Transcript The 2008 Economic Meltdown

Was the U.S.
Government Bailout in
the 2008 Economic
Meltdown a Good Idea?
Using Economic Concepts to Explain a
Real Economic Issue
By R. Mahoney – York Mills CI
THE VIDEO
BACKGROUND
Cheap Loans
Financial institutions make cheap loans
available (subprime loans) below
“reasonable” interest rates
NINJA loans (no income/no job/no assets)
People able to purchase homes with little
or no down payment
Subprime loans went from $35 billion in
1994 to $600 billion in 2006 (Bernanke)
Home Prices Increase
Cheap loans mean more people qualify for
mortgages for homeownership.
Also provides opportunity for speculators or
“home flippers” to participate in the housing
market more easily
40% of purchases were not primary in 2006
(vacation, rental investment or flipping) (Christie)
Both of these factors push up demand for homes
creating a “real estate bubble”
Impact of Increased Demand for
Homes on Home Prices
House Prices
S1
P2
P1
SHORTAGE
D2
D1
Q1
Q2
Quantity of
Homes
Impact of Increased Demand?
Home prices increase by 124% between
1997 and 2006 (“CSI:Credit Crunch”)
The increased value also meant people
took out second mortgages to finance
home expansion or often consumer
spending on goods such as cars and
electronics
Second Mortgages
House valued at $200,000 bought with
$10,000 down and a $190,000 mortgage.
Value increases to $300,000
Take out a line of credit or second
mortgage to the tune of $50,000
Now owe $240,000, but the house is worth
$300,000 ($60,000 in equity instead of
$10,000)
Financial Markets Complicate
Institutions parcel off and re-sell mortgages to
other institutions (so called “credit default swaps”
and “toxic loans”)
Margins (or returns) on the mortgages get
smaller and smaller.
Mortgages are based on property values that
are artificially too high because of cheap loans
and speculators
Few buyers/investors understand the real risks
New Homes
Speculators also cash in through the
building of new homes.
This begins to increase the supply of
homes
An increasing number of “bad loan”
customers begin defaulting on loans
causing banks to foreclose and put more
homes on the market.
These two factors “pop the bubble”
Impact of More Homes on the
Housing Market
Surplus
House Prices
S3
S1
P2
P3
D2
Q2
Q3
Quantity of
Homes
More Foreclosures
Housing prices decrease by 20% between
2006 and 2008 (“A Helping Hand”)
Nervous banks call in more loans and are
quicker to foreclose (take a person’s
house from them to sell it and recover the
loaned money)
Foreclosures went from 717,000 in 2006
to 1.3 million in 2007 (“Number of foreclosures”) and 2.3
million in 2008 (Armour)
So why did banks collapse?
The loans were backed by artificially high
housing prices
In 2008 11% of homeowners had “zero or
“negative” equity (Andrews and Uchitelle)
Negative equity???
Remember the $200,000 home that
increased in value to $300,000?
The owner had $240,000 in loans based
on that value.
Say the increased house supply reduced
its value to $210,000.
If the bank foreclosed and sold the home it
would still lose $30,000
Negative Equity and the Financial
Sector
Total home equity in the US in 2006 was
$13 trillion
By 2008 it had fallen to $8.8 trillion
“Free cash” from home equity extraction
was $427 billion in 2001
This went up to $1.4 trillion by 2005 (and
totaled about $5 trillion over those 5 years)
(“Spending Boosted”)
Impact on Money Supply
Huge mortgage losses frightened depositors that
banks did not have a way to replace reserves to
pay them back
Withdrawals changed in one week from $7
billion to $145 billion (Gullapalli)
Potential to shrink money supply by $1.4 trillion
(with a 10% reserve ratio = money multiplier of
10)
Banks couldn’t replace cash reserves fast
enough (even with foreclosures)
GDP = C + G + I + (X-M)
THE IDEA
The Stimulus Package
Very Keynesian in nature
A tax rebate package - $168 billion to
stimulate Consumption and Investment
(“Bush signs”)
$505 Billion in new government spending energy, education, health care and
infrastructure (Teslik)
Boost US deficit to $1.2 trillion in 2009 (Teslik)
The Bank Bailout
318 US banks collapse between 2007 and
2010 (United States)
Big scare was failure of Fannie Mae and
Freddie Mac in 2008 which owned or
guaranteed 50% of the $12 trillion
mortgage market in the US (Duhigg)
Bailout of $700 billion (boosting reserves)
to prevent banks from further collapse
Also prevents shrinkage of money supply
GDP = C + G + I + (X-M)
AD3
Economic Goals
The actions of the Federal Reserve
and the US government were
designed to promote the goals of:
economic growth
full employment
BUT contradicted the goal of:
reduced public debt
WAS IT A GOOD IDEA?
Was it a Good Idea?
“The White House says the multiyear $814
billion stimulus program passed by
Congress in 2009 boosted employment by
2.5 million to 3.6 million jobs and raised
the nation's annual economic output by
almost $400 billion. A recent study by two
prominent economists generally agrees,
crediting the pump-priming with averting
"what could have been called Great
Depression 2.0."” (Lynch)
U.S. Unemployment Rate
Year
Unemployment Rate
2006
4.2
2007
4.2
2008
5.2
2009
8.5
2010
8.8
2011
8.2
2012
8.1
United States. United States Department of Labour. Bureau of Labour Statistics. Labor Force Statistics from the Current
Population Survey. Bureau of Labour Statistics, 23 Nov. 2012. Web. 23 Nov. 2012.
<http://data.bls.gov/timeseries/LNS14000000>.
U.S. Real GDP Growth Rate
Year
Real GDP Growth Rate
2006
2.7%
2007
1.9%
2008
-0.3%
2009
-3.1%
2010
2.4%
2011
1.8%
2012
2.0% (3rd Q)
United States. U.S. Department of Commerce. Bureau of Economic Analysis. Table 1.1.1. Percent Change From Preceding Period in
Real Gross Domestic Product. Bureau of Economic Analysis, 26 Oct. 2012. Web. 23 Nov. 2012.
<http://www.bea.gov/iTable/iTable.cfm?ReqID=9>.
U.S. Annual Inflation Rate
Year
Inflation Rate
2006
2.5%
2007
4.1%
2008
0.1%
2009
2.7%
2010
1.5%
2011
3.0%
2012
2.2% (Oct.)
United States. United States Department of Labour. Bureau of Labour Statistics. Table Containing History of CPI-U for
United States. Bureau of Labour Statistics, 16 Nov. 2012. Web. 23 Nov. 2012.
<ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt>.
Year
Unemployment
Rate
Real GDP
Growth Rate
Inflation Rate
2006
4.2%
2.7%
2.5%
2007
4.2%
1.9%
4.1%
2008
5.2%
-0.3%
0.1%
2009
8.5%
-3.1%
2.7%
2010
8.8%
2.4%
1.5%
2011
8.2%
1.8%
3.0%
2012
8.1%
2.0% (3rd Q)
2.2% (Oct.)
Was it a Good Idea (cont’d)
“economists at Goldman Sachs, IHS Global
Insight, JPMorgan Chase and Macroeconomic
Advisers….say the stimulus boosted gross
domestic product by 2.1% to 2.7%.” (Lynch)
“The fiscal stimulus created 2.7 million jobs and
added $460 billion to gross domestic product.
Unemployment would be 11% today [instead of
9%] if the stimulus hadn't been passed and
16.5% if neither the fiscal stimulus nor the
banks' rescue had been enacted, according to
Zandi and Blinder.” (Lynch)
Sources
“A helping hand to homeowners.” The Economist. 23 October 2008. 28 September 2009
<http://www.economist.com/businessfinance/displayStory.cfm?story_id=12470547>
Andrews, Edmond L. and Louis Uchitelle. “Rescues for Homeowners in Debt Weighed.” New York Times. 22
February 2008. 28 September 2009 <http://www.nytimes.com/2008/02/22/business/22homes.html?_r=1>
Armour, Stephanie. “2008 foreclosure filings set record.” USATODAY.com. 14 January 2008. USA TODAY. 28
September 2009 <http://www.usatoday.com/money/economy/housing/2009-01-14-foreclosure-recordfilings_N.htm>
Bernanke, Ben S. “Fostering Sustainable Homeownership.” Speech. 14 March 2008. United States Federal
Reserve. 28 September 2009 <http://www.federalreserve.gov/newsevents/speech/bernanke20080314a.htm>
"Bush Signs Stimulus Package into Law." Msnbc.com. Msnbc.com, 13 Feb. 2008. Web. 3 May 2012.
<http://www.msnbc.msn.com/id/23143814/ns/business-stocks_and_economy/t/bush-signs-stimuluspackage-law/#.T6MkZMXwCSo>.
Christie, Les. “Homes: Big drop in speculation.” CNNMoney.com. 30 April 2007. 28 September 2009
<http://money.cnn.com/2007/04/30/real_estate/speculators_fleeing_housing_markets/index.htm>
“CSI: credit crunch.” The Economist. 18 October 2007. 28 September 2009
<http://www.economist.com/specialreports/displaystory.cfm?story_id=9972489>
Sources (cont’d)
Duhigg, Charles. “Loan-Agency Woes Swell From a Trickle to a Torrent.” NYTimes.com. 11 July 2008. 28 September 2009
<http://www.nytimes.com/2008/07/11/business/11ripple.html?_r=1>.
Lynch, David J. "Economists Agree: Stimulus Created Nearly 3 Million Jobs." USAToday.com. USA Today, 30 Aug. 2010. Web.
3 May 2012. <http://www.usatoday.com/money/economy/2010-08-30-stimulus30_CV_N.htm>.
“Number of foreclosures soared in 2007.” msnbc.com. 29 January 2009. 28 September 2009
<http://www.msnbc.msn.com/id/22893703/>.
Shell, Adam. “Stock market losses take a personal toll on investors.” USATODAY.com. 23 March 2009. USA TODAY. 28
September 2009 < http://www.usatoday.com/money/markets/2009-03-23-investor-pain_Nhtm>.
"Spending Boosted by Home Equity Loans: Greenspan| Reuters." Business & Financial News, Breaking US & International News |
Reuters.com. Reuters, 23 Apr. 2007. Web. 04 Nov. 2010. <http://www.reuters.com/article/idUSN2330071920070423>.
Teslik, Lee H. "The U.S. Economic Stimulus Plan." The U.S. Economic Stimulus Plan. Council on Foreign Relations, 18 Feb.
2009. Web. 03 May 2012. <http://www.cfr.org/united-states/us-economic-stimulus-plan/p18348>.
United States. Federal Deposit Insurance Corporation. Failed Bank List. 25 Mar. 2011. Web. 05 Apr. 2011.
<http://www.fdic.gov/bank/individual/failed/banklist.html>.