime borrowers. Housing prices started falling as supply outpaced demand. That trapped homeowners who couldn’t afford the payments, but couldn’t sell their house. When the values of the derivatives crumbled, banks stopped lending to each. The repeal allowed banks to use deposits to invest in derivatives. Bank lobbyists said they needed this change to compete with foreign firms. They promised to only invest in low-risk securities to protect their customers. It specifically exempted trading in energy derivatives. Who wrote and advocated for passage of both bills? He listened to lobbyists from the energy company, Enron. His wife, who had formerly held the post of Chairwoman of the Commodities Future ,oney Commission, was an Enron board member.