An economic analysis of the financial collapse
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An Economic Analysis of the Financial Collapse. National Council for the Social Studies Vital Issues Session November 14, 2009. Presenters. Glen Blankenship Georgia Council on Economic Education Mark Schug University of Wisconsin-Milwaukee George Vredeveld University of Cincinnati

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An economic analysis of the financial collapse

An Economic Analysis of the Financial Collapse

National Council for the Social Studies

Vital Issues Session

November 14, 2009


Presenters

Presenters

  • Glen Blankenship

    Georgia Council on Economic Education

  • Mark Schug

    University of Wisconsin-Milwaukee

  • George Vredeveld

    University of Cincinnati

  • Richard MacDonald

    St. Cloud State University


Overview

Overview

  • How did the financial crisis affect us?

  • What are some likely hypotheses regarding the causes of the financial collapse?

  • What do today's banks do?

    Hint: Do they still follow the 3-6-3 rule?

  • Ideas for teaching about the financial crisis

  • Questions


How did the financial crisis affect us

How did the financial crisis affect us?


Average real disposable income was rising

Average Real Disposable Income Was Rising


Savings rates were falling

Savings Rates Were Falling


Household debt to disposable personal income ratio increases

Household Debt to Disposable Personal Income Ratio Increases


Subprime alt a and home equity loans increase

Subprime, Alt-A, and Home Equity Loans Increase


Fall in housing prices

Fall in Housing Prices


Djia s p and nasdaq trends stock wealth evaporates

DJIA, S&P and Nasdaq Trends: Stock Wealth Evaporates


Default rates rise

Default Rates Rise


Foreclosure rates increase

Foreclosure Rates Increase


Recession

Recession


Unemployment

Unemployment


What are some likely hypotheses regarding the causes of the financial collapse

What are some likely hypotheses regarding the causes of the financial collapse?


What happened

What Happened?

  • In1989 Berlin wall falls.

  • China and India deregulate.

  • Expanded production capacity puts damper on inflation. Central banks now can increase money supply without much concern about inflation.


What happened1

What Happened?

  • In 2001, the Fed consistently lowered interest rate from 6.5% to 1.75 % and to 1.0 % by June 2003. 

  • Central banks around the world followed suit creating an unprecedented increase in the supply of credit.


What happened2

What Happened?

  • The low rates made borrowed money cheap and households and businesses responded as expected: they bought and bought.

  • In the housing market, the Case-Shiller home price index increased 80% from January 2001 to December 2005.


What happened3

What Happened?

  • Federal government aggressively promotes home ownership

  • Homeownership rate increased from normal 64 percent (which was the rate for 35 years) to 69 percent in 2004

  • Subprime loans totaled $330 billion in 2001

  • By 2004 they reached $1.1 trillion (37% of residential mortgages)

  • By 2006 they were 48% of all mortgages.


What happened4

What Happened?

  • In mid-2004, the Fed reversed its interest policy -- the rate climbed to 2.25 % by December 2004 and reached 5.25% in 2006.

  • The demand for houses and other durable goods decreased and prices declined 33% from a peak in July 2006.


Interest rates and lagged housing prices

Interest Rates and Lagged Housing Prices

Housing prices

Interest rates


An economic analysis of the financial collapse

Housing Bubble – Jan 92 to July 09source: S&P Case-Schiller National Home Price Index 1987-2008 - inflation adjusted


Leverage

Leverage

The magnitude of the current financial crisis has grown because of the amount of leverage used.


Leverage and incentives

Leverage and Incentives

  • Investment banks were leveraged by a ratio of 30 to 1, government sponsored mortgage giants Freddie and Fannie were closer to 50 to 1.

  • When asset prices are rising, this system works like a dream.


What do today s banks do

What do today’s banks do?


What do banks do source http www fdic gov deposit insurance risk 2005 01 economy fig14 html

WHAT DO BANKS DO? (source: http://www.fdic.gov/deposit/insurance/risk/2005_01/economy_fig14.html


An economic analysis of the financial collapse

Non-Interest income is increasing as a proportion of net operating revenue (source: Bank Management,6th edition.imothy W. Koch and S. Scott MacDonald

90%

90%

80%

80%

70%

70%

Net Interest Income

60%

60%

50%

50%

40%

40%

30%

Noninterest Income

30%

20%

Actual Data

Predicted

20%

10%

0%

10%

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009


An economic analysis of the financial collapse

Composition of Noninterest Income by Bank Size as a Percentage of Total Assets, 2004 (source: Bank Management,6th edition.Timothy W. Koch and S. Scott MacDonald

0.8%

0.7%

< $100M

$100M-$1B

0.6%

>$1B

All Comm. Banks

0.5%

0.4%

0.3%

0.2%

0.1%

0.0%

service

Deposit

charges

activities

Fiduciary

Investment

advisory,

noninterest

banking,

brokerage,

income

Other

other assets

(losses) on

Net gains

Net servicing

securitizations

fees

sales of loans

(losses) on

and other

Net gains

venture cap.

Trading,

and


Teaching about the financial crisis

Teaching about the financial crisis


The 3 oops 11 tools of monetary policy

THE 3 (oops—11) TOOLS OF MONETARY POLICY

Open Market Operations

Discount Policy

Reserve Requirements

Interest on Required Reserve Balances and Excess Balances

Term Auction Facility

Primary Dealer Credit Facility

Term Securities Lending Facility

ABCP MMMF Liquidity Facility

Commercial Paper Funding Facility

Money Market Investor Funding Facility

Term Asset-Backed Securities Loan Facility


Teaching financial crises a resource for high school teachers

Teaching Financial Crises: A Resource for High School Teachers

Upcoming publication of Council for Economic Education

Planned Table of Contents

Lesson 1 The Financial Crisis of 1907 and the Financial Crisis of 2007: A Comparison

Lesson 2 Data Analysis: How the Numbers of U.S. Economic Performance in 2008 and 2009 Compare to Other Periods in History

Lesson 3 Manias, Bubbles, and Panics in World History

Lesson 4 The Japan Comparison: Japan in the mid-1980s through 1990s and the U.S. in the 2000s


Planned table of contents cont

Planned Table of Contents (cont.)

Lesson 5 Monetary Policy in the Recent Financial Crisis

Lesson 6 The Role of Housing in the Recent Financial Crisis

Lesson 7 The Instruments and Institutions of Modern Financial Markets

Lesson 8 Understanding Financial Markets in 2007 - 2009


Questions

Questions


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