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THE SUBPRIME CRISIS

THE SUBPRIME CRISIS. Gary Klass Pos232 It’s a Wonderful Life It's a Wonderful Life: Bank Run.   other links 1 2 3. Depositors. Investors. Depositors. Fannie Mae Freddie Mac. FSLIC – FDIC INSURES DEPOSITS. FHA INSURES MORTGAGE. What can go wrong (for lenders).

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THE SUBPRIME CRISIS

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  1. THE SUBPRIME CRISIS • Gary Klass • Pos232 • It’s a Wonderful LifeIt's a Wonderful Life: Bank Run.  other links 12 3

  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 InsurersAIG Mortgage-backed securities(collateralized debt obligations) 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.pdfhttp://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. 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. • (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 • 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. College Illinois Investments

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