Question;Graded Project - NAKED SHORT SELLING;Overview;The declining values in Fannie Mae and Freddie Mac stocks in;2007?2008 were the result of risky mortgages and foreclosures. This led to a;surplus of declining real property values in the United States and a;significantly negative impact on equity prices and FINANCIAL markets in the;United States and;around the world. It?s likely that this topic will be;studied for many years, as Alan Greenspan, former Federal Reserve Chairman, has;referred to it as a once-in-a-century ?financial tsunami.?;On the following page are graphic representations of the;STOCK price per share for Fannie Mae (FNM) (Figure 1) and Freddie Mac (FRE);(Figure 2), the holders of approximately 50 percent of the mortgages in the;United States.;Instructions;Read the boxed article, ?Reinflating Real Property Values,?;by A. J. Cataldo and Anthony P. Curatola, from Strategic Finance, October 2008.;Then respond to the questions that follow. Feel free to use Google, Wikipedia;or any other reliable Internet sources for your research. Be sure to verify;your;answers by checking multiple sources.;96 Graded Project;FIGURE 1;FIGURE 2;Graded Project 97;REINFLATING REAL PROPERTY VALUES;By A. J. Cataldo, CMA, CPA, and Anthony P. Curatola;Reprinted with permission from Strategic Finance, October;2008.;On September 8, 2008, Freddie Mac (NYSE: FRE) and Fannie Mae;(NYSE: FNM), the holders of approximately 50% of mortgages in the United;States, were seized by the U.S. government in;a ?bailout? that may cost American taxpayers between $100;billion and $300 billion. Effectively, owners of common equity saw the value of;their holdings in these two firms decline by 80% to 90% as the common STOCK;price per share for Freddie dropped from $5.10 to $0.88 per share and the;common stock price per share for Fannie dropped from $7.04 to $0.73 per share.;Because short positions effectively increase the number of;shares issued and outstanding, more than 110% of the shares of both Freddie and;Fannie were held by institutions. Approximately 50% of the shares of Freddie;and Fannie were TRADED on Monday, September 8, 2008, following the news of the;seizure over the preceding weekend. While many possible solutions may be under;consideration, one possible fiscal policy-based answer may be to simply reduce;the depreciable lives for residential real property, effectively increasing the;net present value (and, therefore, the value) of these properties, if held for TRADE;or business purposes. Some comparison between a less-recent historical crisis;and the present situation warrants review.;Change in Fiscal Policy: 1987 Crash;The Economic Recovery Tax Act of 1981 (ERTA81) greatly;accelerated the depreciation deductions;available for all asset classes, including real property;under the accelerated cost recovery;system (ACRS).The Tax Reform Act of 1986 (TRA86), passed by;Congress on October 22;1986, provided for an increase in the depreciable lives of;real property from their ACRS-based;lives of 15 years to a MACRS-based (modified ACRS) life of;27.5 years (or longer) while;severely restricting passive activity losses (PALs).;Approximately one year later, on Monday;October 19, 1987, the Dow Jones Industrial Average (DJIA);dropped more than 22% in a single;TRADING day. While there?s no denying that program TRADING;led the list of contributing variables;to the 1987STOCK MARKET ?crash,? another possible causal;link is the extension of depreciable;lives?the move from ACRS to MACRS?and the imposition of;passive activity loss limitations;(PALs), which together placed downward pressure on real;property values as an asset class.;These provisions of TRA86 may have made economic sense on;one dimension, but they were;also likely to have contributed to the end of the real;estate boom in the early to mid-1980s as;well as to the savings and loan (S&L) ?crisis? and the;formation of the Resolution Trust;Corporation (RTC) that followed.;(Continued);98 Graded Project;REINFLATING REAL PROPERTY VALUES?Continued;Change in Monetary Policy: 2008 Crash;The stage was set for the current housing crisis during the;2002 through 2004 period. Many;Americans refinanced their existing home mortgages at lower;interest rates, effectively ?cashing;in? and consuming much of their equity, but the real problem;arose when no-qualifying and;no-documentation (no-doc) mortgages were approved by;lenders. In many cases, these were;negative amortization loans for the first few years of the;life of the mortgage and/or adjustable;rate mortgages, and, as interest rates recovered (June;2004), payments on these mortgages;were reset at higher interest rates and higher monthly;payments. Many new homeowners, as;well as speculators anticipating a continuing rise in real;property values, were unable (or;unwilling) to make these higher payments as their equity;positions evaporated. Lenders?;declining collateral positions in these real properties;loan defaults, and home foreclosures;grew, increasing the nonperforming components of lender;portfolios of home mortgage loans.;The Mortgage Forgiveness Debt Relief (MFDR) Act of 2007;provided some relief to taxpayers.;As real property values declined and mortgages exceeded the;fair MARKET value of these;properties, financial institutions holding these;nonperforming, or ?at risk,? loans experienced;increased shorting and even naked shorting of their equity;securities. (?Naked shorting? is the;sale of a stock that you don?t own in anticipation of buying;or ?covering? this position at a;future date and a lower price for a profit.) The Securities;Exchange Commission, the Federal;Reserve, and the Secretary of the Treasury joined forces to;suspend ?naked shorting? of;Freddie, Fannie, and 17 other financial institutions, but;the suspension was only temporary.;During the early portion of the suspension period (July 11;2008, through July 23, 2008);nearly one-third of a trillion dollars of MARKET;capitalization recovery occurred for these;financial institutions.;Stabilizing Residential Housing Values and Stimulating;Demand;One of many possible solutions might include a reduction in;the depreciable lives for residential;housing. Increases in depreciation expense increase the;depreciation tax shield, after-tax cash;flow, and net present values for long-lived assets. While;this may not solve the problem for;homeowners, the consensus in the business and general press;is that home foreclosures and;mortgage defaults combined with the increase of these;nonperforming loans in lenders? portfolios;suggests that many of those approved for these troubled;loans simply weren?t economically;able to purchase these homes at the time these mortgages;were approved. Therefore, it;appears that an insufficient number of creditworthy;homeowners may be available to absorb;the increased inventory of residential housing, and the only;alternative may be to provide fiscal;policy-based economic incentives to investors to absorb the;surplus supply for the near term.;Perhaps it?s merely a question of the ?form? of the bailout;(1) a tax-incentive-based fiscal;policy measure or (2) direct governmental ownership of;Fannie and Freddie.;A. J. Cataldo, II, CMA, CPA, Ph.D., is a professor of;accounting in the School of Business and;Public Affairs at West Chester University, West Chester, Pa.;He can be contacted at;a..firstname.lastname@example.org. Anthony P. Curatola is the Joseph F. Ford;Professor of Accounting at;Drexel University in Philadelphia, Pa. You can reach Tony at;(215) 895-1453 or;c..email@example.com. ? 2008 A. P. Curatola.;Project Questions;1. Fannie Mae and Freddie Mac are GSEs. Define GSE with a;brief explanation. (10%);2. To slow the decline of MARKET values of Fannie Mae;Freddie Mac, and 17 other FINANCIAL firms, the Securities and Exchange;Commission (SEC) suspended naked shorting for a short period.;a. What is a long position in a STOCK? (5%);b. What is a short position in a STOCK? (5%);c. What is a naked short position in a STOCK?;(Distinguish between a short and a naked short.) (10%);d. Are retail investors or TRADERS permitted to naked short;a STOCK? (10%);e. Who is permitted to naked short a stock (assuming there;has been no suspension of this practice)? (5%);3. a. Following the first SEC suspension of naked shorting;(post?June 2008), did other nations follow this practice? (5%);b. If not, explain why. If so, list a few. (5%);4. When the temporary suspension of naked shorting was;imposed by the SEC, STOCK prices increased, due to a ?short squeeze.? Explain;the term ?short squeeze.? (10%);5. The problems with Fannie Mae, Freddie Mac and other;FINANCIAL institutions were said to have been caused by the securitization of;risky mortgages issued to uncredit worthy borrowers along with credit default;swaps to insure these risky mortgages. The credit default swaps weren?t;capitalized?there was nothing available to pay off on these credit default;swaps, so when the borrower defaulted on the mortgage and the credit default;swap was to be ?cashed in,? there was nothing available and;these securitized mortgages became worthless.;100 Graded Project;a. Worldwide, what?s the approximate value of credit default;swaps in circulation during this period? (5%);b. How did this amount compare to U.S. and worldwide gross;domestic product (GDP) during this period? (5%);6. a. In whatCURRENCY is oil TRADED? (5%);b. In what CURRENCY are credit default swaps traded? (5%);7. a. Will the U.S. dollar remain the CURRENCY of choice?;(5%);b. Have any nations called for a switch from the U.S.;dollar? (10%);Writing Guidelines;1. Type your submission, double-spaced, in a standard print;font, size 12. Use a standard document format with 1-inch margins. (Do not use;any fancy or cursive fonts.);2. Include the following information at the top of your;paper;a. Name and complete mailing address;b. Student number;c. Course title and number (International Business, BUS 430);d. Project number (50067000);3. Read the assignment carefully and answer each question.;Use proper citation in either APA or MLA style.;4. Be specific. Limit your submission to the questions asked;and issues mentioned.;5. Include a reference page in either APA or MLA style. On;this page, list Web sites, journals, and all other references used in preparing;the submission.;6. Proofread your work carefully. Check for correct;spelling, grammar, punctuation, and capitalization.
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