Financial Terms: Stress Test, Toxic Assets, Debt Equity Swap, “Haircut”, Zombie Banks, Predatory Lenders,
Sub-Prime Mortgages, Hedge Funds, Trillion
A new lexicon (vocabulary) has emerged over the last eight months or so, as a result of the “economic downturn” (recession). One gets the feeling that Wall Street, financial institutions and the government toss out words and phrases not commonly used in everyday vernacular (conversation) in order to avoid explaining what is really going on!
Therefore, I have compiled a simplified, handy-dandy vocabulary list of financial terms you should know.
STRESS TEST: Technically, the tests are meant to give the public (especially the investing public) some much-needed clarity on the actual health of the U.S. banks, and restore faith in the banking system. The test is to determine if the banks can tolerate a worst-case economic scenario – worse than we already have, that is. (BusinessWeek)
TOXIC ASSETS: Example: A house loan is given by a bank with the house as collateral. The bank giving the loan now has “mortgage paper” which is an asset. They can sell the mortgage to anyone they wish, who will then receive the payments plus interest. However, if the homeowner defaults on the loan, and the house is devalued, as in a recession, the mortgage paper is now illiquid (can't be sold for its full value) and becomes a “toxic asset”.
DEBT/EQUITY SWAP: Specified shareholders are given the right to exchange debt for a predetermined amount of equity (or stock), usually at current market rates. An equity/debt swap is just the opposite. The exchange of stock for a predetermined amount of debt (i.e. bonds) in the same company. (Investopedia)
“HAIRCUT”: Old meaning: Actually getting your hair cut at the barbershop or salon. New meaning: Banks sell big blocks of debt, i.e. leveraged loans and high-yield bonds, to private equity firms, but well below par. In other words, at a big loss, therefore “taking a haircut”.
ZOMBIE BANKS: A Zombie Bank refers to a financial institution with an economic net worth that is less than zero, but which continues to operate because its ability to repay its debts is shored up by implicit or explicit government credit support. A zombie bank keeps draining bailout capital from the government but doesn’t respond with any meaningful lending that helps the economy recover. (NPR)
The Treasury Department could make a horror movie right now about all the zombie banks they are supporting.
PREDATORY LENDING: Describes unfair, deceptive, or fraudulent practices of lenders during the loan origination or mortgage servicing process. Think CountryWide Financial, Ameriquest Mortgage and New Centrury Financial.
SUBPRIME MORTGAGE: A type of mortgage that is normally made out to borrowers with lower credit ratings. As a result of the borrower's lowered credit rating, a conventional mortgage is not offered because the lender views the borrower as having a larger-than-average risk of defaulting on the loan. Lending institutions often charge interest on subprime mortgages at a rate that is higher than a conventional mortgage in order to compensate themselves for carrying more risk. (Investopedia)
Predatory Lending and Subprime Mortgages often go hand-in-hand as they did during the last eight years, helping to create our current economic crisis. Predatory lenders tend to target the less educated, racial minorities and the elderly, often enticing them to obtain a subprime mortgage they cannot afford, thus leading to foreclosure.
HEDGE FUNDS: Legally, hedge funds are most often set up as private investment partnerships that are open to a limited number of investors and require a very large initial minimum investment (think: super rich), which must be left in the fund for a least one year. Hedge funds are similar to mutual funds in that investments are pooled and professionally managed, but differ in that the fund manager makes speculative investments. Also, for the most part, hedge funds (unlike mutual funds) are unregulated because they cater to sophisticated investors (supposedly). Have you noticed lately how many “sophisticated” hedge fund managers have been arrested for fraud and using the fund as their personal bank account? Ahh, well, those investors didn’t want any regulations. (Investopedia)
TRILLION: The new million.
Drop these words into a casual conversation. Example: “Did you see where B of A took a real haircut the other day?” or “Citibank is definitely a zombie!” If the person you are talking to doesn’t understand, make a highly audible sigh and say, “It’s really too complicated to explain,” then walk away quickly, shaking your head before you are asked to really explain what it means.
Cheri Cabot, Politics Correspondent
Cheri’s column, “Personal About Politics,” published every week, will reflect on how the life of a 59 year-old, middle class woman is affected by politics, policy and the current state of the nation - a look at the personal aspects of politics. Her column is part of Gather Essentials.
Cheri is a freelance writer, living in Southern California. She has two grown children, one in Iowa and one a recent graduate of Columbia University, and is the proud grandmother of two. Cheri is also a purveyor of fine coffee, warm chatter and dry wit.
You can find all of Cheri’s columns on Personal About Politics at www.personalpolitcs.gather.com, The Obama Watch at theobamawatch.gather.com or her home page here, www.ccabot.gather.com.