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Speculative Bubbles

2002 - 2007. 1996 - 2000. Holland 1634 - 1637. Speculative Bubbles. 1925-29. The Housing Market Crisis. What Happened?. “The Economist” Magazine Covers During the Economic Crisis. The Housing Market Crisis. What Happened?. Buying a house (before 2000):. PRIME MORTGAGES ONLY!!!.

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Speculative Bubbles

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  1. 2002 - 2007 1996 - 2000 Holland 1634 - 1637 Speculative Bubbles 1925-29

  2. The Housing Market Crisis • What Happened?

  3. “The Economist” Magazine Covers During the Economic Crisis

  4. The Housing Market Crisis • What Happened?

  5. Buying a house (before 2000): PRIME MORTGAGES ONLY!!! Consumers were required to put a 20% down payment • For a $500,000 home: • $100,000 down payment & borrow $400,000 (mortgage) • loan is paid back over 30-years at a fixed interest rate (ex: 6%/year) • The loan is less than the value of the house • So banks are taking very little/no risk of default

  6. New Sub-prime Mortgages • Sub-prime mortgages were introduced in the year 2000 • These mortgages required no down payment to borrowers with poor credit history • Mortgages often had low initial interest rates which adjusted up later • Known as ARMs (Adjustable Rate Mortgage) or variable rate loans • Example: 2% interest rate/year for the first 3 years; after that the interest rate changes to 9%/year • Personal example

  7. Major Problem! Initial Value of House $1,000,000 Housing Bubble Analysis Subprime Mortgage Example • Price Paid: $1,000,000 • Down Payment: 0 • You owe: $1,000,000 Housing Bubble Bursts: New Value of House: $900,000 Homeowner now owes 1 million but only has a house worth $900,000. • Now he can’t refinance his loan and his house payments skyrocket when the loan resets. • If he can’t pay his monthly mortgage, the Bank will foreclose on his house! • Huge incentive to just walk away from the house.

  8. Subprime Mortgage Analysis The Binge • Banks made loans to consumers who were not qualified with zero down payments • In the short run, this caused home prices to rise • In the long run, this led to “inflated” home prices & people unable to pay their mortgage • The Hangover: • home prices fell substantially • consumers lost their homes to foreclosure • banks failed (as they took the losses on foreclosures)

  9. Caused by Credit Bubble Led to House of Cards

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