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Meltdown. Economic Crisis and Government Response. I. Causes: Competing Explanations. Trigger: Most agree that housing bubble triggers the crisis, because bubbles encourage risk taking (and use of leverage) and because investment in housing (through mortgages) spread throughout economy.

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Meltdown

Meltdown

Economic Crisis and Government Response


I causes competing explanations

I. Causes: Competing Explanations

  • Trigger: Most agree that housing bubble triggers the crisis, because bubbles encourage risk taking (and use of leverage) and because investment in housing (through mortgages) spread throughout economy.

    Video overview


B what caused the bubble

B. What caused the bubble?

  • Easy Money (consensus): Very low interest rates encourage bubbles. Why were interest rates low?


2 government housing incentives controversial

2. Government Housing Incentives (Controversial)

a. Home mortgage interest deduction

  • Argument: Subsidizes larger mortgages

  • Objection: Has existed since creation of income tax (all interest deductible until 1986)


B housing loan agencies

b. Housing Loan Agencies

  • Argument: Government encourages risky lending

    • FHA: Insures mortgages (reduces risk to lenders)

    • Fannie Mae and Freddie Mac: Buy mortgages  allows banks to clear balance sheets and issue new loans (amplifies credit available for mortgages)

  • Objection: FHA/Fannie Mae established during Depression to increase mortgage lending, long before current crisis


C hud regulations of housing agencies

c. HUD regulations of housing agencies

  • Argument: In 1996 HUD gave Fannie/Freddie a target -- 42% of mortgage financing had to go to borrowers with income below the median in their area  increased to 50% in 2000 and 52% in 2005.

  • Objections

    • Between 2004 and 2006, Fannie and Freddie went from holding 48 percent of the subprime loans that were sold into the secondary market to holding about 24 percent

    • Why? Possible reason: Fannie and Freddie were subject to tougher standards than the unregulated players in the private sector


3 community reinvestment act controversial

3. Community Reinvestment Act (Controversial)

a. Purpose: Passed in 1977 to prevent “redlining” – refusing to issue mortgages or loans in high-crime areas, regardless of credit-worthiness of borrower

  • Example: Banks might lend to low-income residents of blue neighborhoods (i.e. whites) but refuse a loan for high-income residents of red neighborhoods (i.e. African Americans)


B amendments

b. Amendments

  • Original CRA: required use of same lending criteria in all communities – largely self-enforced

    • 1989: Added public data on CRA compliance created by federal agencies

    • 1995: Compliance to be measured by outcomes (lending in communities) rather than process (procedures for evaluating loans)

    • 1994 and 1999: Conditioned bank expansions & mergers on CRA compliance

    • 2005 and 2007: CRA weakened for large banks (allowed to count lending in place of banking services or investment in communities)


C effects of cra amendments

c. Effects of CRA/Amendments

  • Argument: CRA requires banks to make risky loans, so helped fuel subprime lending  created homeowners out of people who traditionally could not own homes


Meltdown

2008

1995: CRA Strengthened

1977: CRA Established


Ii objections to blaming cra

ii. Objections to Blaming CRA

  • CRA preceded crisis by decades

  • CRA applies only to banks and thrifts that are federally insured – not independent mortgage companies (e.g. Countrywide) which made half of all subprime loans

  • Non-CRA institutions made subprime loans at more than twice the rate of CRA institutions


4 irrational exuberance moderate consensus

4. Irrational Exuberance? (moderate consensus)

a. Shiller’s feedback model:

  • Asset price rise occurs, leading to profits

  • Profits attract less sophisticated investors

    • Problem: Investors have incentives to promote “new era” theories of why “this is no bubble” – but investors get their information from each other

  • People speculate – i.e. pay any price to resell at higher price tomorrow

  • Any dip in prices  doubts about the “new era” theory  some investors exit

  • Exits  further price declines  further exits until underlying economic value of asset reached

    • Problem: Price declines extrapolated into future = unduly pessimistic assessment of underlying value

      Summary: Extrapolation from current trends  undue optimism  undue pessimism


Example housing bubble theory full of hot air sept 2003 article

Example: “Housing-bubble theory full of hot air” – Sept 2003 article

  • “Ever since the NASDAQ meltdown some folks have been waiting for the next big bad equity story. Since most equity is found in peoples' homes, that's where pundits have been focusing. They face disappointment however as they watch and wait for the "house-price bubble" to burst. It's not going to happen -- there isn't one….

  • “Housing supply in the United States is growing slower than housing demand. That means prices will rise… Supply is growing more slowly because it is constrained by local growth control ordinances, increased environmental cost, time requirements for land development… Demand will grow faster because demographic factors like population growth, household formation rates, immigration, employment growth and income growth are all going to push demand forward more rapidly…. there were 11 million immigrants to the United States over the past decade that will create 4 million new home buyers over the next two decades. Recent gains in the economy's rate of productivity mean that income growth will be strong for probably the next decade. When placed in the context of conservative supply growth, this is a recipe for real price increases, not collapse.”


4 irrational exuberance moderate consensus1

4. Irrational Exuberance? (moderate consensus)

a. Shiller’s feedback model:

  • Asset price rise occurs, leading to profits

  • Profits attract less sophisticated investors

    • Problem: Investors have incentives to promote “new era” theories of why “this is no bubble” – but investors get their information from each other

  • People speculate – i.e. pay any price to resell at higher price tomorrow

  • Any dip in prices  doubts about the “new era” theory  some investors exit

  • Exits  further price declines  further exits until underlying economic value of asset reached

    • Problem: Price declines extrapolated into future = unduly pessimistic assessment of underlying value

      Summary: Extrapolation from current trends  undue optimism  undue pessimism


B who was irrational

b. Who was irrational?

  • Homebuyers? Took risks to get better homes

  • Speculators? Took higher risks to get bigger profits

  • Mortgage Brokers? Would be irrational to refuse to broker risky loans when everyone else does it! No risk for the broker.

  • Mortgage Lenders? Would be irrational to refuse to make risky loans when everyone else does it! Why?

    • Creates lower short-term return for shareholders than other companies

    • Also creates lower yields for depositors

    • Executive compensation based on short-term returns (i.e. a given year) and often shields executives from risks (golden parachutes)


Who was irrational cont

Who was irrational? (cont)

v. Shareholders: Why do they insist on short-term profits?

  • Popularity of employee stock compensation – options generally vest quickly, giving employees an incentive to focus on short-term gains

  • Long-term investors require information which is held by companies themselves – who hire their own auditors ( long-term investment strategy may not reduce risk if company has other incentives to focus on short term)

    vi. Mortgage Backers and Investment Banks: Able to construct MBS to manage risk, passing it on to investors and focusing on short-term profits (the lowest tranch) for similar reasons as banks


Who was irrational cont1

Who was irrational? (cont)

vii. Investors in MBS:

Relied on ratings and insurance to determine risk

Hedge funds and other large investors driven by short-term profits for familiar reasons

viii. Raters:

Paid by investment banks (possible conflict of interest)

Not subject to real risk

Oligopoly: limited number of players means reputation hits have limited impact (three government-approved ratings agencies until recently – now four)

Bond ratings protected by First Amendment – cannot challenge in court

Used automated systems (formulas) to rate that were “gamed” by investment banks during the bubble (MBS complexity made/makes accurate valuation difficult)


One hedge fund manager s story

One hedge fund manager’s story:

  • “I didn’t understand how they were turning all this garbage into gold”

  • He brought some of the bond people from (investment banks) Goldman Sachs, Lehman Brothers, and UBS over for a visit.

  • “We always asked the same question. Where are the rating agencies in all of this? And I’d always get the same reaction. It was a smirk.”

  • He called Standard & Poor’s and asked what would happen to default rates if real estate prices fell. The man at S&P couldn’t say; its model for home prices had no ability to accept a negative number.

  • “They were just assuming home prices would keep going up… I cannot f*** believe this is allowed—I must have said that a thousand times in the past two years.”

Source: Condé Nast Portfolio.com, Dec 2008


Who was irrational cont2

Who was irrational? (cont)

ix. Insurers:

  • Partly relied on ratings, but mainly focused on short-term profits (securities more profitable to insure than individuals  shift to booming MBS market)

  • Use of Credit Default Swaps (CDFs) to hedge risk – no underlying collateral required!


C are cdses irrational

c. Are CDSes irrational?

  • Invented in 1997

  • Type of derivative (value tied to some other security or quantity)

  • Buyers make payments to sellers but receive payoff if underlying security defaults

  • Market expands 10x from 2003-2007

  • Current value = about $15 trillion of the CDS market tied to MDSes but…

  • Defaults are rare – about .2% of companies default, so most payments are simple “premiums”


D summary risk and rationality

d. Summary: Risk and Rationality

  • Risk-taking can be quite rational, yet generate catastrophe

  • Four key features of decision-making in the bubble:

    • Underestimation of risk: can correct formulas for this, but uncertainty will always remain

    • Moral hazard (incentives to do the wrong thing): CFOs do not require “insurable interest”  allows one to “short” stocks, inducing pessimism and creating default, then benefit from the default. This is why we don’t let people buy fire insurance on homes they don’t own or take out life insurance on their enemies.

    • Focus on short term returns: Created by…


Iv the principal agent problem

iv. The Principal-Agent Problem

  • Principal: Someone who represents others

  • Agents: Those who are represented

  • The Problem:

    • Principals are self-interested but charged with looking out for agent’s interests

    • Principals have more information than the agents, creating opportunities to profit at expense of agents


Examples

Examples:

  • Managers represent stockholders

  • Leaders represent citizens

  • Brokers represent mortgage banks

  • Executives represent companies

  • Solving the problem requires tying principal’s interests to those of agents


5 deregulation controversial

5. Deregulation (controversial)

a. Commodity Futures Modernization Act (2000): Made CDS deregulation explicit.


Cds deregulation cont

CDS Deregulation (Cont)

  • Argument: CDSes allowed businesses to leverage themselves without restraint (no reserves required, CDSes can become the basis of a new CDO in a never-ending cycle)  Small number of bad loans = huge losses

  • Objection: CDSes allow risk to be spread around, which reduces chances of collapse


Meltdown

The mortgage-securitization sausage-grinderHow well does Investor 1 on the right understand the risk of Mortgage 1 on the left?

Mortgage 1

CDO

Investor 1

Securitiza-

tion trust

Mortgage 2

CDO

CDO2

Investor 2

Mortgage 3

CDO

Investor 3

Mortgage 4

Investor 4

Collateralized

debt

obligation

(CDO)

Securitiza-

tion trust

Mortgage 5

CDO2

Investor 5

Mortgage 6

Investor 6

Mortgage 7

CDO

Investor 7

Securitiza-

tion trust

Mortgage 8

CDO

CDO2

Investor 8

Mortgage 9

CDO

Investor 9


Cds deregulation cont1

CDS Deregulation (Cont)

  • Argument: CDSes allowed businesses to leverage themselves without restraint (no reserves required, CDSes can become the basis of a new CDO in a never-ending cycle)  Small number of bad loans = huge losses


B amalgamation of banks and fragmentation of regulation

b. Amalgamation of banks and fragmentation of regulation

i. Argument: “Too big to fail and too big to regulate”

  • Amalgamation: 1994 and 1999 laws allowed banks to spread across state lines and into all sectors at once (investment banking, insurance, commercial banking)


Fragmentation

Fragmentation

  • Banks now permitted to choose state or federal regulation, AND

  • Banks allowed to choose BETWEEN federal regulators – and agency funding is tied to banks’ choice of regulator, AND

  • Different sectors of banks can be overseen by different regulators, allowing assets to be shifted into least-regulated sectors and preventing any one agency from evaluating the overall soundness of the bank


Ii objections

ii. Objections

  • Traditional investment banks (those which did not take advantage of the ability to enter other sectors) did worse than other banks (no large ones left).

  • Deregulation allowed US banks to better compete against foreign banks

  • Deregulation made banks more profitable, and hence better able to withstand shocks


C federal pre emption

c. Federal Pre-Emption

  • Argument: Federal regulatory authority was used to “pre-empt” (render null and void) anti-usury laws of states, allowing expansion of subprime loans (some interest rates as high as 22%!)

  • Objections:

    • Impossible to know what states would have done absent federal pre-emption

    • Pre-emption (Depository Institutions Deregulation and Monetary Control Act) occurred in 1980, decades before the crisis


6 market failures and the absence of regulation some controversy

6. Market failures and the absence of regulation (some controversy)

  • Securitization: As new derivatives were invented, few people actually understood them  inability to price them properly when risks begin to rise

  • SIVs: Allow banks to move actual loans off balance sheets, then guarantee the loans anyway to sell MBSes – move made purely to avoid regulations on maintaining reserves


From superhero to zero aaa to b in eight months

From Superhero to Zero:“AAA” to “B” in Eight Months


6 market failures and the absence of regulation some controversy1

6. Market failures and the absence of regulation (some controversy)

  • Securitization: As new derivatives were invented, few people actually understood them  inability to price them properly when risks begin to rise

  • SIVs: Allow banks to move actual loans off balance sheets, then guarantee the loans anyway to sell MBSes – move made purely to avoid regulations on maintaining reserves


C unregulated principals

c. Unregulated principals

  • Brokers: Unregulated and paid by commission – and banks are permitted to pay them higher fees for steering borrowers to more lucrative subprime loans

  • Executives: Compensation not tied to long-run performance

  • Corporate governance: Boards are supposed to oversee executives but often fail to do so (insulated from shareholders)


7 long term causes highly speculative

7. Long-term causes (highly speculative)

  • Low net national savings rate

    • NS = S – BD

    • Implication: budget deficits reduce savings. Large deficits normal since 1970s

    • Why do we care? Investment (spending on new capital equipment) must come from savings or borrowing from abroad


Outstanding credit as a percentage of gdp

Outstanding credit as a percentage of GDP


B current account deficits

b. Current Account Deficits

  • How investment is financed when savings are low

  • Problem: finance occurs through asset sell-off (i.e. mortgages)


Total foreign debts

Total Foreign Debts


Iii causes of current account deficit

iii. Causes of Current Account Deficit

  • Low national savings rate

  • Attractiveness of US securitization – draws in foreign capital (which otherwise might have been invested in developing countries)

  • Economic growth in developing nations – especially China and oil exporters


C business cycles

c. Business Cycles

  • Is this recession unusual?


D income inequality

d. Income inequality?

  • Income inequality correlates with asset bubbles. But which causes which?

    • Perhaps it contributes to the surplus of investment capital since rich people consume less than poor

    • Perhaps bubbles produce a handful of very, very rich people

  • Note: Middle-class consumption increased this decade, financed by borrowing (much of it against home values)


8 exacerbating factor accounting rules

8. Exacerbating factor: accounting rules

  • Old rules: Asset value was based on purchase price (allowed losses to be masked by keeping toxic assets around instead of selling them for a loss)

  • New rules (1990s): Asset value based on current market value  “Mark to market”

  • Problem: What if market value is unknown because no one has bought or sold this CDO?  Suddenly, banks and firms look under-capitalized, with many liabilities and few marketable assets  exacerbates credit crunch


Ii consequences and predictions

II. Consequences and Predictions

  • Continued Asset Deflation?

    1. Home ownership rates still higher than normal 


2 the second wave alt a and option arm mortgages will reset in 2010 2011

2. The Second Wave? Alt-A and Option ARM mortgages will reset in 2010-2011


1 high risk would you lend based upon these mortgage delinquency rates percent or buy us bonds

1. High Risk: Would you lend based upon these mortgage delinquency rates (percent) -- or buy US Bonds?

B. Credit Crunch


2 response banks hoarding cash and buying bonds

2. Response: Banks Hoarding Cash and Buying Bonds


3 cdo uncertainty deepens crunch

Problem: Banks and other lenders don’t know the value of what they’re holding – and neither do potential buyers

Result: Securitization has almost halted and asset-backed securities (like MBS) aren’t trading

Implication: Harder to get credit when lender is unable to spread risk and restore “liquidity” through securitization  fewer funds for auto loans, student loans, credit cards, etc – not just home mortgages

3. CDO uncertainty deepens crunch


Asset backed securities in decline

Asset-Backed Securities in Decline


C deflationary dangers

C. Deflationary dangers

  • Current models expect it to be brief

  • But expectations can become self-fulfilling prophecies if consumers spend less


D us recession

D. US Recession

1. Duration

  • December 2008: US official figures show recession started in December 2007

  • Recession is already 17 months old  longest since 1930s (43 months)

  • Recovery unlikely before end-2009  at least 24 months in length


2 severity sharper than most recessions 5 7 million jobs lost since dec 2007

2. Severity: Sharper than most recessions (5.7 million jobs lost since Dec 2007)


Unemployment compared to previous recessions

Unemployment compared to previous recessions


3 consequences

3. Consequences

  • Increased racial inequality:

    • As in other recessions, minority assets evaporate more quickly

    • Minorities disproportionately “steered” to subprime loans even when income/assets identical


Iii asset portfolios inequality

iii. Asset portfolios  inequality

Minority wealth more likely to be concentrated in primary dwelling (whites more likely to have business equity or investments)


Iv minority unemployment usually rises more during recessions

iv. Minority unemployment usually rises more during recessions


B worldwide recession

b. Worldwide recession


Global industrial output down

Global industrial output down


Meltdown

Latest IMF Projections (Jan 2009)


C declining interdependence

c. Declining interdependence

  • Decline in world trade volume: 1929 vs. 2008


D the iceland example

d. The Iceland example

  • Boom Years

  • Privatisation of banks (1999-2003)

  • Banks entered the housing market in 2004, competing agressively with the government’s HFF

    • Financed foreign investments of Icelandic entrepreneurs

  • Used low international interest rates, ample liquidity and low degree of perceived risk to expand internationally. Fast! Grew increasingly large – out of proportion to the country’s economy

    • Total assets about = Iceland’s GDP at end of 2000

    • Total assets about 10 times GDP at end of 2007

  • Important for domestic economy

    • Financial services, excluding insurance” about 8% of GDP (2007);

    • Approx. 2% of domestic labor force (4000 employees)

    • Big taxpayers


Ii the bank collapse

ii. The bank collapse

  • August 2007: Onset of the international (subprime) crisis. All banks perceived as at some risk.

  • Loss of confidence: A vicious spiral began where Icelandic banks, with balance sheets on the order of 10 times GDP, were perceived as too large for the government to back up

  • Since Iceland dependent on banking, investors assume economy will suffer  unload investments and deposits, flooding market with Icelandic kroner (ISK)

  • September: Kaupthing fails after UK government seizes assets of UK branch to protect UK depositors

  • October 7-9 2008: All major banks go down.

  • Government nationalised the domestic part of the banking sector


Iii stagflation in iceland

iii. Stagflation in Iceland

  • Currency lost value as economy plummeted, so imports became very expensive

  • Iceland depends on imports  general inflation on the island


Iv the imf steps in

iv. The IMF steps in

  • Objective: strengthen currency reserves and support exchange rate

  • IMF and others lend 5 bn USD to strengthen currency reserves

  • Concomitant package of measures designed to gurantee repayment

    • Banking: review and revision

    • Public sector: fiscal consolidation

    • Monetary policy and foreign exchange; extreme tightening

  • Considerable fiscal tightening needed over next 3-4 years (cumulative 12% of GDP) – IMF money cannot finance government spending, only purchases of ISK

  • Monetary policy extremely tight (policy rate started at 18%, now down to 15.5%)


Isk slide halted but still volatile

ISK slide halted – but still volatile


Iii policy responses

III. Policy Responses

  • Monetary policies

    • Further rate cuts impossible – interest rates about zero


Iii policy responses1

III. Policy Responses

  • Monetary policies

    • Further rate cuts impossible – interest rates about zero

    • “Quantitative easing” possible – easiest way is to purchase troubled assets, exchanging liquid dollars for lead weights


B recent legislation two stimuli and a bailout

B. Recent Legislation: Two Stimuli and a Bailout

  • Economic Stimulus Act of 2008 (passed Feb 2008): $152 billion, mostly tax rebates. $45 billion in business incentives and aid to homeowners.

  • Bailout: Emergency Economic Stabilization Act of 2008 (passed Oct 2008). $700 billion intended to prevent banking collapse. Major provisions:


A tarp troubled asset relief program

a. TARP: Troubled Asset Relief Program

Few strings attached  program has evolved over time

  • Original plan was to buy MBSes and other CDOs, so they would have a market value

  • Then plan was to recapitalize banks (boost reserves so they would lend)

  • Latest plan ($300 billion remaining) = allow private investors to buy troubled assets – but how? Insure them? Pay % of price?

  • TALF: Related program using some TARP funds to back up to $1 trillion in loans by a new quasi-private agency created by the Fed. Goal is to buy assets underlying MBSes, thus guaranteeing their market value and restarting securitization.


B other provisions

b. Other provisions

  • Allows suspension of mark-to-market rules: SEC has declined to suspend them – suggests basing value on incoming mortgage payments

  • Provides for nonbinding shareholder votes on executive compensation (recent amendment limits bonuses)

  • Requires preferential hiring of US workers over immigrants (H1-B visas)


C effects no bank collapse but no end to the credit crunch either

c. Effects – no bank collapse, but no end to the credit crunch either

  • Many banks took money at government request – some have since repaid it

  • Most money spent on buying bank stocks/equity to shore up stock prices and guaranteeing assets in largest banks

  • Banks have used the money to “pay down debt, acquire other businesses or invest for the future” – everything BUT lending more.

  • President Bush declared part of the law nonbinding and extended funds to auto companies ($40 billion so far)


3 stimulus round ii american recovery and reinvestment act of 2009

3. Stimulus Round II: American Recovery and Reinvestment Act of 2009

  • About $800 billion, passed Feb 2009

  • Mostly old-fashioned Keynesian stimulus financed through deficit spending


A major spending programs 10 billion or more allocated

a. Major Spending Programs ($10 billion or more allocated)

  • For more info, get the pdf linked on the course website


I science and energy

i. Science and Energy

  • $32 billion: Funding for “smart electricity grid” to reduce waste

  • $16 billion: Renewable energy tax cuts and a tax credit for research and development on energy-related work, and a multiyear extension of renewable energy production tax credit

  • $10 billion: Science facilities


Ii infrastructure

ii. Infrastructure

  • $30 billion: Transportation projects

  • $31 billion: Construction and repair of federal buildings and other public infrastructure

  • $19 billion: Water projects

  • $10 billion: Rail and mass transit projects


Iii education

iii. Education

  • $41 billion: Grants to local school districts

  • $21 billion: School modernization ($15.6 billion to increase the Pell grant by $500; $6 billion for higher education modernization)

  • $79 billion: State fiscal relief to prevent cuts in state aid (but how much will really go to education?)


Iv health care

iv. Health Care

  • $39 billion: Subsidies to health insurance for unemployed; providing coverage through Medicaid

  • $87 billion: Help to states with Medicaid

  • $20 billion: Modernization of health-information technology systems


V welfare and unemployment benefits

v. Welfare and Unemployment benefits

  • $43 billion for increased unemployment benefits and job training.

  • $39 billion to support those who lose their jobs by helping them to pay the cost of keeping their employer provided healthcare under COBRA and providing short-term options to be covered by Medicaid.

  • $20 billion to increase the food stamp benefit by over 13% in order to help defray rising food costs.


B tax cuts and rebates

b. Tax cuts and rebates

i. Individuals:

  • $400 per worker, $800 per couple tax cut for two years (cost > $100 billion)

  • Greater access to the $1,000-per-child tax credit for the working poor (make it fully refundable)

  • Expansion of the earned-income tax credit to include families with three children (i.e. give them larger benefits)

  • A $2,500 college tuition tax credit.

  • Repeal of a requirement that a $7,500 first-time homebuyer tax credit be paid back over time.


Ii businesses

ii. Businesses

  • An infusion of cash into money-losing companies by allowing them to claim tax credits on past profits dating back five years instead of two.

  • “Bonus depreciation” (50% in first year) for businesses investing in new plants and equipment

  • Doubling of the amount small businesses can write off for capital investments and new equipment purchases.

  • Allowing businesses to claim a tax credit for hiring “disconnected youth” and veterans


C summary from recovery gov

c. Summary (from Recovery.gov)


D timeline actual spending is staggered over several fiscal years

d. Timeline: Actual Spending is staggered over several fiscal years

  • FY 2010 begins Oct 1, 2009


C other proposals

C. Other proposals

  • Financial reforms

    • Mortgages

      • Consumer protection, incl. standards for mortgage brokers

      • Fix “originate to distribute” model so lenders stay on the hook

    • Banks: make reserve requirements countercyclical – i.e. 12% in good times and 8% in bad times

    • Extend bank regulation to “near banks”

    • Outlaw or restrict the use of SIVs to camouflage risk

    • Regulatory agencies: Merge so one regulates all banks

    • Reduce ratings agencies’ conflicts of interest

    • Regulate CDSes – or at least establish central clearing house for them

    • Suspend mark-to-market rules

    • Limit mergers: “Too big to fail is too big to exist”


2 stabilize the housing market sample proposals

2. Stabilize the Housing Market: Sample Proposals

a. “Right to Rent:” Homeowners facing foreclosure have the right to stay in their home as tenants paying the market rent.

  • Gives homeowners security in their home

  • Keeps home occupied – and off the market, slowing the fall in home values

  • Gives bank an incentive to negotiate mortgage terms that allow homeowner to remain a homeowner.

  • Requires no bureaucracy or tax dollars, takes effect immediately.


B mortgage cram downs

b. Mortgage “Cram-Downs”

  • Businesses entering bankruptcy can renege on contracts such as pension agreements, etc – “cramming down” a new, more affordable agreement in order to continue to operate

  • This proposal would allow homeowners entering bankruptcy to do the same thing with mortgages, as long as they pay current market value plus reasonable interest


Simulation preview

Simulation Preview

  • What steps would you take to deal with the economic crisis? Think:

    • Financial System

    • Monetary Policy

    • Housing Policy

    • Regulatory Agencies

    • Spending Programs

    • Taxes and Cuts

    • Principal-Agent Problems


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