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Principles of Macroeconomics

Principles of Macroeconomics. Economic Crisis. HOW DID WE GET HERE. C HANGES H AZARD A CCOUNTABILITY O VERSIGHT S PECULATION. HOW DID WE GET HERE. Chaos Theory Study of nonlinear dynamics, where seemingly random events are actually predictable

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Principles of Macroeconomics

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  1. Principles of Macroeconomics Economic Crisis Macroeconomics, March 30, 2009, Martha Stuffler

  2. HOW DID WE GET HERE CHANGES HAZARD ACCOUNTABILITY OVERSIGHT SPECULATION Macroeconomics, March 30, 2009, Martha Stuffler

  3. HOW DID WE GET HERE Chaos Theory Study of nonlinear dynamics, where seemingly random events are actually predictable ASK YOURSELF: Could this have been predicted? Macroeconomics, March 30, 2009, Martha Stuffler

  4. HOW DID WE GET HERE CHANGES IN BANKING LEGISLATION Glass-Steagall Act (1932 & 1933) Distinction between everyday banks and investment banks Repealed in 1999 Macroeconomics, March 30, 2009, Martha Stuffler

  5. HOW DID WE GET HERE Depository Institution Deregulation And Monetary Control Act 1980 Allowed banks to both lend and invest Macroeconomics, March 30, 2009, Martha Stuffler

  6. HOW DID WE GET HERE 1982 Garn St Germain & Alternative Mortgage Transactions Parity Act Allowed banks to offer: Adjustable Rate Loans Interest Only Loans Balloon Payment Loans Macroeconomics, March 30, 2009, Martha Stuffler

  7. HOW DID WE GET HERE 1982 Garn St Germain & Alternative Mortgage Transactions Parity Act Allowed banks to make: Adjustable Rate Loans Interest Only Loans Balloon Payment Loans Macroeconomics, March 30, 2009, Martha Stuffler

  8. HOW DID WE GET HERE Gramm-Leach Bliley ACT (1999) Banks, investments and insurance under one umbrella Macroeconomics, March 30, 2009, Martha Stuffler

  9. HOW DID WE GET HERE EXAMPLES JP Morgan buying Bear Stearns Bank of America buying Merrill Lynch Macroeconomics, March 30, 2009, Martha Stuffler

  10. HOW DID WE GET HERE MORAL HAZARD Behavioral change because something is reducing our risk We do not bear 100% of the risk Macroeconomics, March 30, 2009, Martha Stuffler

  11. HOW DID WE GET HERE MORAL HAZARD Individuals who are risk adverse become more tolerant or accepting of risk Macroeconomics, March 30, 2009, Martha Stuffler

  12. HOW DID WE GET HERE MORAL HAZARD Seat Belts FDIC Federal Deposit Insurance Corp. $250,000 per account Macroeconomics, March 30, 2009, Martha Stuffler

  13. HOW DID WE GET HERE MORAL HAZARD Consumers and lenders took on excessively high levels of risk Macroeconomics, March 30, 2009, Martha Stuffler

  14. HOW DID WE GET HERE CONSUMERS Sub Prime Mortgages Low credit scores – high risk loans Higher interest rates Higher loan origination fees Macroeconomics, March 30, 2009, Martha Stuffler

  15. HOW DID WE GET HERE CONSUMERS About 80% of the Sub-Prime loans were Adjustable Rate or Pick-A-Payment Loans Macroeconomics, March 30, 2009, Martha Stuffler

  16. HOW DID WE GET HERE CONSUMERS Interest Only Loans If unpaid, interest becomes part of the loan principal Macroeconomics, March 30, 2009, Martha Stuffler

  17. HOW DID WE GET HERE CONSUMERS “Liar Loans” – lied about income Fraud--False income claims Worst Liar loans “NINJA LOANS” No Income, No Job, No Assets Macroeconomics, March 30, 2009, Martha Stuffler

  18. HOW DID WE GET HERE CONSUMERS Today, homeowners with “liar loans” are stuck -- no help Did moral hazard only affect consumers? Macroeconomics, March 30, 2009, Martha Stuffler

  19. HOW DID WE GET HERE LENDERS Encouraged people to take out loans they couldn’t afford Believed housing P continue to rise, if default, pricey asset Macroeconomics, March 30, 2009, Martha Stuffler

  20. HOW DID WE GET HERE LENDERS Moral Hazard Government bailed out thrifts and loans and saving and loans in the 1980s Government will do it again Transferred risk from lenders to government Macroeconomics, March 30, 2009, Martha Stuffler

  21. HOW DID WE GET HERE LENDERS Lenders didn’t have to keep the loans, they could sell to investors Sell to investors and get more money to lend Macroeconomics, March 30, 2009, Martha Stuffler

  22. HOW DID WE GET HERE LENDERS Risk is transferred from lenders to investors Not all lenders did this Macroeconomics, March 30, 2009, Martha Stuffler

  23. HOW DID WE GET HERE LENDERS SECURITIZATION began 1970s: Banks pool mortgages into MBS (mortgage backed securities) Sub-prime loans were securitized - packaged with high quality loans Sold to investors as mortgage-backed securities Macroeconomics, March 30, 2009, Martha Stuffler

  24. HOW DID WE GET HERE LENDERS Bad loans combined with good or high quality mortgage backed securities Toxic Assets Macroeconomics, March 30, 2009, Martha Stuffler

  25. HOW DID WE GET HERE LENDERS Faulty rating process that overrated sub prime loans for investment purposes Ratings underestimated true risk of sub prime loans Macroeconomics, March 30, 2009, Martha Stuffler

  26. HOW DID WE GET HERE LENDERS FANNIE MAE AND FREDDIE MAC Government sponsored enterprises (GSEs) since 1968 Privately owned and operated Macroeconomics, March 30, 2009, Martha Stuffler

  27. HOW DID WE GET HERE LENDERS Only lenders not required to report publicly their financial problems Protected by US government Macroeconomics, March 30, 2009, Martha Stuffler

  28. HOW DID WE GET HERE LENDERS Freddie Mac and Fannie Mae Borrowed money at low interest rates from foreign investors, if mortgage defaults, US government would protect the investors Macroeconomics, March 30, 2009, Martha Stuffler

  29. HOW DID WE GET HERE LENDERS FANNIE MAE AND FREDDIE MAC Guaranteed “liar loans” from Countrywide and Indymac Countrywide bought by BofA and Indymac taken over by FDIC Macroeconomics, March 30, 2009, Martha Stuffler

  30. HOW DID WE GET HERE LENDERS/INVESTORS Carry trade, derivatives, hedge funds, credit default swaps are not discussed here Macroeconomics, March 30, 2009, Martha Stuffler

  31. HOW DID WE GET HERE LENDERS US top 5 banks control 96% of the derivatives Assuming a great deal of risk if buyers stop buying real estate or interest rates rise BofA, Citibank, JP Morgan chase, HSBC Bank USA, Goldman Sachs Macroeconomics, March 30, 2009, Martha Stuffler

  32. HOW DID WE GET HERE ACCOUNTABILITY American Dream Homeownership 1970s political goal Increase US homeownership rate Macroeconomics, March 30, 2009, Martha Stuffler

  33. HOW DID WE GET HERE ACCOUNTABILITY Target low income groups US homeownership rate increased from 64% in 1980 to 69.1% in 2005 Census Bureau estimate 4Q2008 is 67.5% Macroeconomics, March 30, 2009, Martha Stuffler

  34. HOW DID WE GET HERE ACCOUNTABILITY 1996 US Department of Housing and Urban Development (HUD) set a goal for the US Treasury’s Financial Management Service (FMS) At least 42% of the mortgages purchased must be for borrowers whose household income was below the median income in their area Macroeconomics, March 30, 2009, Martha Stuffler

  35. HOW DID WE GET HERE ACCOUNTABILITY 2005: Target increased to 52% At least 52% of the mortgages purchased must be for borrowers whose household income was below the median income in their area By 2008 US Treasury FMS owned or through mortgage pools sponsored about 50% of all US mortgages Macroeconomics, March 30, 2009, Martha Stuffler

  36. HOW DID WE GET HERE ACCOUNTABILITY Banks could be fined—not lending to “nontraditional customers” like those with no credit history Down payment requirements became 2nd mortgages Macroeconomics, March 30, 2009, Martha Stuffler

  37. HOW DID WE GET HERE ACCOUNTABILITY 2003 White House and Alan Greenspan called for stricter controls on GSEs (government sponsored enterprises) and wanted limitations on the amount of their high risk investments Macroeconomics, March 30, 2009, Martha Stuffler

  38. HOW DID WE GET HERE ACCOUNTABILITY From Terry Frieden: CNN Washington BureauFriday, September 17, 2004 Posted: 5:44 PM EDT (2144 GMT) WASHINGTON (CNN) -- Rampant fraud in the mortgage industry has increased so sharply that the FBI warned Friday of an "epidemic" of financial crimes which, if not curtailed, could become "the next S&L crisis." Macroeconomics, March 30, 2009, Martha Stuffler

  39. HOW DID WE GET HERE ACCOUNTABILITY 2004 US Congressional Hearings examined fraudulent accounting practices within Fannie Mae and Freddie Mac Highly publicized Everyone should view the YouTube video or read the transcript of this hearing Macroeconomics, March 30, 2009, Martha Stuffler

  40. HOW DID WE GET HERE ACCOUNTABILITY 2005 US Senate Banking Committee proposed a bill for a new regulator who would be able to adjust the size of the GSEs' (government sponsored enterprises) portfolios. Regulator would oversee GSEs to keep them from running into financial trouble and limit their risk. Regulator would have increased power comparable to that of a bank regulator. Macroeconomics, March 30, 2009, Martha Stuffler

  41. HOW DID WE GET HERE ACCOUNTABILITY 2005 US Senate Banking Committee proposed bill was endorsed by Alan Greenspan and the White House BUT the proposed bill did not come to a vote Macroeconomics, March 30, 2009, Martha Stuffler

  42. HOW DID WE GET HERE ACCOUNTABILITY Fed Moral Suasion to ease lending What Does Moral Suasion Mean? Macroeconomics, March 30, 2009, Martha Stuffler

  43. HOW DID WE GET HERE ACCOUNTABILITY Persuasion method when the Fed influences or exerts pressure, but not force, banks into follow a policy ‘Moral’ is the idea of moral responsibility to operate in a way consistent with furthering the good of the economy When Bernanke appears before Congress and discusses economic activity he can influence financial markets Macroeconomics, March 30, 2009, Martha Stuffler

  44. HOW DID WE GET HERE ACCOUNTABILITY Fed Low interest rates 2001-2004 Easy money-encourages risk taking Raised interest rates during 2005-2006 Adjustable rate mortgage holders began to see rising monthly payments Macroeconomics, March 30, 2009, Martha Stuffler

  45. HOW DID WE GET HERE ACCOUNTABILITY Securities Exchange Commission SEC did not regulate Wall Street securities rating industries Securitized mortgages were overrated, not reflective of the true investment risk Macroeconomics, March 30, 2009, Martha Stuffler

  46. HOW DID WE GET HERE OVERSIGHT Given the class discussions to date and what has occurred in the economy, what do you think about the issue of oversight? Macroeconomics, March 30, 2009, Martha Stuffler

  47. HOW DID WE GET HERE SPECULATION “Irrational Exuberance” Macroeconomics, March 30, 2009, Martha Stuffler

  48. HOW DID WE GET HERE SPECULATION People took out loans they could not afford Why? What went wrong? Macroeconomics, March 30, 2009, Martha Stuffler

  49. HOW DID WE GET HERE SPECULATION Re-Fi mania took place Why? What went wrong? Macroeconomics, March 30, 2009, Martha Stuffler

  50. HOW DID WE GET HERE SPECULATION Lenders made loans to everyone whether or not they were credit worthy Why? What went wrong? Macroeconomics, March 30, 2009, Martha Stuffler

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