The Subprime Crisis

1. The Subprime Crisis Prof. Dr. Thorsten Hens ISB-Zurich and NHH Bergen

2. Contents • The Word Subprime • What has happened? • Historic Perspective • Policy Issues • Outlook • Reference List

3. The Word Subprime (Google)

4. Contents • The Word Subprime • What has happened? • Historic Perspective • Policy Issues • Outlook • Reference List

5. Residential RE-prices 1997-2005

6. Interest Rate Policy

7. Subprime Mortgages

8. Packaging

9. Underestimated Risk in Subprimers March 2007

10. Leverage

11. Economist`s Warning The Economist 28.März 2002

12. The Housing Bubble

13. Residential RE-prices 1997-2005

14. Residential RE-prices

15. Underestimated Risk in Subprimers March 2007

16. Underestimated Risk in Subprimers March 2007

17. Price Decline in Leveraged Mortgages

18. How could that have happened?

19. Losses (international)

20. Bedeutung Immobiliensektor

21. Contents • The Word Subprime • What has happened? • Historic Perspective • Policy Issues • Outlook • Reference List

22. Historic Bubbles • Dutch Tulip Mania (1630s) • South Sea Bubble (1710s) • British Railway Bubble (1840s) • US Railway Bubble (1880s) • Roaring Twenties (1920s) • Multi Bubble (1960s) • Internet Bubble (1990s) • Housing Bubble (2000s)

23. Structure of a Bubble • Displacement (diffusion of new technology starts) • Take off (stock prices show abnormal increase) • Exuberance (stock prices grow at very high rate) • Critical Stage (stock price growth slows down) • Crash (stock prices start tumbling)

24. Ecology of a Bubble Fundamentalists Outsiders Trend Chaser T. Lux (1995): „Herd Behavior, Bubbles and Crashes“; Economic Journal

25. Outsiders Outsiders Trendies Trendies Trendies Trendies Fundies displacement take off exuberance critical stage crash Population Dynamics in the Course of a Bubble

26. Contents • The Word Subprime • What has happened? • Historic Perspective • Policy Issues • Outlook • Reference List

27. Policy Issues • Market Timing • Interest Policy: Soft Landing • Fire Brigade: Bear Stearns, Fannie and Freddie, AIG,… • Banning Short Sales • Who is the winner then?

28. Market Timing The Economist 28.März 2002

29. Interest Rate Policy

30. Prices over time FV baseline FV intervention

31. Economic Bubble does not decrease

32. Banning Short Selling October 18, 1930: NYT on Short Selling Sunday, September 21, 2008 | 08:00 AM in Financial Press | Markets | Short Selling The following editorial on SHORT SELLING was originally published in the New York Times on October 18, 1930. It is so relevant to the current environment, that I have decided to reproduce it here. What makes this so significant is that none of the issues have changed -- and the US Government seems to be increasingly heading down a path of "The ends justifies the means" form of intervention. Other than the names involved, one can hardly discern that this was written 3/4 of a century ago . . .

33. Who is the winner then? • If markets are efficient • not everyone can win • not everyone can lose! • Are markets efficient? • Market break down through lemons problem • Domino effects • Who is the winner then?

34. Who is the winner then? Warren Buffet: “I‘d be a bum in the street with a tin cup in my hands if the markets were efficient.“ MBA applications rise during recessions!

35. Contents • The Word Subprime • What has happened? • Historic Perspective • Policy Issues • Outlook • Reference List

36. Outlook • My question to director of SNB: „When will the subprime crisis end?“ • His answer: „It has already ended. It`s now callled the great financial crisis.“

37. Contents • The Word Subprime • What has happened? • Historic Perspective • Policy Issues • Outlook • Reference List

38. References • Becker, Hens and Fischbacher (2005): Soft Landing of a stock market bubble. NCCR-working paper No. 32. • T. Lux (1995): „Herd Behavior, Bubbles and Crashes“; Economic Journal. • Shiller (2005): Irrational Exuberance. • Shiller (2008): The Subprime Solution.