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					An Economic Analysis of the
Financial Collapse
   National Council for the Social Studies
            Vital Issues Session
            November 14, 2009
                    Presenters
 Glen Blankenship
  Georgia Council on Economic Education
 Mark Schug
  University of Wisconsin-Milwaukee
 George Vredeveld
  University of Cincinnati
 Richard MacDonald
  St. Cloud State University
                    Overview
 How did the financial crisis affect us?
 What are some likely hypotheses regarding
  the causes of the financial collapse?
 What do today's banks do?

     Hint: Do they still follow the 3-6-3 rule?
 Ideas for teaching about the financial crisis

 Questions
How did the financial crisis affect
us?
        Average Real
Disposable Income Was Rising
Savings Rates Were Falling
                               100%
                                      120%
                                             140%




       20%
             40%
                   60%
                         80%
19
  53
19
  55
19
  58
19
  60
19
  63
19
  65
19
  68
19
  70
19
  73
19
  75
19
  78
19
  80
19
  83
19
  85
                                                                  Ratio Increases




19
  88
19
  90
19
  93
19
  95
19
  98
20
  00
20
  03
20
                                                    Household Debt to Disposable Personal Income




  05
20
  08
                             Subprime, Alt-A, and
                          Home Equity Loans Increase


50%


40%


30%


20%


10%


0%
  1994    1995    1996    1997    1998     1999    2000     2001     2002    2003     2004     2005     2006   2007

         Subprime (FRB)          Subprime (JCHS)          Subprime + Alt-A          Subprime + Alt-A + Home
                                                                                    Equity
Fall in Housing Prices
DJIA, S&P and Nasdaq Trends:
   Stock Wealth Evaporates
       0%
            1%
                 2%
                      3%
                           4%
                                5%
                                     6%
19
  79
19
  80
19
  81
19
  82
19
  84
19
  85
19
  86
19
  87
19
  89
19
  90
19
  91
19
  92
19
  94
19
  95
19
  96
19
  97
                                          Default Rates Rise




19
  99
20
  00
20
  01
20
  02
20
  04
20
  05
20
  06
20
  07
       0.0%
              0.2%
                     0.4%
                            0.6%
                                   0.8%
                                          1.0%
                                                 1.2%
                                                        1.4%
19
  79
19
  80
19
  81
19
  82
19
  84
19
  85
19
  86
19
  87
19
  89
19
  90
19
  91
19
  92
19
  94
19
  95
19
  96
19
  97
19
  99
20
  00
                                                               Foreclosure Rates Increase




20
  01
20
  02
20
  04
20
  05
20
  06
20
  07
Recession
Unemployment
What are some likely hypotheses
regarding the causes of the financial
collapse?
                What Happened?


 In1989 Berlin wall falls.
 China and India deregulate.

 Expanded production capacity puts damper
  on inflation. Central banks now can increase
  money supply without much concern about
  inflation.
                What Happened?


 In 2001, the Fed consistently lowered interest
  rate from 6.5% to 1.75 % and to 1.0 % by
  June 2003.
 Central banks around the world followed suit
  creating an unprecedented increase in the
  supply of credit.
                What Happened?


 The low rates made borrowed money cheap
  and households and businesses responded
  as expected: they bought and bought.
 In the housing market, the Case-Shiller home
  price index increased 80% from January
  2001 to December 2005.
                What Happened?
 Federal government aggressively promotes
  home ownership
 Homeownership rate increased from normal
  64 percent (which was the rate for 35 years)
  to 69 percent in 2004
 Subprime loans totaled $330 billion in 2001

 By 2004 they reached $1.1 trillion (37% of
  residential mortgages)
 By 2006 they were 48% of all mortgages.
                 What Happened?

 In mid-2004, the Fed reversed its interest policy
  -- the rate climbed to 2.25 % by December
  2004 and reached 5.25% in 2006.
 The demand for houses and other durable
  goods decreased and prices declined 33%
  from a peak in July 2006.
                                                                                                0
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                                                                                                                        2
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                                                                                                                                                      5
                                                                                                                                                           6
                                                                                                                                                                    7




                                                                                                                                            4
                                                                                January 2000
                                                                                   April 2000
                                                                                   July 2000
                                                                                October 2000
                                                                                January 2001
                                                                                   April 2001
                                                                                   July 2001
                                                                                October 2001
                                                                                January 2002
                                                                                   April 2002
                                                                                   July 2002
                                                                                October 2002
                                                                                January 2003
                                                                                   April 2003




                                                        Target Fed Funds Rate
                                                                                   July 2003
                                                                                October 2003
                                                                                January 2004
                                                                                   April 2004
                                                                                   July 2004
                                                                                October 2004




S&P/Case-Shiller Home Price Indices With 2.5 Year Lag
                                                                                January 2005
                                                                                   April 2005
                                                                                   July 2005
                                                                                                                                                          prices




                                                                                October 2005
                                                                                                                                                          Housing




                                                                                                       Interest rates




                                                                                January 2006
                                                                                   April 2006
                                                                                   July 2006
                                                                                October 2006
                                                                                                100
                                                                                                      120
                                                                                                                            140
                                                                                                                                      160
                                                                                                                                                180
                                                                                                                                                          200
                                                                                                                                                                    220
                                                                                                                                                                          Interest Rates and Lagged Housing Prices
             Housing Bubble – Jan 92 to July 09
source: S&P Case-Schiller National Home Price Index 1987-2008 - inflation adjusted
                    Leverage



The magnitude of the current financial crisis
 has grown because of the amount of
 leverage used.
             Leverage and Incentives


 Investment banks were leveraged by a ratio of
  30 to 1, government sponsored mortgage giants
  Freddie and Fannie were closer to 50 to 1.
 When asset prices are rising, this system works
  like a dream.
What do today’s banks do?
         Non interest income as a % of net    Non interest income as a % of net
Period   operating income (Banks with total   operating income
         assets under $1 billion)             (Banks with total assets over $1
                                              billion)
1991     20.07%                               35.16%
1992     19.39%                               34.82%
1993     20.58%                               36.59%
1994     20.57%                               35.78%
1995     20.91%                               36.65%
1996     22.22%                               37.85%
1997     23.73%                               38.43%
1998     25.59%                               41.47%
1999     26.26%                               44.01%
2000     25.59%                               44.30%
2001     26.23%                               42.89%
2002     26.19%                               42.30%
2003     28.30%                               44.04%
90%                                                                              90%


80%                                                                              80%

70%
                                                                                 70%
                       Net Interest Income
60%
                                                                                 60%
50%
                                                                                 50%
40%
                                                                                 40%
30%                            Noninterest Income
                                                                                 30%
20%                                                    Actual Data   Predicted


10%                                                                              20%


0%                                                                             10%
      1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
              0.0%
                     0.1%
                            0.2%
                                   0.3%
                                          0.4%
                                                 0.5%
                                                            0.6%
                                                                          0.7%
                                                                                 0.8%
     Deposit
     service
     charges

    Fiduciary
    activities

   Trading,
 venture cap.
     and
                                                        >$1B




securitizations
                                                        < $100M




 Net servicing
     fees

   Investment
    banking,
    advisory,
   brokerage,
  Net gains
                                                        $100M-$1B




 (losses) on
sales of loans
  and other
                                                        All Comm. Banks




  Net gains
 (losses) on
 other assets

    Other
  noninterest
   income
Teaching about the financial crisis
   Open Market Operations
   Discount Policy
   Reserve Requirements
   Interest on Required Reserve Balances and Excess Balances
   Term Auction Facility
   Primary Dealer Credit Facility
   Term Securities Lending Facility
   ABCP MMMF Liquidity Facility
   Commercial Paper Funding Facility
   Money Market Investor Funding Facility
   Term Asset-Backed Securities Loan Facility
•   Upcoming publication of Council for Economic Education
•   Planned Table of Contents
•   Lesson 1 The Financial Crisis of 1907 and the Financial
    Crisis of 2007: A Comparison
•   Lesson 2 Data Analysis: How the Numbers of U.S.
    Economic Performance in 2008 and 2009 Compare to Other
    Periods in History
•   Lesson 3 Manias, Bubbles, and Panics in World History
•   Lesson 4 The Japan Comparison: Japan in the mid-1980s
    through 1990s and the U.S. in the 2000s
•   Lesson 5 Monetary Policy in the Recent Financial Crisis
•   Lesson 6 The Role of Housing in the Recent Financial
    Crisis
•   Lesson 7 The Instruments and Institutions of Modern
    Financial Markets
•   Lesson 8 Understanding Financial Markets in 2007 - 2009
Questions

				
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