The Financial Crisis of 2008

Transcription

1 Some Recent Financial Crises The Financial Crisis of 2008 Bradley University s s Economics Department Presented by Dr. Joshua J. Lewer & Dr. Robert C. Scott Theme: Bad Loans U.S. Savings and Loans to 1989 Japan s s Banking Crisis 1989 to present Mexican Banking Crisis of 1995 Asian Flu of The Contagion Russian Implosion of 1998 Argentina 2001 Functions of the Financial System Essential for overall economic performance, see King and Levine (1993) Credit markets funnel savings to borrowers Housing Investment Exchange assets across generations Short term needs Baltimore steel framer story The Roots of the Current Problem The current crisis A crisis in financial institutions Collapse of a speculative bubble in the housing market Triggered a credit crunch Recession since Dec 07 Shiller s s Housing Value Index The Housing Bubble Benchmark = Note: Shiller Index Adjusted for Inflation and Based on

2 Shiller s s Housing Value Index Shiller s s Housing Value Index Peak = 220 (May 2006) Peak = 220 (May 2006) Benchmark = 110 Benchmark = Now = 158 (Aug 2008) Note: Shiller Index Adjusted for Inflation and Based on 1998 Note: Shiller Index Adjusted for Inflation and Based on 1998 Housing Outliers Housing Outliers Los Angeles U.S. 200 U.S Note: Tri-county area has observed a 4.85% average annual increase from (3q). Source: Illinois Association of Realtors Why Do Mania s s Like This Occur? The truth is we don t t know Investors as Pigeons we just fly in circles Major Housing Boom Factors Pigeon investor theory suggests we watch each other rather than focus on fundamentals 2

3 The Savings Tsunami Savings glut in Asia global interest rates low since 1991 Low interest rates stimulate the demand for housing Other factors Historic low federal funds rate Federal policies that promoted homeownership Greed, speculation, and the lack of personal responsibility Enter Subprime SubPrime -- a loan under conditions which make the risk higher than prime Some Examples The borrower could be more risky than one who would get the usual 20% down, 30-year fixed rate The borrower could get a 0% down mortgage Grandma Tesch story Subprime Issuance and Ratings U.S.$ Billions Percentage of Loan Originations 60 All Subprime (100%) 1,421 AAA (80.8%) 1,134 AA (9.6%) 134 A (5.0%) 70 BBB (3.5%) 49 Source: Greenlaw et al. (2008), Inside Mortgage Finance Note: subprime issuance total is $2.71 trillion, before this - minimal 5 of Originations by Product (Total) ARMs Subprime Source: Greenlaw et al. (2008), Inside Mortgage Finance Impact 1 Credit Markets have Seized Up From Wall Street to Main Street: How has the Financial Crisis Impacted the Real Economy? The reduced availability of liquidity 1. Interest rate premiums U.S.: Banks not lending to each other ROW: London Interbank Offered Rate (Libor) Libor is used to set rates on the $360 trillion of financial products worldwide. Three month Libor set an all time high in October at 5.34%. Dec. 7 th 2.18% 3

4 Housing loan premiums 250 basis point gap over 30-Year Treasuries Historical average is 100 basis points Corporate bond issuance premiums CAT paid an all-time high premium of roughly 500 basis points over comparable Treasuries (Dec. 2 nd ) Non-profit bond issuance premiums Methodist Hospital delaying the last two stages of it s s $400 million expansion. NPO bond rates at 8% 2. Banks have implemented selective lending practices More difficult for companies to obtain short-term term funding Baltimore steel framer story 3. Commercial paper market has fallen off dramatically as companies are unable to find buyers for short-term term debt (e.g. money market buyers have dried up) Higher interest rates and the lack of liquidity reduce economic activity and technological progress Impact 2 Financial Institutions Decapitalization and Failures Financial Connections Banks and other financial intermediaries exposed to: virtually untradeable MBS risky loans (e.g. 1 in 10 mortgages) have seen their net worth decline In the rush to recapitalize their balance sheets, we have seen what Irving Fisher called a a stampede to liquidate and debt deflation Impact 3 Household Bankruptcy and Foreclosure Rates Foreclosure Rates in U.S. Bankruptcy The number of Americans filing for consumer bankruptcy increased by nearly 40 percent in Foreclosure Rates A record 1 in 10 American homeowners were either at least a month behind on their payments or in foreclosure at the end of September. Source: RealtyTrac U.S. Foreclosure Market Report 4

5 Appreciation Rates in U.S. Impact 4 Consumer Sentiment Near All Time Low Source: RealtyTrac Monthly Data Impact 5 Job Creation The lack of available credit has weakened business activity considerably - and thus job creation Unemployment Rate The Bureau of Labor Statistics (BLS) Job losses every month in ,000 in November and 1.91m total Unemployment rate has increased to 6.7% Monthly Data The Bailout: The $700b Paulson/Bernanke Plan Emergency Economic Stabilization Act of 2008 Allows the federal government to: Buy and sell MBS Buy and sell illiquid whole loans Serve as an insurer of troubled assets Capital purchase program buy preferred stocks Ben Bernanke Aka: Bailout Ben Goals 1. Provide stability or prevent disruption to the financial markets or banking system. 2. Protecting the taxpayer. 5

6 Does it Fix the Problems? With concurrent Federal Reserve actions, Lowering the Federal Funds rate to 1.00% Using MBS as collateral for Term Auction Facility (TAF) loans - $900B by end of year. Buying commercial paper - $275B since August Buying MBS - $500B starting in Nov. Buying the spectrum of Treasuries to keep long-term interest rates low and increase liquidity - $600B capitalization and liquidity in the financial sector has been significantly enhanced, but credit access still remains a problem in some areas. Risk Indicators Improving 1. TED spread the difference between the yield on the 3-3 month Treasury Bill and the 3-month 3 Libor Indicator of health of global credit markets Excellent measure of fear banks have when lending Spread was 465 basis points in October, Dec 7 th at 217 Normalized credit conditions spread would be Yield curve the ten-year treasury less federal funds rate Currently at (1.71% = 2.71%-1.00%) 1.00%) Recovery spread would be above 2.50% We Still Have a Ways to Go Consensus NABE 4 th quarter 2008 economic numbers look very weak Real GDP growth estimates at -3% (worst quarter was 1 st quarter 1980 = -7.8%) December job loss estimated at 300,000 Consensus 1 st quarter 2009 economic estimates also look negative Real GDP growth estimates -1.3% The Sky Has Fallen. The Sun Also Rises. Unemployment expected to peak at 7.7% 3 rd quarter 09 What Will Drive the Recovery? Thawing of the credit markets Steady decline in the Libor (Oct. at 5.34% - Dec. 7 th 2.18%) Bank-to to-bank and bank-to to-customer lending has improved Keynesian Economics Massive stimulus packages by Obama and rest of world Public works projects for country (and Peoria) Lower oil and commodity prices Stimulates aggregate supply Exports Exports are at an all-time high, and are growing faster than imports The Future Recession but how long? Depression (<1%) Lost decade looking Japanese (25%) Controlled landing bottom out second half of 2009 (65%) longest recession since WWII Easy bounce no lasting effects (10%) Keys to recovery: housing prices stabilize & consumer confidence rebounds 6

7 Visibility of Recession s s End The 2 nd Quarter of 2009 has the potential to be the initial quarter of the next economic recovery. The second half of 2009 should see the economy on the recovery track. Projected 2009 GDP growth at 0.7% Policy Prescriptions Delay Obama s tax increases on high-income income Americans Support open trade...not the time for a trade war Combine fiscal and monetary policies efforts Like pharmaceuticals, the potency is enhanced Provide short-term term support to American families behind on their mortgages Reduce start-up costs and red tape for entrepreneurs End of Presentation Parking Lot Slides Additional Considerations 10-Year Treasury Yield Increased regulation and government involvement in the financial sector (looking more Japanese) Increase in moral hazard (downside punishment is not enforced) Potential reaction in antitrust practices Too big to fail Why do we let firms become too big to fail Costlier to operate in financial markets Monthly Data 7

8 James Galbraith Interview Interviewer: But there are at least 15,000 professional economists in this country, and you re saying only two or three of them foresaw the mortgage crisis? Galbraith: Ten or 12 would be closer than two or three. Interviewer: What does that say about the field of economics, which claims to be a science? Galbriath: It s s an enormous blot on the reputation of the profession. There are thousands of economists. Most of them teach. And most of them teach a theoretical framework that has been shown to be fundamentally useless. Federal Funds Rate Congress pushed Fannie Mae and Freddie Mac (F&F) to increase mortgages going to low/moderate income borrowers. HUD gave F&F percentage targets of their mortgage financing going to low/moderate income % % % Monthly Data Community Reinvestment Act (CRA) of 1977 commercial banks increase loans to low/moderate income households. This doubled the number of bank loans to that category in ten years. Payroll Employment The Taxpayer Relief Act of 1997 increased the demand for higher value properties The capital-gains exclusion increased from $125,000 to $500,000 Capital gains exclusion for most rental properties Overall, public policies increased the demand for housing Monthly Data, -250,000(p) October 8

9 Oversight There be two oversight committees over the Troubled Assets Relief Program of the Act. 1. Congressional oversight panel Five members appointed by House and Senate leadership from both parties. 2. Financial Stability Board Reports to Congressional Panel Made up of -- Fed Chair, SEC Chair, Fed Home Fin Dir, HUD Sec, Treasury Sec 9