crisis presentation for students

7/29/2019 Crisis Presentation for Students

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The U.S. Financial Crisis

Sara Hsu

October 3, 2008


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It all started with US mortgages


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Families just wanted to

pursue the Americandream of home ownership


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But now many families are in danger oflosing the homes they worked so hard for.


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People are also losing money in their401Ks, and may not be able to get a home

or car loan.

In this talk, we will answer the following

questions: How did this begin? Whatexactly is going on, and where is it leading?


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What happened?

The crisis began in the subprimemortgage area, hitting the U.S. andtriggering a global financial crisis in 2008.

The crisis began with the bursting of theUS housing bubble and high default rateson "subprime" mortgages made to higher-risk borrowers with lower income or lessercredit history.


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What is subprime?

The term subprime lending refers to thepractice of making loans to borrowers whodo not qualify for market interest rates.

Interest rates for these borrowers areusually higher.


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Credit Crunch

Banks are all facing aproblem of having lesscredit for lending money,

since so many peoplecannot pay back themortgage loans, andsince other financial

institutions have failed.Other banks now will notlend to them. This is a

credit crunch.


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When did this begin?

The stock market & dot-com crash in 2000resulted in many people taking theirmoney out of the stock market andpurchasing real estate, which manybelieved to be a more reliable investment.

At the same time, the Federal Reserve cut

short-term interest rates to historically lowlevels, from about 6.5% to just 1%, whichallowed more people to purchase homes

for a lower cost.


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Subprime borrowing was a majorcontributor to an increase in

home ownership rates and thedemand for housing.

Some homeowners usedincreased property values fromthe housing bubble to refinancetheir homes with lower interest

rates and take out secondmortgages against the addedvalue to use the funds for

consumer spending.


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Then the bubble burst. Overbuilding duringthe boom period, increasing foreclosure rates

and unwillingness of many homeowners to selltheir homes at reduced market prices havesignificantly increased the supply of housinginventory available, driving down prices.

More homeowners are now at risk of default

and foreclosure.


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Foreclosure has hit some Americans very hard.


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Borrowing Climate Changed

Borrowers took out loans under terms thatwere not so great, since they thought theywould be able to refinance at more favorable

terms later.

But once housing prices started to drop

moderately in 2006-2007, refinancingbecame more difficult. Defaults andforeclosure activity increased dramatically asinterest rates reset higher.
http://www.economy.com/dismal/pro/release.asp?r=usa_cswq


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http://www.economy.com/dismal/pro/release.asp?r=usa_cswqhttp://www.economy.com/dismal/pro/release.asp?r=usa_cswq


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The mortgage lenders thatretained credit risk were the first

to be affected, as borrowersbecame unable to makepayments.

Major banks and other financialinstitutions around the worldreported major losses, with

Lehman Brothers recentlydeclaring bankruptcy and othermajor lenders, including Fannieand Freddie, seeking shelter.


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Financial Institutions

A variety of factors caused lenders tooffer an increasing array of higher-risk loans to higher-risk borrowers.

The risk premium required by lenders

to offer a subprime loan declined.

This occurred even though subprimeborrower and loan characteristicsdeclined overall during the 2001-2006 period.


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Mortgage Brokers

Mortgage brokers do not lend their ownmoney. There is not a direct relationshipbetween actual loan performance and

income for mortgage brokerages.

They have big financial incentives forselling complex adjustable rate mortgages(ARMs), since they earn highercommissions.


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Mortgage Underwriters

Underwriters determine if the risk oflending to a particular borrower meet theircriteria of credit, capacity and collateral,

but these were not closely looked atleading up to the lending crisis.


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Credit Rating Agencies

Credit rating agenciesare now under scrutinyfor giving high ratings to

the securities based onsubprime mortgageloans. Rating agencies

are paid by investmentbanks, so they had afinancial incentive formarking up the ratings.


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Central Banks

The US central bank, the Federal Reserve,lowered interest rates just after the dot-com crash to counter the risk of deflation,

but this encouraged borrowers to take outmore home loans.


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Federal Reserve Response to Crisis

At first, the Fed lowered interest rates andthen sent a call out to banks to negotiatemortgage terms with their borrowers, toprevent foreclosures.

When the crisis deepened, the Fed bailedout Fannie Mae and Freddie Mac, let

Lehman Brothers go bankrupt, andpurchased equity in AIG. The Fed alsopersuaded the President and Congress topass a $700 billion bailout for banks.


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The $700 Billion Bailout

Sets up a Troubled Assets Relief Fund topurchase banks troubled assets at low price

Raises FDIC to $250,000 to aid small

businesses Underlying mortgage holders rights remain

the same; encouraged to contact HOPE

Subject to management/auditing oversight Renewal of R&D tax breaks for businesses

for spending on renewable energy


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Regulatory Responses

The Fed has promised totighten regulation offinancial institutions.

Goldman Sachs andMerrill Lynch jumped thegun by voluntarily

transforming themselvesinto regular banks, whichface tighter regulations.


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Effect on Stock Markets

Stock markets havebeen volatile as variousevents of the crisis

have played out. Overthe past year, the DowJones Industrial

Average has fallen byover 3,000 points, over20%.


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Effect on Stock Markets

Crisis has caused panicin financial markets andencouraged investors to

take their money out ofrisky mortgage bondsand shaky equities andput it into commodities

like corn and oil as"stores of value".


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Effect on Financial Institutions

Financial institutionshave suffered greatly,with Lehman Brothers

going bankrupt andFannie Mae and FreddieMac being taken undergovernment control.Other banks willstruggle to renew theircompetitiveness.


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Effect on Home Owners

Housing prices are expected tocontinue declining until the inventory ofsurplus homes is reduced to more

typical levels.


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Effect on Businesses

The effect on businesses has yet to be seen,since the real economy is next to beaffected by the financial crisis.

Lower supplies of consumer credit meandemand for goods and services will fall.

We have seen unemployment increase in

September, and will likely increase more inOctober, as workers from the financial andthen real sector are laid off, as demand falls.


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Transmission to Global Economies

International banks thatbought securities based onUS subprime mortgageshave been caught up in

the crisis. The crisis has also spread

as international financialmarkets have become

volatile and vulnerable tothe credit crunch.

The global economy facesan enormous slowdown.


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Anger at American Financiers

At a summit meeting on the US financialcrisis, Brazilian President Luiz Inacio Lulada Silva saidthe euphoria of speculators

has spawned the anguish of entirepeoples, in the wake of successivefinancial disasters that threaten the

world's economy. We must not allow theburden of the boundless greed of a few tobe shouldered by all.''


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Transmission to Global Economies

Increase in world foodand commodity priceshas resulted from thetransfer of investmentfrom housing tocommodities such aswheat and corn.

Prices of food aremuch higher in everycountry.


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Future Possibilities

How long it will take markets toovercome the financial crisis andportending recession has yet to beseen. Effects on consumers and

businesses continue as credit becomesless available.

Those who wanted to retire now must

wait until later or cope with having lessin their 401K than they had planned.

Current and future generations face aprodigious tax burden.

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