The Financial Crisis in America
The Financial Crisis in America POLS 1500
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Date Created: 09/06/15
Friday August 28 2015 POLS The Financial Crisis in America Part 1 Governments and Economy What role do governments in democratic countries play in regulating their economies What role ought a democratic government have in the economy regulating it Big Materials that are Responsible for Modern Economic Situations US Housing Market condition leading to the Great Recession of 0708 Current situation of the European Euro Lecture Goals Understand the recent history of US policies towards home ownership the subprime mortgage industry and their effects on the recent financial crisis How have mortgages changed as financial instruments How have governments policies and economic forces shaped those changes Background Subprime mortgage begins in 2007 Lehman brothers collapses in 2008 Impact sends shockwaves around the world US Not just company itself but what the company did impacted other branches of economy Friday August 28 2015 Impact of Great Recession Impact in US US unemployment doubles although official statistics claimed 810 o it can be assumed to be as high as 25 and still with lasting effects Inability to pay mortgage impacts communities schools businesses Overall US GDP goes down for almost a year there is less money in the economy that what would have been in it today Peoples wages have not increased although productivity has increased to almost double of 1970 Change in wealth of American households bottom 93 lost 6 trillion while top 7 gained 56 trillion Difficulty for newer generations millennial to survive economy Impactin Europe Extreme cutbacks in household income Political upheaval protests How to Analyze Everything With this kind of situation often times where you start is often where you finish If you start at Wall Street Banks you re often going to end up blaming those organizations Realtors Even during the worst time to get a house they advertise that in fact it is the best time to buy a house Realtors try to uphold their business during the hard economic conditions In the US homeownership is a path for financial stability Friday August 28 2015 Home Ownership Statistics 655 of households own a home down from 69 in 2006 697 in Ohio 75 of White households own 48 of AfricanAmericans own and 49 of Hispanics own a house 78 of married couples own 49 of oneperson households Average American spends 24 of monthly income on housing expenses American under the poverty line spend more than 80 Middleclass people are highly dependent of housing as a way to buildup wealth Upper percents more reliable on business equities and pensions For a while home ownership was a safe bet for economy Especially in the 90 s home worth has not gone down After 2009 buying a house does not seem like a wise investment How Did We Get Here Why do governments care If people care then governments care If people are settled small businesses schools are more involved active Since the 20th century governments have wanted to make Americans buy homes Mortgages in the US PreDepression Era short terms 310 years low loantovalue ratios you d have to come up with most of the money on your own variable rates of interest due to no set trend of inflation deflation bullet repayment nonamortized mostly bankowned Friday August 28 2015 Amortization Being able to pay back both what you owe and a bit of the interest as well Physical back would take house away when payments could not be made Not that many people bought houses US stepped in to facilitate house buying for citizens FHA Federal Housing Administration If bank doesn39t make money out of someone not being able to pay the FHA would cover that way the bank does not loose profit and can loan more money FDIC If you have money in a bank and that bank goes out of business the FDIC would cover your losses for up to 250000 Organizations encourages people to buy houses and use banks while banks gained more ability to give out loans and grow Monday August 31 2015 POLS The Financial Crisis in America Part 2 Buying a House Not really good in the preDepression Government comes in to assist citizens buy houses encourage banks to provide housing loans Post Depression Era Long term Higher but still fixed loantovalue ratios Fixed rates of interest o Fullamortizing Mostly bank especially savings and loan owned Several banks popped up just to focus on these kinds of loans financial transactions Era of the American Dream suburbs begins Inflation Inflation is the constant decrease of the value of money Banks do not usually care about interest rates as when inflation is steady In the 60 s interest rates constantly rose which was good for homeowners as they paid less interest but bad for banks who lost money in the process Savings and Loan banks are especially hurt by rising inflation many of them go broke FannieMae and FreddieMac Government steps in creates FannieMae and FreddieMac Monday August 31 2015 Government buys loan from government banks make a profit by giving a fee for making contract and homeowner gets a home Banks assume less of the risk of loans Companies only give home contract loans to those who have good credit Since the early 70 s the bank forwards your check of your loan to the ones who actually own your loan Mortgage since the 1970 s Basically unchanged except not bankheld securitized Without securitization the longterm FRM isn t really feasible as a widespread path to homeownership Someone else has to step in another company individual in order to take a risk of a default The Giant Pool of Money All of the money floating around in the economy The US Government is the best place to put the money Makes taxes regulates economy If an investment is safe you don t make much o You have to make risks for high profit For the most part we don t want to make big risks As of recent the US Government drops the rate US Treasury funds In the 80 s and the 90 s private companies start buying loans from banks A little bit less safe Monday August 31 2015 Sells them as safe investments Make loans with poorer people Make profit from loan fee Sell loan to Wall Street Sub Prime Mortgages 2009 ish era Adjustable rate often second mortgages often nonamortizing high loantovalue rations balloon repayments and frequent refinancing not bankowned securitized privately by Wall Street Similar to the poor loans that were distributed in the preDepression Era In the early 90 s house prices were going up If you want to leave a loan you can just sell off your house anyway and come out with a profit By 2005 over half of these mortgages are being bought by private companies not FannieMae or FreddieMac Liar Loans Official procedures in private companies that fake inflate borrowers financial details in order to carry out a loan Basis of fraud and corruption in private business They do not have to worry about the default losses since they sell the money to someone else Wall Street Wednesday September 2 2015 POLS The Financial Crisis in America Part 3 Structure vs Agency Who is at fault for causing massdebt and foreclosure in the US o Banks and private organizations or Individuals who would not read know about the specifics of loans Moral Hazard Any kind of service or thing that can benefit you and not loose out but there are moral implications for your actions that do not impact you but others Ex a man who gets insurance that pays off any speeding ticket might drive more recklessly endangering the lives of other drivers Ex people who make mortgage bonds may still make money despite the losses that both Wall Street and the mortgage individual may suffer The Housing Bubble Houses for a brief moment of time spiked way up Spiked way up in a part because subprime loans existed allowed for more people to get houses despite actual financial qualifications to get a house Informational cascade if you are not a part of something that is both common and popular you are inclined to be a part of it A lot of people validate decisions through this process Buying a house in the early 2000 s came with a lot of popular praise and incen ve Even when people had doubts the informational cascade influenced people to buy houses People that own a product that is hot and selling don t like to talk about what s wrong with it Professor Wednesday September 2 2015 2008 Foreclosures Happened more often in big urban areas Areas where people were moving into wanted to buy houses in wanted to retire in Include Arizona California and Florida Not often in rural areas People don t really move often in rural areas CDO s and CDS s When big companies want to borrow money they can t just go to mom and dad or a loan company Therefore big companies do bonds Issues out bond with an interest rate to the market Once people buy bonds the company will later pay back the money with interest Better reputable companies will likely repay so interest rates are lower Less reliable companies will probably have higher interest Bigger interest more risk but more rewards Usually 401 k investors and such are the ones that buy these kinds of bonds Paying back is different by company can be paid back little by little Usually colleges and universities are institutions that release bonds to the public As long as Ohio University for example keeps getting students and exists as a successful university the interest rate is generally lower than average Ohio University in this instance had a 4 interest when it presented a bond in 2011 Cleveland 1978 first city was the first country in the US that defaulted on its bonds Wednesday September 2 2015 Had to pay much higher ratings the next time around City s credit score was shattered Mortgage Backed Securities Statistics In 2013 about 13 trillion in mortgage debts down from a high of 146 trillion of 2008 At the top of the market about half was held in MBS s 75 trillion in 2008 As of fall 2011 only 3 trillion in MBS s was left with 60 privately issued 18 trillion The large banks and investment firms took between 500 billion and 1 trillion in losses from 2008 to 2010 How do we Make a Bond out of Everyone s Mortgage If 130 people the class decided to buy a house there would be different circumstances for everyone From living quality to kind of house everyone is different In the aggregate most people pay off their houses even considering lowincome home buyers Companies buy all individual loans and collect them together Bond is created out of that pool Bond decided into slices called trenches AAA AAA BBB BBso on Highest level of trench gets the benefits first Low risk therefore lowest interest rate Process continues indirect relation between price and interest through the trenches until it goes down to Unranked or Equity First one to loose High interest rate Wednesday September 2 2015 Big risk Big rewards How do we sell the Unranked CDOs Take Unranked from several different bands and put them together into a new bond Stupidhigh risk stupidhigh reward AAArated CDO not as safe as buying the AAA of a regular mortgage bond Once hundreds if not thousands of amerioans could not pay mortgage millions of people could not make profit Friday September 4 2015 POLS The Financial Crisis in America Part 4 Making Money Steven Eisman and Mike Burry made money betting against stocks borrow shares sell them return them at a lower price The CD8 as Insurance Terminator 3 s Completion Bond 254m fee to International Film Guarantors in exchange for possible 181 6m payout if Schwarzenegger quit or was injured Bigger the risk the more you charge A CDS is like a Completion Bond for MBSs mortgage backed security To take out a CDS you don t have to necessarily own the bond If someone finds a bond is having problems you can bet against that bond without owning any stock You only make money if that bond fails If you re in the life insurance business you know that people are going to die You should try to sell to young people although younger people are not usually keen on buying insurance If you sell CDSs you should try to sell to healthy stocks Friday September 4 2015 The CD8 Market Started off as a small business in 2003 By 2008 there are 35 trillion in CDS values Why Because people did not own the bands so betting was fierce That value was just theoretical though It would happen if everyone died at once In 2008 everyone in the housing market died Magnetar and the 40 Billion Scam Good at buying out poor CDO s Made the worst CDO s 96 of bonds failed unable to be a ed back that s a real shitt roduct Megnetar s plan Buy worst parts of CDO s even their own Bought credit swaps on the CDO s they were buying themselves They essentially bought life insurance and constantly faked their death on several CDO s In 2007 Magnetar was making most of the CDO s on MBS s Shifting expectations of other investors But can t investors sue for a bad product Well it wasn t in 2006 You could bet against your own product on Wall Street Friday September 4 2015 Why could this happen People didn t really understand how bad people could loose in the CDC MBS system Why Did We Fail to See it Coming The Housing Bubble informational cascades Betting on CDS s It s harder emotionally and intellectually to bet against than to bet for Greedy and Unprepared CDO Buyers Wing Chao lack of understanding on why its riskier The Problem of Rating CDO s No regulations were present to make transactions more transparent Fraud and NearFraud Magnetar etc Actively try to trick people In a capitalistic setting there will always be times when Something costs way more than it should Someone knows more of something than someone else The value of something will go downhill Fast So What do We Do Now Why should shouldn t Government protect unwise greedy investors and homebuyers from themselves Friday September 4 2015 The Costs and Benefits of Regulations Costs Raising costs to Businesses lower profit margins costs passed on to consumers discourage innovation Benefits Reducing risks to investors and consumers less chance of catastrophic loss due to factors outside consumer s control Ex If a state bans beer specials on weekdays Costs less creativity on businesses to stand out less business on the weekdays to begin with Benefits better grades and more responsible drinking sociologystudy proven The Lemon Problem Ackerlof wanted to know why the used car business is not as lucrative as it can be Used Car Businesses have a bad reputation because people are both afraid of buying a lemon and don t know how to avoid one Therefore if the buyer assumes that the dealer is being scummy the man who owns the car previously gave it all the hard work and tune ups is hurt as all of his work goes for naug
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