Transcript Causes of the Financial Crisis

Causes of the Financial Crisis
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(PREP: Open NPR clip here and load at beginning of lecture)
(PREP: Open WSJ video clips “End of Wall Street” series)
Main Causes of the Crisis:
 Risky Home Mortgages
 Consumer Debt
 Financial Industry – Risky Investments
 Failure of Regulation
 Failure of Ratings Agencies
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Risky Home Mortgages
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What is a mortgage?
Downpayments
– 20% down vs. less down + mortgage
insurance
Types of Mortgages
– Fixed rate vs. variable and step mortgages
Encouraging Homeownership vs. Risky Subprime
Loans
– Clinton and Bush
– Fannie Mae and Freddie Mac
– Subprime Frenzy
– Predatory Lending
 Knowingly lending more than borrower
could repay
 Unreasonably high interest rates
Real Estate Bubble
Question: Who is to Blame? (see article)
Financial Industry – Risky Investments
Mortgages Bundled into Derivatives (Collateralized Debt
Obligations)
– Mortgages Resold many times
– Hard to know what the investment includes
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Credit Default Swaps Unregulated
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– What is a credit default swap? (NPR clip 15:00 to 17:00)
– Gambling on Risk?
– AIG Example – didn’t diversify; didn’t have reserves to cover costs
(NPR clip on derivatives 31:35 to 33:40)
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Exported our debt  global crisis
Why was this allowed?
– Pressure for ever-more profits for shareholders
– Lobbying? Campaign Donations?
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Question: Who is to Blame? (see article)
Failure of Regulation
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Fannie Mae and Freddie Mac
CONGRESS:
1999 – Financial Services “Modernization” Act
– Gramm-Leach-Bliley Act
– Repealed part of Glass-Steagall Act of 1933
– Tore down firewalls b/w banks, securities
companies, insurance companies
Result? No coincidence that in 1 month we saw…
– Failure of largest insurance company in world
(AIG insurance)
– Largest bank failure in US history (Washington
Mutual savings & loan)
– Largest bankruptcy in American history
(Lehman Brothers investment bank)
– Failure of Fannie Mae and Freddie Mac
(together owned/guaranteed roughly half of all
mortgages in U.S.)
Senator Phil Gramm (TX)
Failure of Regulation
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2000 Commodity Futures
“Modernization” Act
– Phil Gramm
– Slipped into bill at 11th hour in
December
– Exempted derivatives like credit
default swaps from regulation
(lNPR clips 10:00 to 12:40 and 18:30 to
20:30)
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Executive Branch:
Mortgages
Federal Reserve
Securities and Exchange
Commission
Alan Greenspan, former
Chairman of Federal Reserve
Failure of Ratings Agencies
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Conflict of Interest
– Ratings agencies are paid by the companies they
are rating (not by consumers)
– Scrutiny of investments is biased
– NPR audio clip (3:40 to 6:30)
Consumer Debt
Why has consumer debt increased so much?
Material culture
Cost of Living vs. Stagnating Wages
 Taxes
 What kept economy going?
– Moving from 1  2 earner families
– Increasing consumer debt – credit cards
– Housing and stock bubbles
 mortgages and home equity loans
 Homeowners taking out loans on homes until stripped
of equity (predatory lending by some banks)
 How Long can an economy be stable when too much wealth
is concentrated in too few hands? Who will be the
consumers?
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– Income and wealth Distribution
Future Discussions
What role did the Media Play?
 How Could Congress Allow this to
Happen?
 To Bail or not to Bail? How to fix the
Financial Crisis
 A Call to All Americans
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DISCUSSION
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QUESTION: What policies would you put
in place to prevent such a crisis from
happening again?