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A Glossary of Terms Behind the Headlines

Friday, September 26, 2008

The credit crisis that has led to calls for a bailout of the nation's financial system also has introduced some unfamiliar terms to the general public.

Capital markets: Any market where companies or governments raise money to fund themselves. The stock market and the bond market are the most widely used.

Commercial paper: The short-term borrowing that companies use to finance their day-to-day operations and cash needs. The corporate equivalent of a credit card.

Conservatorship: A legal status similar to bankruptcy, in which the government takes control of a company with the intention of restructuring it and returning it to private ownership. Housing finance companies Fannie Mae and Freddie Mac are now under conservatorship.

Credit default swap: A contract that allows investors to make bets on the likelihood a company will be unable to pay its debts.

Exotic home loans: Unconventional loans such as those allowing payment of interest only, those with balloon payments or those with an interest rate that may adjust steeply. (Note: not all adjustable-rate mortgages are exotic. One-year ARMs have been used responsibly since the early 1980s.)

Fannie Mae: A company created by the government in 1938 to expand the flow of mortgage money. Formally known as the Federal National Mortgage Association. It operates under a congressional charter that directs the company to channel its efforts into increasing the availability and affordability of homeownership for low-, moderate- and middle-income Americans. The firm buys mortgages that meet its standards, guarantees their credit and repackages them as bonds for sale to investors. The federal government put the company into conservatorship in early September.

Federal funds rate: The interest rate at which banks make overnight loans to each other through the Federal Reserve. The Fed sets a target for this rate, then buys and sells government bonds to try to keep the rate banks actually charge each other at the target. It is the primary tool that the Fed uses to expand or contract the supply of money in the economy.

Freddie Mac: A company created by the government in 1970 to expand the flow of mortgage money. Formally known as the Federal Home Loan Mortgage Corp. It operates under a congressional charter that directs the company to channel its efforts into increasing the availability and affordability of homeownership for low-, moderate- and middle-income Americans. The firm buys mortgages that meet its standards, guarantees their credit, and repackages them as bonds for sale to investors. The federal government put it into conservatorship in early September.

Jumbo loan: A mortgage that exceeds the limit at which Fannie Mae or Freddie Mac will buy it. Until earlier this year, that limit was $417,000. It was raised to $729,750, creating a category of jumbo conforming loans. Because jumbo loans cannot normally be bought by Fannie Mae or Freddie Mac, the interest rates on them tend to be higher.

LIBOR: London Interbank Offered Rate is the rate at which banks lend to one another. Many other rates, such as those on corporate loans, are tied to this rate. Lately, it has been unusually high, suggesting that banks are hoarding cash and afraid to lend to each other.

Line of credit: An agreement in which a bank agrees to lend up to a certain limit of money for a specified period.

Liquidity: The free flow of money through the financial system.

Money-market mutual fund: A mutual fund that invests exclusively in short-term debt such as Treasury bills, certificates of deposits, or commercial paper. These funds are generally viewed as safe investments that yield more income than savings accounts, though in the past week the government has acted to bolster their safety.

Securitization: The process that converts mortgage loans, credit card debt and other types of assets into securities that can be traded on global markets. This allows investors all over the world to indirectly make credit available to ordinary Americans, while protecting the lender from risk if any one borrower defaults.

Short-sell, short-selling: An action that enables the person doing it to make money if the value of a stock or other asset falls. An investor borrows shares of stock from someone else and sells them. He or she then buys the shares back at a later point to return them, and if the price has fallen in the interim, profits on the difference.

Subprime loan: A loan made to a borrower who is considered risky. That can mean the borrower has a poor credit rating, unstable income or other factors that makes him or her more likely to default. Interest rates are higher than for prime loans to compensate the lender for the extra risk.

Treasury bills: Short-term debt -- effectively, loans that have a duration of less than a year -- of the United States government.

SOURCES: From staff reports, Capital Markets Glossary,

Dictionary of Finance and Investment Terms and Investopedia

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