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					The Financial Crisis

Act I: Mortgages

The Actors
   

home buyers
banks rating agencies investors

  

construction industry
Fannie Mae The government

It Can Only Go Up

Effects
 

USA, population 300m
$9.9T owed in mortgages ($33k/person)‫‏‬


(end of 2006) by households for homes for <= 4 families

 

6% of jobs in construction (2006)‫‏‬ Home equity loans ($750B=$2.5k/person in 2005)‫‏‬ Expansion of suburbs



On Wall St.
 

Mortgage Originators (local banks etc.)‫‏‬
sell them to Fannie Mae, Freddie Mac, and big banks


  

Mortgages bundled and sliced (~60%)‫‏‬
Rating agencies rate the best slices as AAA

Sold to investors
~$24B in Wall St. bonuses (2006)‫‏‬

Why the crash?

Homeowners


house prices expensive


$740k median home price in Santa Clara Co. (Dec 2007)‫‏‬

  

ARM, Option-ARM, teaser rates
liar loans Leverage / Speculation (22% for investment purposes)‫‏‬

Ratings Agencies
  

Only looked at historical data
Ignored correlations / accuracy of info Paid by bank creating the mortgage pool


No payment if you don't like the rating

 

Competition

S&P email “Rating agencies continue to create and even bigger monster—the CDO market. Let's hope we are all wealthy and retired by the time this house of cards falters."

Banks


Could create AAA bonds that paid more than regular AAA bonds
Fees





Kept a lot of it on their books (for capital requirements)‫‏‬
Mark to market



Investors


These AAA bonds paid more than regular AAA bonds
Restrictions on types of assets





Need returns
 

Some pension funds were underfunded Hedge funds need to justify fees



Leverage

Effects

Effects


Foreclosures (9.2% delinquent or foreclosed, Aug 2008)‫‏‬
House values drop (27% from peak)‫‏‬




 

Hard to sell
Real Estate and Construction jobs lost

Property Tax (and income and sales tax) revenues go down

Effects on Wall St.


Investors lose money


losses of entire crises >$10T

 

Banks lose money ($435B in July, now $1T?)‫‏‬ Wall St. bonuses fell 37% to $18.4B


				
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posted:11/15/2009
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