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The History of the 2006- ? Economic Crisis. Three Parts: 1) Government Intervention; 2) Federal Reserve Policies; and 3) Corruption. Time Line. 1938 Fannie Mae as government agency 1967: LBJ spins the Fannie off as GSE 1970: Freddie Mac created 1977: CRA enacted –

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The history of the 2006 economic crisis

The History of the 2006- ? Economic Crisis

Three Parts: 1) Government Intervention; 2) Federal Reserve Policies; and 3) Corruption


Time line
Time Line

  • 1938 Fannie Mae as government agency

  • 1967: LBJ spins the Fannie off as GSE

  • 1970: Freddie Mac created

  • 1977: CRA enacted –

  • 1992: Congress pushes FF to provide low income loans

  • 1995: CRA strengthened

  • 1996: HUD required that 12% of all mortgages purchased by FF be special affordable loans -- income less than 60% of the median in the area – then 20% in 2000, 22% in 2005 and 28% in 2008. HUD also gives FF target for affordable loans of over 50%.


The history of the 2006 economic crisis

FF with implicit govt guarantee can offer product at lower prices: gap between AAA and 10 yr Treasury 1.46% whereas between FF and 10 yr Treasury .5%


Given fannie freddie are as good as us govt can attract funds from around the world
Given Fannie/Freddie are “as good as US govt” can attract funds from around the world



Looser standards
Looser Standards mtg

  • In the 1980s, groups such as the activists at ACORN began pushing charges of "redlining" - claims that banks discriminated against minorities in mortgage lending.

  • In 1989, Congress amended the Home Mortgage Disclosure Act to force banks to collect racial data on mortgage applicants;


Looser standards1
Looser Standards mtg

Larger percentage of NINJA loans included in securities

  • A 1995 strengthening of the Community Reinvestment Act required banks to find ways to provide mortgages to their poorer communities

  • the Boston Fed ruled that participation in a credit-counseling programshould be taken as evidence of an applicant's ability to manage debt.


Securitization
Securitization mtg

  • 1. A borrower – sometimes working with a broker, gets a loan from a lender.


Securitization1
Securitization mtg

  • 2. The lender bundles a number of home loans and sells bundle to an investment bank

Security A


Securitization2
Securitization mtg

  • 3. The investment bank takes pools of home loans worth billions of dollars and places them in a trust. The trust issues bonds secured by the mortgages.


Securitization3
Securitization mtg

  • 4. The investment bank divides the loans into bond risk groups - “tranches”. Rating groups indicate the risk.

Medium risk

Low risk

High risk


Securitization4
Securitization mtg

  • 5. Bonds are sold to bigger investors

  • 6. Potential risk of default is solved by credit default swap




The history of the 2006 economic crisis

Subtracting the averaged trailing 12 months lowered.median CPI (SOURCE: Cleveland Fed) from the average of the monthly Fed Funds rate (SOURCE: Federal Reserve).





Root cause
Root Cause Murphy, Mises.org)

  • The bubble is a combination of “affordable housing” and the Fed's boom-bust policies.

  • The NINJA loans meant that the investors looking for homes to buy and resell got no down, interest only, ARMS also. It was not just poor people.


Is it due to lax regulation were regulators sleeping
Is it due to lax regulation? Were regulators sleeping? Murphy, Mises.org)

  • NO regulators relaxed lending standards - at the behest of community groups and "progressive" political forces.


Securitization5
Securitization Murphy, Mises.org)

  • 4. The investment bank divides the loans into bond risk groups - “tranches”. Rating groups indicate the risk.

AAA

Medium risk

Low risk

High risk


The crunch
The Crunch Murphy, Mises.org)

  • Federal funds rate was kept at 2 percent or lower from November 2001 right through to the end of 2004.

  • Greenspan used the housing market to prop up the economy after the 9/11 attacks.

  • In 2002 he called mortgage markets a "powerful stabilizing force" because they allowed people to extract equity from their homes.

  • In 2004 he said that homeowners should consider using adjustable-rate mortgages to save on interest and prepayment costs.

  • In 2005 Fed Funds rate increased tremendously– from less than 2% to more than 5%




Ohhhh nooooo credit crunch
Ohhhh Nooooo – Credit Crunch Murphy, Mises.org)