Transcript Powerpoint of Housing Crisis/Economics

Economics 2010
Republican Coalition
• Fiscal conservative: belief in limited government,
minimal taxes, strong defense, minimal regulation of
business: pro business, competition and the invisible
hand. (Eisenhower, H.W. Bush. Reagan)
• Working Class White Males: Formally democrats or
Dixiecrats, left the Dems when the civil rights laws were
passed, so saw the Democratic protections laws and
Supreme Court rulings of the Warren court (voting
rights act, Brown v Ed.,) as threats. (Tea Party, Nixon)
• Social Conservatives: Pro Life, Anti Gay Marriage,
Evangelicals. (Reagan, George W. Bush)
Democratic Coalition
• Unions: pro regulation, pro minimum wage,
protection of secret ballots.
• Minorities: Blacks and Latinos, pro entitlement safety
nets, civil rights laws, regulations.
• Limousine Liberals/Social liberals: Urban, highly
educated, high income earners who believe in
government protections for minorities and women. Pro
Choice. Pro Gay Marriage rights. Belief that
government needs to keep eye on business. Often work
in jobs not directly tied to profit/loss.
• Young Voters
Tea Party Coalition
• Far Right Republicans/Libertarians/Independents who basically
believe in limited to no government, they say, although a majority
like social security and Medicare, the biggest part of the
government. Dissatisfied with the Republican party and hate the
Democrats.
• Anxious/afraid business people, independents and working class
people who are really worried about losing their jobs/homes,
think that government is spending and taxing to give money to
poor people, minorities in particular, who aren’t working hard.
• Strong Evangelical Christian Element
• Mostly white middle class people.
• Also provides a home for radical racists/survivalists: 11% say
Obama’s race and religion are reasons that they joined the Tea
Party
TARP (1st Trillion, ¼ not spent,
much being returned.
• If you believe that the government needed to
bail out the banks by purchasing the “trouble
assets” CDOs, MBS and CDS from AIG and
other Wall Street banks rather than risking a
collapse of the banking system, vote:
• Republican or Democrat.
• If not,
• Vote Tea Party.
Health Care Basics
nd
(2
Trillion)
• By 2014 All Americans must purchase health care or
pay a fine of $700 a year. 32 million more Americans
will be insured.
• Subsidies will be provided for those who cannot afford
(remember poor are already insured under Medicaid, so
these are young people and working poor).
• Establishment of “exchanges” competitive health care
programs where the uninsured and underinsured can
purchase health care where they’ll have “economy of
scale.”
• No government single payer option. (competition?)
Health Care
• Health Care companies will now have to spend 80% of
their income on health care, as opposed to
administrative costs, advertising, and profit.
• There cannot by Caps on how much health care is
available to insured, cannot be discontinued for
expensive illness. (No health insurance death panel)
• Cannot be dropped when sick
• No denial of children with preexisting conditions.
• Must provide free preventive care.
• Expanded appeals process with health care plans deny
certain procedures (death panels?)
Health Care
• To address the young: they may stay on parents
policy until 26.(Unless the work for someone
who provides)
• Employers with more than 50 employees must
provide health insurance. Or Pay fine. Subsidies
available for companies that cannot afford.
Cost: mostly accounted for by 1
trillion cost over 10 years, offset by
reduction
of the
same
• May cost 10 billion
per year.
1 toof
2% deficits:
increase in
•
•
•
•
•
premiums, which have been going up substantially
more than that.
Medicare taxes on investment profits, currently not
taxed.
Reductions in fraud/waste in Medicare/Medicaid, some
estimates as high as 60 Billion per year.
Decrease of 23% payments to Doctors (opt out)
Increase of 3.8% Medicare tax on those making more
than $250,000 per year. (Broad shoulders)
Took over student loan management from banks.
•
•
•
•
If you oppose the plan, vote:
Republican or Tea Party.
If you support it:
Democrat.
Stimulus Package (3rd Trillion): To
spend when consumers won’t
• 900 Billion dollars to try to reverse the downward recessionary
spiral caused by housing bubble collapse.
– ¼ Went to Tax cuts for middle class and small business to help them
survive the downturn.
– Went to States to help them support increased Medicaid, unemployment
benefit extensions, and loss of tax revenues as property values dropped.
Kept teachers, fire fighters, clinics etc. employed.
– Went to investments in education (college loans/grants increased for low
income, preschool, charter school programs etc),
– “Cash for Clunkers” and First Time homeowner tax credit, to support
housing and auto industry. Incentives to help auto (unions) and housing
– To infrastructure for rebuilding roads, bridges, water systems etc.
hopefully shovel ready, spread out throughout the entirecountry.
– Investment in Green technologies, credits for making homes more energy
efficient.
• If ok with those spending items, vote:
• Democrat
• If you think we should have cut taxes more
instead, hoping that consumers would eventually
spend and business would invest the tax cut in
jobs and not financial instruments like MBS,
then vote:
• Republican or Tea Party.
If you think the housing bubble and
economic collapse and 9.7%
Unemployment
• Was caused by deregulation and lack of
regulation enforcement during the Bush years,
vote:
• Democratic.
Happened during the Bush years, but that Obama
has had the time to fix it and hasn’t, or is on the
wrong track to fix it, vote:
Republican or Tea Party
The Wars in Iraq and Afghanistan
Which NO ONE is talking about
• If you believe they were the right thing to do,
and that announcing a timeline if Afghanistan is
a mistake, and that we need to keep troops there
to make the country safe, vote:
• Republican
• Were mostly mistakes, particularly Iraq, and that
we should get out as soon as possible, vote:
• Democrat
Bush lowered the tax rate by about
4% across the board
• If you favor keeping those tax cuts on both
those families that make more than 250 K a year
and under, vote:
• Republican. (unless your Reagan’s budget chief)
• If you favor raising the tax on the 250k +
people, but keeping the one on those under
250k, vote:
• Democrat
• If you don’t believe in cutting anything
meaningful out of the budget, vote:
• Republican or Democrat.
• If you believe in cutting things that will truly
reduce spending, like Social Security or
Medicare/Medicaid.
• Vote Tea Party.
If you are:
• A Hayek, Sowell, Freidman, Chicago School
believer:
• Vote Republican or Tea Party.
• A Keynesian, Vote:
• Democratic.
Some Terms
• Supply is the amount of any commodity there
is. (a Commodity is anything that can be
owned, bought or sold). Scarcity of a product
determines its value. Theoretically all
commodities are not infinite.
• Demand: How many people want to buy a
commodity.
• Price: is what someone is willing to pay for a
commodity.
Supply, Demand and Price interact
• If the Supply of a commodity goes up and demand
stays the same, prices go down
• If Supply goes down and demand stays the same,
price goes up.
• If Price goes up, demand generally goes down.
• If Demand goes up (ADVERTISING), supply stays
the same, prices go up.
• You get the point, I hope.
More Terms
• Incentives: are anything that makes you do something, like buy a
commodity. It can be money, love, sex, feeling good, looking good, etc.
• Externalities are costs accrued for the production or use of an activity
that is not paid for by the consumer or the user of the activity.
– Does Walmart pay their fair share extra for road use or for jobs lost overseas?
– Do smokers pay for the air they pollute or the extra health care they cost or litter
pick up? (oil companies, electric companies etc.
– Do the uninsured pay for their hospital costs, they don’t pay, the extra ambulances
required etc?
– Does a company who ships jobs overseas, reducing the work force, reducing
demand for products, have to pay the cost for that action?
– Do car manufacturers get compensated for creating jobs for salesmen, mechanics
or gas station, because they made a good car that increases car use.
Fiscal Policy
• Revenue: Taxes
• Expenses: what the government spends. (Social Security,
Medicare/Medicaid, Defense)
• Deficit: when the government doesn’t have enough revenue to
pay expenses. To get the money the government borrows money
from individuals, companies and foreign governments (China,
Britain, etc.)
– They pay interest on that loan, which comes out of Revenue, reducing
what can be spent of other items.
• National Debt: the combined totally of all deficits. About 13.5
Trillion (14.5 Trillion is the GDP, about 93% debt ration)
• About half of fiscal 2008 discretionary spending
paid for defense, and most of the rest went for
domestic programs such as agricultural
subsidies, highway construction, and the federal
courts (see figure 3). Only 3 percent of
discretionary spending funded international
activities, such as foreign aid.
Where the real problem lies
www.washingtonpost.com/wpsrv/special/politics/budget-2010/
Income growth rates during Republican/Democratic administrations (Source: Larry M. Bartels. Princeton
Uviv. Political Scientist, Slate magazine)
Question: Can Income equality coexist with a growing economy?
Here’s the reality about debt: three major rises
in debt WWII, Reagan Era, Bush 2 Era:
Reagan, Bush senior and Clinton all allowed
taxes to go up after Reagan:
By the 1990s, the budget was balanced.
The Problem of Debt
• The CBO reported several types of risk factors related to rising debt levels in
a July 2010 publication:
• A growing portion of savings would go towards purchases of government
debt, rather than investments in productive capital goods such as factories
and computers, leading to lower output and incomes than would otherwise
occur;
• If higher marginal tax rates were used to pay rising interest costs, savings
would be reduced and work would be discouraged;
• Rising interest costs would force reductions in important government
programs;
• Restrictions to the ability of policymakers to use fiscal policy to respond to
economic challenges; and
• An increased risk of a sudden fiscal crisis, in which investors demand higher
interest rates.[51]
Old School conservative economics:
Fredrich Hayek and Milton Friedman
• There should be limited government. Strong on
defense.
• We should pay as we go, revenue should roughly equal
expenses, unless there is an emergency like WWII.
• Keep as much money in public sector to incentivize
companies to invest and to grow the economy.
• Economy will be controlled by the invisible hand of
supply, demand, price and incentives.
• Laissez faire economic policy.
No, not that Hayak, That’s Selma
This one: Fredrich
Liberal Economics: Keynesian
• Government should act to control boom and bust
cycles by using Fiscal (stimulus package) and
Monetary (Fed lower interest, print money) to monitor
and correct the economy.
• Government have responsibility to the people to
provide safety nets for the neediest.
• Provide services business won’t, or aren’t able to,
provide. (infrastructure)
• Government can handle a certain amount of debt
without harming economy (80% is the top end)
Liberal Economics
• Liberal/Progressives began to take care of people
after the Great Depression, Social Security,
unemployment insurance.
– Originally got it a 65, when life expectancies were 68.
– Now it’s 62 and life expectancies are 78.
• In the 60s (richest time in U.S. History), the Democrats
added Medicare for the old, Medicaid for the very
poor. These are a Large part of our current budget.
Commonly referred to as “entitlements,” because they
are seen as rights. Now Health Care.
Life Expectancy
• http://www.infoplease.com/ipa/A0005140.html
John Maynard Keynes: Government
involvement in Economy
Neo Conservative Economics:
Supply Side
• During the Reagan years, some (Laffer curve)
believed that cutting taxes would increase
revenue, paradoxically.
• Taxable stuff: 100 eagles
• Tax Rate:
.3 (30%)
• Revenue
30 Eagles
• Expenses
40 eagles
• Deficit
10 eagles.
Supply side economics:
Conservatives
• Drop tax rate to 20% (particularly on the suppliers of
taxes, the rich)
• Here’s how’d they’d hoped it would work:
• Taxable stuff 100 eagles. (GDP)
• New Tax rate .2 (20%)
• Revenue
20 eagles
• Expenses
40 eagles
• Deficit
20 Eagles up from 10.
• But wait you knee jerk liberals….
Supply Side Economics
• The extra money given to the suppliers of capital would
be invested into the jobs and business and this would
eventually happen:
• Taxable stuff 200 Eagles (GDP growth)
• Tax Rate
.2 (20%)
• Tax Revenue 40 Eagles
• Expenses
40 Eagles
• Bam! No deficit, more jobs, more happy rich people,
more happy employed people.
Laffer Curve
Bush Tax Cuts
• This is why after 911 the Bush tax cuts were enacted, to
stimulate a flagging economy. It cut taxes about 4% on
everyone.
• These were written to expire in 2010.
• The debate now is whether or not to expand, as they
increased the National Debt by a lot.
• Republican want them extended at least two years, but
preferably forever.
• Obama wants to let the ones for those making more
$250,000 to expire and extend the cuts for those under
– Demand side economics, give more money to consumers.
In Defense of Reaganomics
• It was the growth of the economy that eventually
balanced the budget by the 90s.
• It was 911 and the two ensuing wars that spiked the
deficits of the Bush years, followed by the housing bust
that cost the Bush deficits.
• Somewhat ironic that tea party candidates are blaming
the Obama administration for the current big spending
as they attempted to fix the economy after the housing
bust of the Bush era.
• However, the uncertainty of cost attached to health
care is still hanging out there.
Liberal Progressive/Keynesians
• Probably would raise taxes to compensate for the deficits,
because they don’t like to cut programs:
• Taxable Stuff 100 eagles (GDP)
• Tax Rate
.35 (35%, 5% raise)
• Revenues
35 Eagles
• Expenses
40 Eagles
• Deficit
5 Eagles
• Hopefully inflation and GDP growth would pay off the deficit
before it gets too large.
• In the late 90s it did, in part, because of the Tech bubble.
Income growth rates during Republican/Democratic administrations (Source: Larry M. Bartels. Princeton
Uviv. Political Scientist, Slate magazine)
Question: Can Income equality coexist with a growing economy?
The Great Divergence (Pt 2)
Compression>>>>
In 2000, the trend is reversed, a
recession hits, Bush 2 tax cuts are
put in place: dropping tax rate about
4%
• Then 911 Hit and everyone was worried about
economic melt down, so Congress passed Bush tax
cuts.
• Deficits roared back, partially because economy didn’t
grow enough and largely because of two wars.
• Bush’s administration continued a trend of (small
government) deregulation and lax enforcement of the
financial industry (Wall Street banks, generators of
capitol)
Housing is the General Motors of
Today
• Bush continued a Clinton era push to expand home
ownership among lower income people, by relaxing
banking rules allowing less stringent rules for making
loans to people to buy houses.
– People who own their home take better care of them and
make neighborhoods better.
– Building and selling homes put people to work, so they can
buy more homes.
• Carpenters, plumbers, Home Depot, gardeners, R.E. Agents and
attorneys, etc.
So here’ how you used to buy this
house.
• Save between ten and twenty percent of the cost
of the house: 20 to 40 thousand dollars.
• Go to a Savings and Loan (think It’s a
Wonderful Life), borrow the other 80% or
90%. This loan is called a mortgage. (if you
don’t pay, they take the house back, that is called
a foreclosure).
Lovely Couple wants a House
>>>>>>>>
Wants to Buy
$20,000 is all they have.
Cost: $200,000
So they go to a Savings and Loan (or
bank or mortgage banker) to obtain
a loan to buy the house, called a
mortgage.
$180,000
<<<<<<<<<<<<
The guy making the mortgage gets paid
a commission for each mortgage he
makes. The mortgage earns monthly
interest for the owner of the mortgage.
Incentive Alert!!!!!!!
Happy Couple buys House,
Sellers takes money and moves to
Fla.
$20,000 they had +
$180,000 Mortgage
Loan=$200,000, >>>>>
They give to seller
**They Get House.
**And Pay mortgage
company
$1500 per mth for their
mortgage (p+i)
What if they don’t pay their
mortgage?
Foreclosing people
The Bank Comes Back and takes the house through
foreclosure and tries to sell it for at least the $180,000
they lent the happy couple (remember they have 20k in
the house of their own the lose.)
That’s how it worked in the Good
Old Days
• Plus the lender made sure that :
• Happy Couple didn’t spend more that 30%
of their income on the mortgage.
• And that they had good jobs.
• And they paid their bills on time
• $1500 is 30% of $5000, so they had to earn
• $70,000 a year to qualify (5000x12)
• So, you give your $20,000 and the S and Ls
$180,000 you got in a mortgage to the owner of
the home.
• The ower/seller of the home walks away with a
smile and $200,000. (He probably has to pay
back the bank whatever he owes on his
mortgage, the rest he keeps, that amount is
called equity.)
So what happened to the economy?
After the Tech bubble bust, 911 and
Deregulation of the banks
• They cut down the amount of down
payment required to buy the house.
– Down payments were designed to make sure you had a
vested{money} interest in staying in the house, so you
wouldn’t simply walk away, leaving the bank holding the bag,
so to speak.
• They also reduced the amount of paperwork necessary,
– Making it possible to make statements about income and job
histories that wouldn’t be checked.
–INCENTIVE ALERT
These “new mortgages” were
call Sub Prime Mortgages
Sub prime mortgage worked great
for a while
• Here’s the thinking:
– Real estate in the U.S. Always goes up.
– So as long as the Happy Couple didn't default right
away, everything would be cool.
– If they don’t make their payments (default), the
house value would have risen and the bank will get
its money back when it takes the house back.
So, now you could buy the house with 5%
or even 0 money down (in some cases
they’d GIVE you money to buy.
(Remember they get commissions when
you buy)
• You go to the mortgage banker (Remember he works
on commissions he gets for placing loans
INCENTIVE ALERT).
• You tell him what you make and how long you’ve
worked.
• He gives you a mortgage for the full price of the house,
$200,000. NO MONEY DOWN
• You give it to the owner who pays of his mortgage and
walks away with his equity.
• Sweet!
Supply of Buyers goes Sky High
• Sub Prime Buyer
Can be anyone willing to say
they make X and work at Y
Everybody Gets
In the Mortgage
Business to Get
Paid
So, of course Prices Skyrocketed
with all the demand!
Sub prime time
Supply and Demand Time
• Now virtually ANYBODY can buy a house
because you don’t have to save, have a good job
or even tell the truth, because no one checked.
• Well, that increased Demand for homes, did
what you’d expect, it made house prices
skyrocket.
The Fed also goosed the prices by
keeping interest on your mortgage
low, and therefore payments low
Prices went up so quickly
• You could buy a house with 0 money, make a
few payments, turn around and sell if for
$100,000 profit in a year. So of course, people
did.
• Which created more demand of course
• Which escalated prices some more….
• You get the picture?
Where’s the money to buy all these
houses coming from?
• The one glitch would be if there wasn’t enough money in the
mortgage market to give all those sellers and buyers cash for the
transactions.
• Here comes Wall Street, who had been kept out of the
mortgage markets previously, by now thanks to deregulations
were players.
• And then there is Freddie Mac and Fannie Mae who are
quasigovernment entities set up by the U.S. government to make
sure there is money (called liquidity) in the mortgage market.
– Unfortunately they had some rules they were suppose to follow.
– Wall street could fund whoever they wanted.
Mortgages Companies would run out of
money to lend because loans are
expensive, so they package and sell their
loans to entities called secondary lenders
They sell these packages of Mortgages
to Secondary Lenders
So they mortgage bankers can use that
money to make more loans, and
commissions
Government
>>>>>
$$$$$$$$$$
<<<<<<<
Smelled Money and
bought
Trillions of dollars
of mortgages
Home buyer
Mortgage
Company
<<<<<<<
$$$$$$$$$$
Used to be…
• Wall Street couldn’t buy these, but with Deregulation…..
• Wall street banks aren’t like commercial banks like Bank of
America or Wachovia, or S&Ls or Credit union who get their
money from depositors.
• They get money from Hedge Funds, Retirement Plans, Insurance
Companies, State Governments, Foreign Governments, People
that need long term investments:
• These groups are called Institutional
Investors
So Where do Freddie, Fannie and
Wall Street get their money?
• From investors who want to make profits.
• In real estate it’s usually long term profits for industries
that have funds that get paid into and don’t pay out for
a while.
• These are called Institutional Investors. They need to
make money on that money:
–
–
–
–
Retirement plans, like VRS.
Life insurance companies.
Local Governments, socking money away for a rainy day.
Foreign governments, saving for their employees retirement.
Here’s how it works a review:
• Sally goes to bank to get a mortgage.
• Mortgage banker gives her money, she signs an IOU called a
mortgage.
• Mortgage banker bundles Sallie, Betty, and Johns mortgages
together and sells them to Freddie, Fannie or Wall
Street.(Lehaman Bros, Bear Stearns, Merrill Lynch, Citigroup etc)
• With the money mortgage companies get from the above, they
make new mortgages, and charge a fee for every mortgage they
place.
• Their incentive is to make fees by placing as many mortgages as
possible….and they did.
So, Mortgage Bankers were living
large, as were Fannie, Freddie and
Wall street
• So to get the money to give the mortgage bankers to
give to the buyers to give to the sellers, Fan, Fred and
Wally took the big bag of mortgages they had and
made something called a Mortgaged Back Security.
(A security is a package of IOUS, could be credit card,
car loans, personal debt, insurance policies or
mortgages).
• They would then sell them to Institutional Investors,
like Iceland, or the Virginia Retirement System, who
would get long term interest on their securities.
Mortgage Back Securities
• As the name implies, these securities are backed by U.S.
(in the bubble) real estate, considered the safest bet
there is.
• But just to make sure, Fred, Fannie, and Wally would
get their securities rated by Bond Rating agencies like
Moody’s and Fitch, who were paid a commission to rate
Fannie, Freddie and Wally’s securities. (INCENTIVE
ALERT).
• They did, and they rated them Triple AAA.
• Iceland was satisfied.
Mortgage Back Securities were big
bags of mortgages that were sold to
these Institutional Investors
>>>>>>
<<<<<<
$$$$$$$$
Iceland needs a
Safe long term
Investment for
Its geo money
How does Iceland know those
investments are good?
•
Companies like Moody’s rate
securities for worthiness: AAA is
the best.
• Ratings agencies get paid commissions by Wall
Street Bankers for rating the bonds.
• INCENTIVE ALERT!!!!!!!!!
To Make Sure they could sell what
seemed to be weak loans, the Sub
Prime ones, they created something
called a collateralized debt obligation
or CDO
CDOs buried the crap subprime
loans, under AAA ones (the old
school, money down ones) in a
complicated system
Worked like a Charm
The Ratings people really didn’t
understand them, if the raters knew
a lot, they’d be bankers.
• So they rated them AAA and took their
commissions.
And Wall Street sold them to:
Institutional Investors
Like Iceland, VRS,
Insurance companies etc.
Who trusted the Raters
Like Moody’s and others
Let’s Review
Freddie
Fannie
Wall Street
But other investors were nervous, so
they bought Insurance.
• For less than a dollar per 100 you could go to
AIG and buy insurance on your MBS. So if you
bought 100 million worth of mortgages, for a
pittance, say 1 million per year, you could be
sure that if the mortgage went bad, you got your
money back from AIG.
• AIG NEVER thought U.S. mortgages could go
bad.
But let’s say Iceland is still afraid and
wants to be safe, they can get
insurance
AIG is an insurance
Company that would insure
Your MBS or CDO for
A pittance, say 1%. So
For 100 million in MBS
You pay 1 million a year
To sleep better.
These were called Credit
Default Swaps
AIG was so sure of the CDOS
They were insuring, they’d
Let someone who DIDN’T
Own the CDO buy a Credit
Default Swap Against it. Like
Vegas, baby.
If you thought the house
Of cards would fall, you could
Now
on it.
This guy
bet abet
billion.
Credit Default Swaps
• Were, in fact, insurance policies,but by calling
them “swaps” they were not regulated by
insurance regulators.
• Had they been insurance policies, the sellers
would have had to keep reserves on hand to pay
them off, in case of unforeseen circumstances
(such as the collapse).
• These swaps multiplied the catastorophe.
Not just AIG sold Credit Default
Swaps
• Merrill Lynch, Bear Stearns, Lehman bros. all
the Wall Street Banks sold them:
• When selling a CDO, they would also sell the
insurance on them: what a deal.
• By the end, they were buying insurance
themselves on the very CDOs they were
promoting as being solid.
More Review
The foundation
So, more and more money
(INCENTIVE ALERT) went into
the market.
• So mortgage bankers were pressured to make more and
more mortgages for all the money coming in
(remember everyone along the way is paid for placing
mortgages, ANY mortgage)
• So soon, busboys were buying million dollar homes,
hoping to flip them in less that a year to make a profit.
Everyone was getting paid.
• Demand rose and rose.
By 2006/7 This was your buyer. If
he was breathing, he could get a
mortgage, and they’d pay him to take
one
Only one thing could go wrong:
Eventually
THIS Price rose so
High, good
Borrowers
were
Price out,
demand
dropped!!!!!!
Then, something odd happened
• The prices rose so high, that even with lying
about your income, no money down loans,
adjustable rate mortgages (that you didn’t even
have to pay the full amount to keep the house),
that they couldn’t find enough buyers.
• So demand dropped, supply went up as people
tried to sell and the PRICES DROPPED and
DROPPED FAST.
Once Demand dropped
• Prices Dropped and Dropped Fast.
• During the bubble years, when you
couldn’t pay your mortgage, you’d
refinance, get a new mortgage to pay
off the old one, take some extra
money and make your payments, until
you sold.
Here’s how refinancing worked
during the bubble
• Buy house for $300,000 no money down.
• Years worth of payments: $18,000
• At end of year, get a new mortgage for $400,000
because the value of the house went up.
• Pay off the $18000, and the previous mortgage
of $300,000 Total $318,000. Stick $72,000 in
your pocket.
• A year later, sell for $500,000 and walk away
with another $100,000.
But when the bottom fell out
• Your $300,000 house, was now worth $250,000
or $200,000. But you still owed the payments of
$18,000. So you couldn’t refinance, even sub
prime mortgages couldn’t work there.
• But there wasn’t any of your money in the deal
anyway, only the bank’s (and Iceland’s), so you
mail the keys back, sell the frig for pocket
money and roll out, bye bye.
TAKES
Sold at Auction
Upside Down/UnderWater
• Soon the prices fell way below what people
owed on their mortgages. They couldn’t sell the
houses because they owed more than a buyer
was willing to pay. But….
• Hey no problem, the buyer never put any of
their money in it anyway…so they rolled out,
sending the keys to the bank and saying “it’s
been real.”
• So supply of these foreclosed on house went up and
up, demand went down and down as people freaked
out, prices dropped more and more.
• Now the MBS had a whole bunch of mortgages in
them that weren’t worth the paper they were written on.
• The Institutional Investors were left holding the bag,
Poor Iceland…but wait…
• What about the insurance, what about AIG?
• AIG didn’t have nearly enough to pay off all
these bad insurance polices on the MBS, so they
were technically bankrupt. Well if they couldn’t
pay all these retirement plans, foreign countries,
insurance companies, and hedge funds , the
institutional investors would have lost
TRILLIONs of dollars and it would have been
the end of the Western World….it’s hunter
gather time.
The Banks froze
• Commercial Banks were holding tons of the
MBS too, Wall Street Banks were holding these
too, there was no money to borrow. They were
afraid to lend, plus they didn’t have enough
reserves left, their assets were crap.
• Business must have short term loans to operate,
with credit markets, they go under…more
hunting and gathering.
TARP to the Rescue
In a Perfect “invisible hand”
conservative economic world
• These banks would have been allowed to fail, joining
the Edsall, Studebaker and other companies in the dust
bin of history but.
• These banks had become so big, that they supplied the
life blood of the economy: CREDIT. The were
deemed….
• Too Big to Fail.
So we held our noses, and
bailed them out…the alternative was hunter gathering.
Winners and Losers
Winners
Sellers took equity and ran
Early Buyers
Mortgage Makers
Wall Street Bankers
Rating agencies.
Subprime borrowers, mostly
The guy who bought 1
billion in insurance against
the market. BIG WINNER
Losers
Good credit homeowners
Institutional investors like
Iceland
U.S Taxpayers
Bear Stearns
AIG
Companies that went
bankrupt because no credit.
Biggest Loser
• The World Economy/The U.S Economy
• Fell into a massive recession, which would have been a
depression if government didn’t act: If they:
• Didn’t bail out banks and buy trouble assets. (TARP)
• Didn’t bail out AIG and make good on their policies.
• Didn’t support banks to unfreeze credit market and
lower Prime Interest rate to stimulate.
• Did not pass a stimulus bill to make people feel better
and to spend when consumers went into their shells.