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Finance 129

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

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  1. Finance 129 Background on the Financial Crisis And Current Economy

  2. The Big Picture Problems in Mortgage Market Global Credit Crisis / Bank failures / Equity Losses Declining Consumer Spending Decreased Business Investment

  3. Who’s to Blame?

  4. How Financial Markets Enabled“Keeping up with the Joneses” • New Products • Poor Underwriting • Public Policies Unintended Consequences • Low Rates and International Capital Flows

  5. 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

  6. 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

  7. Impact of Subprime Loans on Home Ownership "SubPrime Lending: A Net Drain on Homeownership," Center for Responsible Lending: March 2007

  8. Fannie Mae’sGuarantee of Alt A Loans NY Times October 4 "Pressured to Take More Risk Fannie Hit a Tipping Point"

  9. 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

  10. International Capital Flows Consumer Spending On Exports Increased Foreign Holdings of $ Increased Inflow of Dollars Helps Keep Long Term Rates Low

  11. “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

  12. Non Agency Mortgage Foreclosure Rates

  13. Response of Consumers • Increased access to credit and delusional optimism resulted in: • Short-Term Speculative Focus • Borrowing More and Saving Less

  14. 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

  15. Borrowing More & Saving Less

  16. Equity Prices Compared to Past Recessions

  17. 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

  18. Confidence in Having Enough Money to Live Comfortably Throughout Retirement Years Employee Benefits Research Institute – Retirement Confidence Survey

  19. 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

  20. Consumer Credit Outstanding

  21. ISM Manufacturing Survey

  22. Employment: Non Farm Payrolls

  23. Employment: Non Farm Payrolls Peak = 138 M Jan 2009 Current = 133.2 M July 2012 Min = 129.2 M Feb 2010

  24. 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

  25. Other Forces • Government Contraction • Tight Credit • Uncertainty US, Europe, China The Slow Recovery: It’s No Just Housing FRBSF Economic Letter April 9, 2012

  26. 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

  27. 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

  28. Changing Landscape The Group of Twenty a History www.g20.org

  29. 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

  30. 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

  31. 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.

  32. Deficit as a % of GDP ECB http://www.ecb.int/stats/gov/html/dashboard.en.html

  33. Euro Area Debt

  34. Long Term Borrowing Costs (10 year debt) Jan 2010 – May 2012

  35. 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

  36. Public Debt Comparison

  37. Treasury Bid to Cover Ratio

  38. Average Interest Expense

  39. GAO Baseline • Revenues as a share of GDP increase and discretionary spending as a share of GDP decreases

  40. GAO Baseline

  41. GAO Alternative Scenario • Revenue and Discretionary Spending are at historical averages over long term. • Soc Sec, Medicare, Medicaid and interest exceed revenue by 2030

  42. GAO Alternative Scenario

  43. 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

  44. Cost of Closing the Gap www.gao.gov The Federal Government's Long-Term Fiscal Outlook January 2012

  45. 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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