Presentation Transcript

1. THE SUBPRIME CRISIS Gary Klass Pos232 Revised 2/3/14 Key slides: 6 9 10 13 14 And: Michael Comiskey and PawanMadhogarhia,Unraveling the Financial Crisis of 2008,PS,  April 2009, especially points 11-14 (who’s to blame)
2. Depositors
3. Investors Depositors Fannie MaeFreddie Mac FSLIC – FDICINSURES DEPOSITS FHAINSURES MORTGAGE
4. What can go wrong (for lenders) Depositors run (fix with FDIC, FSLIC) Interest Rates Rise: Interest on deposits exceeds interest on loan Causes falling housing prices:mortagage exceeds house value Interest Rates Fall Homeowner refinances loan

5. Subprime loans

   Balloon mortgage: borrower pays only interest for 10 years before a big lump-sum payment is due. Liar loan: borrower is asked merely to state his annual income, without presenting any documentation. Option ARM: in which the borrower can pay less than the agreed-upon interest and principal payment, simply by adding to the outstanding balance of the loan. Piggyback loan: a combination of a first and second mortgage eliminates the need for any down payment. Teaser loan: artificially low initial interest rate – difference added to loan’s principal. Stretch loan: borrower has commits more than 50 percent of gross income to make the monthly payments. NINJA loan -- "No Income, No Job and No Assets."
6. Investors InsurersAIGcredit default swaps Mortgage-backed securities(collateralized debt obligations)Investment banks: J.P Morgan, Bears StearnsGoldman Sachs, Lehman Brothers Rating Firms:Moody’s S&P Servicer Lender Mortgage Broker Subprime, Alt-A, Jumbo Loans Appraiser HOMEOWNERS
7. http://stlouisfed.org/publications/re/2008/d/pdf/mortgage.pdf http://stlouisfed.org/publications/re/2008/d/pdf/mortgage.pdf
8. Dow Jones Industrial Average

9. History

   1977 Community Reinvestment Act (CRA) 1986 Only home mortgage interest is tax deductible; home-equity loans become common. Bank interest rates deregulated. 1985-1990 1,000 S&Ls go bankrupt. 1999 repeal of the Glass-Steagalllaw (Clinton*) 2000 Dot-com stock bubble bursts, Fed lowers interest rates 2001 mild recession, Fed lowers rates more 2004 Fed starts increasing interest rates. Home prices up 25% in CA, FLA. More loans are adjustable (30% vs. 10% in 2001) Fannie Mae and Freddie Mac buy subprime loans Home prices increase (10% on the coasts)
10. 2004 Fed starts increasing interest rates. Home prices up 25% in CA, FLA. More loans are adjustable (30% vs. 10% in 2001) Homeownership peaks at 69.2% 2005: 22% of mortgages are subprime (8% in 2003). Home prices slow. CRA lower-income market rules relaxed 2006: Interest rates and home prices hit peak. 2007: Subprime market collapses, July: Dow Jones hits 14,000 International markets fall. October 2008: Stock Market Falls
11. Government response to the crisis: Federal Reserve Lowers “discount” interest rate to near 0 $30 Billion for Bears Stearns buyout $200 Billion to nationalize Fannie and Freddie Buys most of AIG for $182 Billion (or $85B)-- “covers” investors who bought credit default swaps at full value. (+ 40 Billion TARP money) (2008-9) Buys $300 Billion of US Debt(“monetizes” the debt) Buys $1.25 Trillion in Mortgage-backed securities
12. Government response to the crisis: GW BushTARP: Troubled Asset Relief Program $750 Billion (half Bush half Obama) Fall, 2008 (big issue in presidential campaign) Initial purpose: to buy “toxic” mortgage securities Instead: to “buy” the Banks themselves:AIG: $40B CITI $45B Bank of Am. $45BGM: $13.4B Chrysler: 4B
13. Government response to the crisis: ObamaAmerican Recovery and Reinvestment Act of 2009“Stimulus Bill” Feb, 2009: $787 Billion Tax cuts: $288B Health Care: $144B (Medicaid and COBRA) Education: $90B Income assistance: $83B (unemployment, Food Stamps, Social Security bonus) Infrastructure\vehicles\energy $81B Homebuyers tax credit $8000 (until 4/30/10) 2011: The American Jobs Act
14. Dodd-Frank Created Consumer Financial Protection Bureau Ends “Too Big to Fail” Bailouts of investment banks (sort of): Requires reserve funds Transparency for Credit Default Swaps and derivatives, requires reserve capital New rules for ratings agencies Federal Reserve reforms (public audit) Executive compensation and corporate governance reforms Credit card fees limited Volker rule: limitations on banks proprietary trading  Link
15. Not prosecuted Countrywide Financial (largest mortgage lender in 2005-6: officers forged loan applications, issued liar loans, did not disclose quality of loans, concealed fraud, fired whistle-blower CEO Angelo Mozilo banned from banking $22milion fine B of America (new owner) pays $335 million finefor discrimination Goldman Sachs: “shorted” the CDO it was selling to investors
16. Not prosecuted Goldman Sachs: “shorted” the CDOs it was selling to investors $550 million SEC settlement did not admit wrongdoing FabriceTourre, 28-year-old salesman, sued by the SEC
17. Not prosecuted Citigroup (bought and sold Countrywide mortgages) employee discovered fraud in 60% of loans in 2006 Citigroup kept buying and selling, and concealed its own exposure from regulators Employee demoted and told not to come in $48 Billion bailout SEC settles with Citigroup for $238 million But Judge Rakoffrefuses to OK the settlement
18. Acquitted Bear Stearns Cos. 2 hedge-fund managers Sold $1.6 billion in securities they knew (in email) were not good Stock falls from $172 share to $2 FED finances takeover by J.P. Morgan
19. College Illinois Investments