Glossary

Credit Crisis Glossary

It can be hard to keep track of all the jargon and names in the news these days, but with our handy credit crisis glossary you'll be able to understand all the latest developments. Just click on the words below for quick and easy explanations.

Barney Frank
Barnett “Barney” Frank is a Democratic congressman from Massachusetts, and the Chairman of the House Financial Services Committee, which oversees industries including banking, insurance, and housing.
Basis Point

A basis point is a unit that is equal to 1/100th of a percentage point. It is frequently used to express percentage point changes of less than 1%. It is common practice in the financial industry to use basis points to denote a rate change in a financial instrument (such as a bond).

For example, a rate change from 6.7% to 6.9% reflects a change of 0.2 of a percentage point or 20 basis points.

Ben Bernanke
Ben Bernanke is the Chairman of the Board of Governors of the United States Federal Reserve. Before taking office in 2006, he was a professor of economics at Princeton University. Bernanke has worked closely with Treasury Secretary Timothy Geithner in coordinating the US government’s response to the ongoing financial crisis.
Commercial Paper
In the global money market, commercial paper is an unsecured promissory note with a fixed maturity of 1 to 270 days. Since it is only backed by the issuing corporation’s promise to pay, only firms with excellent credit ratings can sell their commercial paper at a reasonable price. While usually regarded as safe, if the issuing corporation goes bankrupt, holders of commercial paper can lose their investment (as in the case of Lehman Brothers’ 2008 bankruptcy).
Counterparty Payment
Money paid by one company to another, to settle a financial contract. For example, if AIG sells a $10 million credit derivative to Deutsche Bank, Deutsche Bank is AIG’s counterparty. If AIG ends up having to pay out on the derivative, that is a counterparty payment.
Cramdown
A cramdown is a reorganization or modification of a loan, ordered by a court, usually against the will of the lender. The term has been in the news recently in reference to proposals to “cram down” the mortgages of homeowners who have declared bankruptcy.
Credit Default Swap
Often abbreviated as CDS, credit default swaps are a type of credit derivative contract. A CDS is similar to an insurance policy on a financial product, generally a bond or a loan. Unlike most insurance, however, the owners of CDS’s are not required to own the asset that is being insured. This is roughly equivalent to buying a life insurance policy on your neighbor. The market for credit default swaps is enormous, with tens of trillions of dollars in contracts outstanding, and has been widely blamed for helping cause the financial crisis.
FDIC
The Federal Deposit Insurance Corporation (FDIC) is a United States government corporation that guarantees the safety of checking and savings deposits in member banks, currently up to $250,000 per depositor per bank. The FDIC was created in 1933, in response to the large number of bank failures caused by runs on the bank in the Great Depression.
Insolvency

Insolvency means the inability to pay one's debts.

This is defined in two different ways. Cash flow insolvency is the inability to pay debts as they fall due. Balance sheet insolvency is having negative net assets, i.e. one’s liabilities exceed one’s assets. For banks, which need to be constantly borrowing and lend large sums of money, insolvency usually means going out of business, either by declaring bankruptcy or being purchased by another bank.

Leverage

Leverage means borrowing money for investments.

A simple example: if someone invests $1000 of their own money in a corporate bond that promises an 8% return, they will make $80 in profit after one year. If they instead borrow $10,000 at an interest rate of 3% (a cost of $300), and buy the same corporate bond with that money, their profit will be $500 ($800 in interest, minus the $300 cost of the loan). However, if the corporate bond defaults, and pays no interest, the borrower will end up losing the $300 they paid for their loan. Many of the large bank failures in the current financial crisis happened after the banks borrowed too much money and were unable to repay their debts after the value of their investments fell.

LIBOR:
The London Interbank Offered Rate (or LIBOR) is a daily reference rate based on the interest rates at which banks borrow unsecured funds from other banks in the London financial market. When the LIBOR is very high, as happened in the 2008 financial crisis, it is expensive for banks to borrow money, which means it is more difficult for corporations and consumers to get access to credit.
Liquidity:

Liquidity refers to an asset's ability to be easily converted through an act of buying or selling. Strong global currencies like the US Dollar and the Euro are the most liquid form of assets, as the number of potential buyers and sellers is very high. (In this sense, anyone who sells a product and receives payment in dollars is “buying” dollars.)

Illiquid assets, on the other hand, are difficult to convert. A house is an example of an illiquid asset: while it may be very valuable, selling a house takes a lot of time and effort.

Complex financial assets, such as mortgage-backed securities and collateralized debt obligations, became very illiquid after the financial crisis raised doubts as to their value. Many of these assets may turn out to be valuable, but for now it is difficult to find buyers.

Mary Shapiro
Mary Shapiro is the current chair of the Securities and Exchange Commission, which holds primary responsibility for enforcing the federal securities laws and regulating the securities industry. She is the first woman to head the SEC.
Mortgage-backed Securities
A mortgage-backed security (MBS) is a type of financial instrument called a security (bonds are also securities) whose cash flows are backed by the principal and interest payments of a set of mortgage loans. Because MBS’s are backed by a bundle of mortgage loans, the risk of default is lower (because it is unlikely that, for instance, all 500 mortgages in an MBS would go into default simultaneously). The subprime mortgage meltdown made the valuation of MBS’s more difficult, because the number of foreclosures and loan defaults turned out to be much higher than predicted.
Option ARM
An Option ARM (“Adjustable Rate Mortgage”) is a type of mortgage that offers borrowers a choice of payment options. The minimum payment on an option ARM is often less than the accruing interest, which means that borrowers actually get deeper into debt with each new payment.
Predatory Lending
Predatory lending refers to dishonest or deceptive practices by lenders taking advantage of borrowers. For example, during the subprime mortgage bubble of the past few years, many first-time homebuyers ended up with mortgage payments they could not afford, due to confusing and misleading terms and conditions. Predatory mortgage lending was a major contributor to the surge in home foreclosures in 2008, as well as the current economic and financial crisis.
Short Selling
Short selling is the practice of selling a financial instrument (such as a stock or a bond) that the seller does not own at the time of the sale. Short selling is done with the intent of later purchasing the asset at a lower price. Short-sellers are effectively betting that the price of the asset will fall, as opposed to “going long,” which is buying an asset in the hopes that it will rise in value.
Subprime Mortgages
“Subprime” is a financial term that was popularized by the media during the "credit crunch" of 2007 and involves financial institutions providing credit to borrowers perceived as risky or unreliable. Subprime borrowers include individuals with a history of loan delinquency or default, those with a recorded bankruptcy, or those with limited debt experience. Although there is no standardized definition, in the U.S. subprime loans are usually classified as those where the borrower has a credit score below a particular level, e.g. a FICO score below 660.
Timothy Geithner
Timothy Geithner is U.S. Secretary of the Treasury.  Geithner previously served as the 9th president of the Federal Reserve Bank of New York.  As President, he also served as the Vice Chairman of the Federal Open Market Committee. (His name is pronounced GITE-ner.)
Treasuries
“Treasuries” refers to government bonds issued by the United States Department of the Treasury. There are four types of marketable treasury securities: Treasury bills, Treasury notes, Treasury bonds, and Treasury Inflation Protected Securities (TIPS). Because they are backed by the credit of the United States government, treasury securities are considered among the safest investments in the world.
U.S. Federal Reserve
The Federal Reserve System (or “Fed”) is the central banking system of the United States. The Fed performs a variety of functions within the U.S. economy, including the regulation of banks and the management of the money supply. The Fed is an independent institution, and can act without prior approval from Congress or the President. Ben Bernanke is the current Chairman of the Board of Governors, having replaced Alan Greenspan in 2006.

Personal Finance Glossary

Borrowing
Receiving money now with the commitment of paying it back in the future, usually with interest
Budgeting
A spending-and-saving plan based on estimated income and expenses covering a specific period of time. Budgets are used by individuals and organizations to reach short and long term financial goals. See Econ4U's eight financial and budgeting tips for help getting started.
Compound interest
Interest that is earned not only on the principal but also on interest already earned. Compound interest is regarded as a fundamental way to build wealth for the long term. Saving early and regularly allows time for wealth to accumulate. See Econ4u.org’s Money Matters: Compound Interest for more information.
Credit
The opportunity to borrow money or other items in the present, in return for a commitment to repay in the future
Credit report
A record of past borrowing and repayment, including information on late payments and bankruptcy. Old loans and credit cards accounts all show up on your credit report, as well as overdue bills that were sent to a collections agency. This record is used to calculate your credit score. See Econ4u.org’s Money Matters: Credit Reports for more information.
Credit score
A numerical score used by lenders and others to evaluate your credit worthiness. The most common credit score is called the FICO Score, and is a number between 300 and 850. Factors like your payment history, debt-to-income ratio, and total outstanding debt influence your credit score. Having a higher credit score will help you get lower interest rates on loans, and can even help you get a job or an apartment, as some employers and landlords use credit checks as well. To learn more about credit scores, visit myFICO.com or Econ4u.org’s Money Matters: Credit Scores.
Debt-to-income ratio
A ratio of the total amount of money someone owes, compared to their income. This ratio is a good indicator of whether someone can afford to borrow more money. Calculate your debt-to-income ratio here. If you are in the market for a loan, like a mortgage or car loan, lowering your debt-to-income ratio can raise your credit score and help lower the interest rate.
Financial markets
Mechanisms allowing people to buy and sell common financial products like stocks, bonds, and commodities (like gold and silver).
Human capital
The health, education, training, skills and values of people. Investing in human capital, much like investing in physical capital, makes individuals more productive and often leads to higher incomes.
Insurance
The promise of compensation for specified forms of loss or harm to property or life in return for premium payments during the life of the insurance contract. Insurance policies allow for spreading risk over a pool of policy holders. Common types of insurance are renters, auto, home and life.
Interest
Interest is money paid over time in exchange for a loan. When you borrow money from a bank, you pay the bank interest. When you put money in a bank account, you are basically loaning the money to the bank, so the bank pays the interest to you.
Interest rate
The percentage of the principal amount paid to borrow or save money
Investing
The process of using money in hopes of earning a financial gain. Common investments include stocks, bonds, mutual funds and real estate.
Investment
Funds placed in an asset - - such as a savings account, mutual fund or home with the expectation the asset will earn a financial gain. Investment requires weighing the financial risks against the possible financial rewards.
Return
Earnings on an investment; usually stated in terms of the percentage of the original amount invested. If you buy stock at $25 and after a while it is worth $30, you have gotten a 20% return on your investment.
Risk
The possibility of gaining or losing value on your investment. If you buy stock at $25 and after a while it is only worth $20, you have lost $5 or 20% of your initial investment. Every investment has some risk, and some are riskier than others.
Risk-return tradeoff
Because some investments are riskier, people only invest in them if they expect to make more money than with a safer investment. Buying treasury bonds from the US government is generally one of the safest investments in the world, but the bonds only pay a small amount of interest. Investing money in an Internet start-up is a lot riskier: the company may go out of business, in which case your investment is worth nothing. But the company may also be very successful, in which case your investment is worth many times what you originally paid.
Saving
Spending less than you earn. Saving is an essential part of financial success. See Econ4U's eight financial and budgeting tips for help with saving and budgeting.
The contents of this glossary are licensed under the GNU Free Documentation License. Entries incorporate material from sources listed here.