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Bank CEO's: Two Biggest Risks to the Financial System -- ICYMI

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Although Senator Mark Warner (D-VA), member of the Senate Banking Committee and an original engineer of the Dodd-Frank Act, recently told TheStreet, "I think most Americans should sleep better at night, knowing the banks have more capital," there are still systemic risks to watch.  

During Wednesday's informational hearing between the CEO's of Goldman Sachs (GS) - Get Goldman Sachs Group Inc. (The) Report , Morgan Stanley (MS) - Get Morgan Stanley Report , Citigroup (C) - Get Citigroup Inc. Report , Bank of America (BAC) - Get Bank of America Corporation Report , Bank of New York Mellon (BK) - Get The Bank of New York Mellon Corporation Report   and the U.S. House Committee on Financial Services, something important was revealed. 

Two Big Systemic Risks

Democratic House Representative from Connecticut Jim Himes asked each CEO to tell which market risk is the greatest to the financial system. JPMorgan Chase CEO Jamie Dimon asserted without hesitation: "(1) Leveraged lending and (2) student lending." 

The answers from all the CEO's were weighted most heavily toward those two risks.  

Himes' question was motivated by the sore memory of what caused the financial crisis: Excesses in mortgage debt. 

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For those slightly hazy, here's a run-down of what happened to cause the 2008 financial crisis:

What Was the Financial Crisis?

The Federal Reserve, then led by Chairman Alan Greenspan, kept interest rates too low for too long, as the economy heated up. This caused overheated activity in the housing market, as almost any person could get a mortgage loan (loose lending regulations weren't helping quell the activity either). Banks would put hidden provisions in mortgage contracts saying that the borrowers interest rate would spike during the life of the loan. A lot of home buyers had poor credit and headed for default when their rates spiked. 

Meanwhile, banks were creating a huge financial market for the loans. The loans were packaged into collateralized debt obligations (CDO's), which were financial products containing thousands of mortgage bonds, many of which were of bad credit, but they were listed as having triple A credit. Other banks bought the products. Insurance companies like AIG (AIG) - Get American International Group Inc. Report insured CDO holders against losses in some cases. All parties long on the credit, and with large positions in the asset, crumbled. The banking system was subsequently in danger of freezing. 

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