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Lecture 4
Learning Objectives
Understand the background of the late-2000s financial crisis Understand how government policies interact with market Understand the implications of corporate social responsibility in exacerbating financial swings Apply models of government business relations to interpret current events
California Trends
The national trends disguise the effects on the hot markets: West Coast, AZ, NV, TX, and Florida which were on boom-bust cycle In early 2007 the median house in CA was over $500,000. Today southern CA median is $270,000. (7% drop in 2011)
Started in 1913 Became very substantial in the 1950s Became one of the major investment strategies of the American family
1930~1940s Creation of Federal Home Loan Banks and Federal National Mortgage Association (Fannie Mae) 1960~1970s Privatization of Fannie Mae and the creation of Federal Home Loan Mortgage Corporation (Freddie Mac) 2000s: allowed risk to be disguised in bundled and securitized arrangements with Fannie and Freddie taking on larger and larger risks; when markets dont
function primarily on risk, problems will eventually occur
Spurred by HUDs affordable housing goal for Fannie Mae and Freddie Mac (under both D and R) gov Rose from below 10% to nearly 20% Profits from subprime loan bundles were wonderful (so lots of private investors held around the world)
The Fed lowered rate from 6.5% to 1.0% (2000 to 2003); only went to 5.25% to cool market; again dropped precipitously after crash in 2008 A flood of funds from foreign countries flowed in to U.S.
Causes, cont.
Weak and fraudulent underwriting practices boomed in 2000s and became common practice
Down payments Income and assets proof Suspicious Activity Reports pertaining to Mortgage fraud increased by 1,411 percent between 1997 and 2005
Predatory lending:
The Depository Institutions Deregulation and Monetary Control Act of 1980 (allowing similar banks to merge and set any interest rate). The GarnSt. Germain Depository Institutions Act of 1982 (allowing Adjustable-rate mortgages). The GrammLeachBliley Act of 1999 (allowing commercial and investment banks to merge).
Government Response
$700 billion to purchase the toxic assets (borrowing $1.7 trillion: $250 b deficit + $700 b bailout + $800 b stimulus package of 2009) Housing and Economic Recovery Act of 2008 (300 b)
Wall Street Reform and Consumer Protection Act of 2009 (Dodd-Frank legislation)
Some re-regulation
Impacts to US Economy
Unemployment
Real GDP Decrease Stock market drop: Nearly 50% from peak to bottom;
currently about 15% from peak
Discussion
Do you think the $700 billion bailout is a wise decision and based on what timeline? (e.g., short term risk of depression and long-term moral hazard) Who should be responsible and who should assume the burden? What are the ethical implications? Should government regulate more than Dodd-Frank or less? Use the four Government-Business models to explain your answer (market capitalism, dominance,