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James Dennin, Kapitall: Several years out of the financial crisis, we screened for financial stocks who might handle a crash if it happened again today.
If you haven't read former Treasury Secretary Hank Paulson's
first-hand account of the financial crisis – you should consider reading it now. And not just because he was the orchestrator of the Troubled Asset Relief Program. Paulson also has a deep understanding of how one bank's failure nearly brought down the entire system. While the crisis affected all of us, this guy lived it, from the moment he first realized a lack of transparency to when he finally convinced lawmakers to approve a controversial, highly unpopular bailout.
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When he first briefed then-President Bush about the possibilities of a financial crisis in 2006, Paulson was already concerned about over-the-counter derivatives and the size of certain hedge funds. However, when President Bush asked him what would be the straw that broke the horse's back, so to speak, it was still too early to tell. It wasn't until the French Government began freezing funds in its biggest bank,
BNP Paribas (OTC:BNPQY), that he realized what would bring the system down –
subprime mortgages. Subprime mortgages are mortgages that are given to people with credit ratings below 600.
To compensate themselves for the risk, banks charge higher interests on these loans than they do on others. Pre-financial crisis, these mortgages were "sliced and diced" and packaged alongside other securities (to make them more lucrative) and then sold around the world. Every aspect of the system ended up tied to these bad loans that were unlikely to get paid back. A number of extremely old and reputable banks – Lehman Brothers, Bear Sterns, Merrill Lynch – didn't have the capital they needed to cover their losses by investing in these securities. A massive capital injection, accepted by troubled banks and healthy ones, was the only way to restore confidence in the market.