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Finance 129. Background on the Financial Crisis And Current Economy. The Big Picture. Problems in Mortgage Market. Global Credit Crisis / Bank failures / Equity Losses. Declining Consumer Spending. Decreased Business Investment. Who’s to Blame?.

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finance 129

Finance 129

Background on the Financial Crisis

And Current Economy

the big picture
The Big Picture

Problems in Mortgage Market

Global Credit Crisis / Bank failures / Equity Losses

Declining Consumer Spending

Decreased Business Investment

how financial markets enabled keeping up with the joneses
How Financial Markets Enabled“Keeping up with the Joneses”
  • New Products
  • Poor Underwriting
  • Public Policies Unintended Consequences
  • Low Rates and International Capital Flows
average size of subprime loans
Average Size of Subprime Loans

Demyanyk and Van Hermert, "Understanding the Subprime Mortgage Crisis" Federal Reserve Bank of St. Louis, Working paper 2007-05, August 2008 (sample represents approximately 85% of securitized subprime loans, over 50% to total subprime

credit quality of subprime loans originated each year
Credit Quality of Subprime Loans Originated each year

Demyanyk and Van Hermert, "Understanding the Subprime Mortgage Crisis" Federal Reserve Bank of St. Louis, Working paper 2007-05, August 2008 (sample represents approximately 85% of securitized subprime loans, over 50% to total subprime

impact of subprime loans on home ownership
Impact of Subprime Loans on Home Ownership

"SubPrime Lending: A Net Drain on Homeownership," Center for Responsible Lending: March 2007

fannie mae s guarantee of alt a loans
Fannie Mae’sGuarantee of Alt A Loans

NY Times October 4 "Pressured to Take More Risk Fannie Hit a Tipping Point"

blaming fannie and freddie
Blaming Fannie and Freddie?
  • No - Fannie and Freddie were small relative to the entire market.
    • Combined Subprime Purchases (% of Market)**
    • Consumer demand created rapid prince increase
  • Yes – Overall Size put them at risk for any Mortgage Market problem
    • Securitizing more risky loans opened door for Private securitization

Gramlich, E. "Subprime Loans: America\'s Latest Boom an Bust" 2007 ** "how HUD Mortgage Policy Fed the Crisis", Washington Post June 10, 2008

international capital flows
International Capital Flows

Consumer Spending On Exports

Increased Foreign Holdings of $

Increased Inflow of Dollars

Helps Keep Long Term Rates Low

the perfect storm 2004 2007
“The Perfect Storm” 2004 - 2007
  • Domestic and global institutions buy MBS in attempt to increase margins on “safe” securities, incorrectly rated.
  • Institutions use higher debt levels for securitization.
  • Underwriting standards deteriorate.
  • Increased interest rate environment makes loans more likely to default
  • Increasing Home Prices encourage consumers to overextend and speculate in housing market
response of consumers
Response of Consumers
  • Increased access to credit and delusional optimism resulted in:
    • Short-Term Speculative Focus
    • Borrowing More and Saving Less
case study natalie brandon
Case Study: Natalie Brandon
  • 1985 Buys $105,000 house
    • 30 Year fixed rate loan Payment = $770
  • 2000-2006
    • Paid penalties to Refi 5 times in 5 years
    • Yearly income = $100,000
    • 2006 New Loan $625,500 2/28 7.99% teaser
    • Payment = $4,585
  • Fall 2007
    • Home Value = $450,000
    • Attempt to Refi for 40 years at 6% Fails
precautionary saving
Precautionary Saving

If you were to lose your job, for how long could you afford to be out of

work and still meet your financial obligations including monthly expenses?

The 2009 MetLife Study of the American Dream

confidence in having enough money to live comfortably throughout retirement years
Confidence in Having Enough Money to Live Comfortably Throughout Retirement Years

Employee Benefits Research Institute – Retirement Confidence Survey

the keys to recovery the big picture
The Keys to Recovery – The Big Picture

Consumers

Precautionary or Long Term Savings?

Lost Faith in Investment Planning?

View of home ownership

Corporate Earnings

Financial Markets and Regulation

Regulatory Changes

Long Term Inflation Fears

Monetary and Fiscal Policy & Interest Rates

Global Concerns

employment non farm payrolls1
Employment: Non Farm Payrolls

Peak = 138 M

Jan 2009

Current = 133.2 M

July 2012

Min = 129.2 M

Feb 2010

employment
Employment
  • Peak Employment Jan 2009 = 138.023 Million
  • Current Employment July 2012 = 133.245 Million
  • Average monthly gain needed in payrolls to return to peak level in:

1 year 398,166 2 years 199,083 3 years 132,722

Feb 240,000 March 154,000 April 77,000

May 77,000 June 64,000 July 164,000

other forces
Other Forces
  • Government

Contraction

  • Tight Credit
  • Uncertainty

US, Europe, China

The Slow Recovery: It’s No Just Housing FRBSF Economic Letter April 9, 2012

history of eu 1950
History of EU 1950

The Schuman Declaration

Plan for France and Germany to pool coal and steel production.

European economic unity will make war “Not merely unthinkable but materially impossible”

Robert Schuman

French Foreign Minister

slide28
1951

European Coal and Steel Community

France, Germany, Italy, Netherlands, Belgium and Luxembourg

High Authority (oversees coal and steel production)

Common Assembly (future European Parliament)

Council of Ministers

changing landscape
Changing Landscape

The Group of Twenty a History www.g20.org

a brief history of european debt crisis
A Brief History of European Debt Crisis
  • January 2001 – Greece Joins Euro zone and adopts Euro.
  • Nov 2004 – Greece admits its deficit has been above the required EU limit (3% of GDP) since 1999
  • March 2005 – Trade Unions impose 24 hour strike to protest austerity measures after cost of hosting Olympics causes high deficits

Greek timeline on this and future slides from news.bbc.co.uk/2/hi/Europe/country_profiles/1014812.stm

slide31
2002
  • Germany’s Debt hits 60.7% in 2002 of GDP and is still above 60%
  • Germany’s budget deficit hits 3.8% of GDP in 2002 and remains above 3% until 2006
  • France’s debt hits 63.3% of GDP in 2003 and is still above 60%
  • France’s budget deficit hits 3.3%in 2002 and remains above 3% until 2006
  • Neither country receives penalties from the European Union
slide32
2005
  • The 1997 Growth and Stability Pact is altered to allow “exceptional circumstances” and “other relevant factors” to be considered when the deficit and debt targets are missed.
  • Memebers are allowed two year to correct the problem and could be given more time with an exception.
deficit as a of gdp
Deficit as a % of GDP

ECB http://www.ecb.int/stats/gov/html/dashboard.en.html

contagion
Contagion
  • November 28, 2010
    • Ireland receives €67.5B in bailout loan commitments
    • Given to 2015 to decrease deficit to 3% of GDP
  • May 2011
    • May 3 Portugal accepts €116B loan commitment package

shttp://www.huffingtonpost.com/2010/11/28/ireland-bailout-european-union_n_788922.html

gao baseline
GAO Baseline
  • Revenues as a share of GDP increase and discretionary spending as a share of GDP decreases
gao alternative scenario
GAO Alternative Scenario
  • Revenue and Discretionary Spending are at historical averages over long term.
  • Soc Sec, Medicare, Medicaid and interest exceed revenue by 2030
fiscal gap or current value of future primary deficits
Fiscal Gap or Current Value of Future Primary Deficits
  • The sum of the present values of the difference, or gap, between revenue and noninterest spending over the next 75 years.
  • Assumes the goal of having today’s debt to GDP ratio at the end of the period
cost of closing the gap
Cost of Closing the Gap

www.gao.gov The Federal Government\'s Long-Term Fiscal Outlook January 2012

the world in 2050
The World in 2050
  • The G7 vs the E7 (Brazil, Russia, India, China, Indonesia, Mexico and Turkey)
  • Emerging Middle Class in Developing Economies
    • 2005 G7 is currently about 20% larger in Purchasing power parity (PPP) and 75% larger in terms of market exchange rates (MER)
    • E7 will be 75% larger than G7 in PPP and 25% larger in terms of the (MER)

The World in 2050, Price Waterhouse Coopers, March 2006

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