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Figure 8.3: Subprime Lending Fiasco – U.S. Housing Bubble

Figure 8.3: Subprime Lending Fiasco – U.S. Housing Bubble. House Prices Crash. Very Low Interest Rates. U.S. Housing Bubble Unsustainably High House Prices. Excessive Foreign Savings. Unsuspecting Investors Lose Jobs, Pensions. Transfer of Risks From Lenders To Investors.

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Figure 8.3: Subprime Lending Fiasco – U.S. Housing Bubble

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  1. Figure8.3: Subprime Lending Fiasco – U.S. Housing Bubble House Prices Crash Very Low Interest Rates U.S. Housing Bubble Unsustainably High House Prices Excessive Foreign Savings Unsuspecting Investors Lose Jobs, Pensions Transfer of Risks From Lenders To Investors Mortgage Securitization & Resale Government Bailouts Bad Mortgage Loans Liar, No doc, Ninja, No deposit Bad Ratings Lack of Transparency Misguided Regulators Greed & Conflicts of Interest Public Pressure

  2. Figure 8.1: Subprime Lending Fiasco – Stages • Enabling the • Housing Market • Securitization starts • Credit default swaps • Banks can speculate • No leverage limits • Stimulation starts • Building the • Housing Bubble • More stimulation, low int. • Securitization transfers mortgage risk to investor so lender can take poor risks • Unlimited investor demand for mortgage-backed securities • Competition to loan leads to subprime loans, inflated house prices, more securitizations • Credit ratings inflated • The Housing • Bubble Bursts • 2007-8 • Economy slows • Subprime loan defaults rise • Foreclosures rise deflating house prices • Walk-aways rise • Securitizations default • Insurers cannot pay • Investors fail • Liquidity/credit crisis • Bailouts start • The Aftermath • Subprime mortgage loan defaults rise • Economy slows further as failure cycle continues • Liquidity/credit crisis continues • Investment banks fail • TARP bailouts and liquidity support continue • Stocks crash • Securitization insurers fail • Insurance companies fail • Contagion spreads worldwide • Countries become insolvent • Worldwide bailouts start • Restrictions start on business and capital markets • More quantitative easing (QE2)

  3. Figure 8.2: Subprime Lending Fiasco – Key Events 1997 1st Publicly Available Securitization of CRA loans 1999 Gramm-Leach-Bliley Act allows banks to speculate • 2000-2 • Commodity Futures Modernization Act allows banks to trade in Credit Default Swaps • Recession gives rise to stimulus: lower interest rates, housing tax credits, subsidies, liquidity increases • 2003-4 • Loan standards discarded • Securitization grows • Bank leverage limits suspended allowing unlimited • borrowing to buy • subprime mortgage-backed securities • 2007 • Housing bubble bursts as house prices fall • Subprime lending collapses, failures • Foreclosures rise • Bear Stearns halts redemptions on two funds • Stock market peaks • Credit crunch begins • Liquidity & bailout measures begin • 2006 • U.S. Housing prices fall • Subprime lenders start to fail • Smartest investors start to reduce subprime exposure • (J.P. Morgan, • Goldman-Sachs) • 2005 • Credit default swaps allowed as insurance on subprime collateralized debt obligations • Housing market boom stops • 2008 • Home prices plummet • Credit default swap insurance fails • Bear Stearns sold to J.P. Morgan • Banks fail, Bailouts start, Fannie Mae & Freddie Mac taken over • Bk. of America buys Merrill Lynch • Lehman Bros. Bankrupt • AIG & Iceland bailed out • Washington Mutual & Wachovia taken over. Stocks crash • Troubled Asset Relief Progr. (TARP) • Massive bailouts, liquidity support • 2009 • Contagion worldwide • Fears over Irish, UK, European banks • Short-selling restrict. in Japan UK, France • Quantitative easing • GM Bankrupt • Flash crash • TARP: exec. comp. restricted & repayments start • 2010 • European Debt Crisis – Greece, Ireland, others • Greece bailout • U.S. foreclosure crisis • 2nd Quantitative easing wave (QE2) • Rating agency reform • Fin. Enforcement Task Force created • Flash order ban • Dodd-Frank Act Sources: Timelines documents from the Federal Reserve Bank of New York and Wikipedia

  4. Lehman’s Bankruptcy • Update: A statement from Ernst and Young: Lehman's bankruptcy occurred in the midst of a global financial crisis triggered by dramatic increases in mortgage defaults, associated losses in mortgage and real estate portfolios, and a severe tightening of liquidity. • We firmly believe that our work met all applicable professional standards, applying the rules that existed at the time. Lehman's demise was caused by the global financial crisis that impacted the entire financial sector, not by accounting or financial reporting issues. • http://www.cbsnews.com/8301-18560_162-57417397/the-case-against-lehman-brothers/?tag=pop;stories

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