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How the Housing Market is Supposed to Work (absent government intervention)

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How the Housing Market is Supposed to Work (absent government intervention). Safe Borrowers. Commercial Banks. Safe Mortgage. Risky Mortgage. Risky Borrowers. Safe Borrowers. Investment Banks (Lehmann Brothers). Commercial Banks. Hedge Funds. Safe Mortgage. Risky Mortgage.

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Presentation Transcript
slide1

How the Housing Market is Supposed to Work

(absent government intervention)

slide2

Safe Borrowers

Commercial Banks

Safe Mortgage

Risky Mortgage

Risky Borrowers

slide3

Safe Borrowers

Investment Banks

(Lehmann Brothers)

Commercial Banks

Hedge Funds

Safe Mortgage

Risky Mortgage

Risky Borrowers

slide4

Moody’s

Standard & Poors

Mortgage Backed Security

Investment Banks

(Lehmann Brothers)

Commercial Banks

Hedge Funds

Safe Mortgage

Reinsurance Companies

(AIG)

Risky Mortgage

Pension Funds

Other Large Savers

slide5

Investment Banks

(Lehmann Brothers)

Commercial Banks

Mortgage Backed Security

Hedge Funds

Reinsurance Companies

(AIG)

Pension Funds

Other Large Savers

slide6

Safe Borrowers

Investment Banks

(Lehmann Brothers)

Commercial Banks

Hedge Funds

Safe Mortgage

Reinsurance Companies

(AIG)

Risky Mortgage

Pension Funds

Risky Borrowers

Other Large Savers

slide7

Safe Borrowers

Commercial Banks

Safe Mortgage

Risky Mortgage

Risky Borrowers

slide8

Safe Borrowers

Mortgage Backed Security

Investment Banks

(Lehmann Brothers)

Commercial Banks

Hedge Funds

Safe Mortgage

Reinsurance Companies

(AIG)

Risky Mortgage

Pension Funds

Risky Borrowers

Other Large Savers

slide9

Removing the intermediaries, we see that the end result is that entities with large amounts of savings loan to people who, in turn, buy houses.

slide10

Safe Borrowers

Mortgage Backed Security

Mortgage Backed Security

Mortgage Backed Security

Mortgage Backed Security

Safe Mortgage

Safe Mortgage

Reinsurance Companies

(AIG)

Risky Mortgage

Risky Mortgage

Pension Funds

Risky Borrowers

Other Large Savers

slide11

How the Market Polices Itself

(absent government intervention)

slide12

What if banks started making too many risky loans?

Risky Borrowers

Commercial Banks

Risky Mortgage

Risky Mortgage

Risky Borrowers

slide13

Lenders would demand a higher interest rate to compensate for the greater risk.

This would increase the cost of borrowing and

so fewer people would borrow.

Risky Borrowers

Reinsurance Companies

(AIG)

Mortgage Backed Security

Pension Funds

Risky Borrowers

Other Large Savers

slide14

With less borrowing, demand for houses would be reduced.

With a reduced demand for housing, housing prices would not inflate and no price bubble would form.

Risky Borrowers

Reinsurance Companies

(AIG)

Mortgage Backed Security

Pension Funds

Risky Borrowers

Other Large Savers

slide15

Summary: How the Market Polices Itself

More risky borrowers means lenders demand higher interest rates.

Higher interest rates limits the number of risky borrowers.

Limited number of risky borrowers means stable demand for houses.

Stable demand for houses means stable housing prices.

Stable housing prices means no housing bubble forms.

slide16

How the Housing Market Did Work

(behold government intervention)

slide17

Two government (or government-type) players enter the game.

Lowers interest rates making borrowing less expensive.

At the direction of Congress, buys mortgages with little regard for risk.

slide18

As the Fed lowers interest rates, more people seek loans.

As Fannie and Freddie ignore borrowers’ riskiness, risky borrowers find it very easy to get loans.

Safe Borrowers

Safe Borrowers

Safe Borrowers

Safe Borrowers

Commercial Banks

Risky Borrowers

Risky Borrowers

Risky Borrowers

Risky Borrowers

Risky Borrowers

Risky Borrowers

Risky Borrowers

Risky Borrowers

slide19

Summary: How the Government Short-Circuited the Market

The Fed drove interest rates to low levels encouraging people to borrow.

Fannie and Freddie bought high-risk loans from banks thereby encouraging the banks to make more high risk loans.

The resulting surge in demand for housing drove housing prices up making housing appear to be a good investment.

Encouraged by this apparent good investment, more people bought houses driving prices higher.

slide20

On average, every 1% increase in the size of the Federal government (relative to the economy) reduces per-capita GDP by $4,000 (in 2008 dollars).

Data source: U.S. Census Bureau

slide21

Since 1969, the top income tax bracket has ranged from a high of 77% to a low of 28%.

But, over that same period, Federal tax revenue has averaged a constant 18% of GDP (plus/minus 2.3%).

Data source: Bureau of Labor Statistics, National Taxpayers Union

slide22

The total amount of money the U.S. government has either borrowed or owes retirees exceeds the size of the economy of planet Earth.

Source: www.treasurydirect.com and CIA World Factbook

slide24

$10,000

A stack of $100 bills, ½ inch high.

Adapted from pagetutor.com

slide25

$1 million

100 packets of $10,000.

Adapted from pagetutor.com

slide26

$100 million

$100 million fits on a standard pallet.

Adapted from pagetutor.com

slide27

$1 billion

Adapted from pagetutor.com

slide28

$1 trillion

About twice the amount of money the U.S. government spends on interest on the national debt in one year.

Adapted from pagetutor.com

slide29

$12 trillion

The value of all goods and services produced in the United States in one year.

Also, the U.S. national debt (as of 2009).

Adapted from pagetutor.com

slide30

$65 trillion

Total debt and unfunded Social Security and Medicare obligations (as of 2009).

Adapted from pagetutor.com

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