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2008 Financial Crisis - Lessons Learned

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2008 Financial Crisis - Lessons Learned Powered By Docstoc
					Lisa M. Lynch Dean Heller School for Social Policy and Management

Bruce R. Magid Dean Brandeis International Business School

Origins of the problem

Average Percentage of Subprime over Housing Units 2004-2006
Data from Paul Milstein Center for Real Estate, Columbia Business School

Case-Shiller index peaks in April 2006 Most recently declines 15.4% in 2nd quarter 2008

Brandeis University

The Heller School for Social Policy and Management

Brandeis University

The Heller School for Social Policy and Management

Timeline of the Crisis

The early signs: February-March 2007 - HSBC experiences significant losses in its holdings of US 2nd-lien mortgage loan losses
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March – shares in subprime mortgage lenders drop sharply

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April New Century Financial in Chapter 11

May – Goldman Sachs cites concerns about Bear Stearns heavy exposure to mortgage securitization market
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Brandeis University

The Heller School for Social Policy and Management

The situation deteriorates: June 2007 – Bear Stearns reports 10% earnings declines in mortgage securities area
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July – Bear Stearns informs investors in its two struggling hedge funds that the funds have little value
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Defaults on subprime loans reach highest rate since 2002

July 30 IKB Deutsche Industriebank, a German bank says earnings would be hurt by losses on United States subprime loans
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July 31 – American Home mortgages shares drop 90% they are an Alt-A lender
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August 6 American Home mortgage files for bankruptcy

Brandeis University

The Heller School for Social Policy and Management

The Crisis Begins: August 8 German fund invested in US mortgage-backed securities stops payouts
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August 9 BNP Paribas halts withdrawals from 3 investments funds; Fed and ECB inject liquidity into the financial system
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August 14 Goldman struggles with three of its hedge funds

August 15 – Merrill Lynch predicts Countrywide Financial could go bankrupt
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August 17 – Fed cuts discount rate 50 bps, keeps federal funds rate at 5.25, extends to 30 days the lending period
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September 18 – cuts federal funds rate 50 bps at regular FOMC meeting
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Brandeis University

The Heller School for Social Policy and Management

Interventions by the Fed September 2007 – August 2008 5 cuts in the federal funds rate – from 5.25% to 2% by March 2008
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Decrease in the gap between the discount rate and federal funds rate from 100 bps to 25bps
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Creation and growth of the Term Auction Facility

Extension of credit to other centrals banks -- ECB and the Swiss National Bank
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Term Securities Lending Facility

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Primary Dealer Credit Facility
Loan to JPMorgan Chase to purchase Bear Stearns

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Bear Stearns Share price

180 171.51 147.55 160 139.81 140 120 100 80 60 40 20 0 1/1/2007 July

113.81 91.42 71.01 61.58 30.85 2 10

December

12-Mar

17-Mar

Current Round: The week of September 15, 2008:
• September 15 Lehman Files for Bankruptcy • September 15 Bank of America to Acquire Merrill Lynch

• September 16 Fed to lend $85 billion to AIG, take 80 percent stake
• First indications of run on money market funds – we see first examples of “break the buck” • September 19 Treasury announces $50 billion insurance fund for money markets; Fed announces new program for commercial banks through the Boston Fed discount window to purchase asset backed commercial paper from money market funds •September 21 (SUNDAY) Fed announces that Goldman and Morgan Stanley will become bank holding companies – provides additional funds to help this transition

Tool Box
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Monetary Policy • Rate setting - Federal Funds and Discount • Changes in the composition of Fed’s assets (TAF and TLSF) • Changes in who can borrow using Article 13.3 (PCDF) Fiscal Policy • $150 billion tax rebate – rebates received spring 2008 • Increase in the size of mortgages purchased by Fannie Mae and Freddie Mac • $50 billion insurance guarantee for money market accounts • Sept 7, 2008 – Fannie Mae and Freddie Mac taken over by the Federal Housing Finance Authority with Treasury support Regulation - SEC and UK Financial Services Authority halt short selling September 19, 2008 on 799 companies

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Brandeis University

The Heller School for Social Policy and Management

Consequences for the Real Economy

Growth of real consumer spending

0.6 0.4 0.2 0 -0.2 -0.4 Jan07 April July Oct Jan08 April July

Brandeis University

The Heller School for Social Policy and Management

Additional Policy Responses in Play:

Treasury Authority to buy troubled assets -- $700 billion Extension of unemployment insurance Loans to the auto industry (Range $7-25 billion) Stimulus aid package to states Additional mortgage relief to homeowners

Knowledge Advancing Social Justice

Brandeis University

The Heller School for Social Policy and Management

What Next – or What Keeps Me Awake at Night?

• Immediate Concerns: • The Labor Market • Net Exports • Business Investment • Longer Term • Nature of Regulatory Reform/Social Contract • Investments in Human Capital - Financial Literacy • Consequences for my own workplace

Knowledge Advancing Social Justice

Financial Crisis at Home and Abroad: Lessons Learned and the Way Forward
September 23/24, 2008 B. Magid Dean

Brandeis IBS

The Evolving Global Economy
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United States Economic Stress
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Assumption that home prices would continue to soar Lax supervision and regulation of banking industry

Bursting of U.S. Housing Market
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Bursting of home price bubble Home prices dropped – foreclosures increased Financial companies lost billions on bad mortgage loans Firms cut back on all lending

During Wall Street financial crisis, the hyenas pick off the weakest first U.S.  Insurance Companies U.S. Banks U.S. Intervention

Market Forces

Hedge Funds

Government as Lender of Last Resort

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Who pays when the U.S. government intervenes?

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Moral hazard: Government rescue of risk takers

Current U.S. Financial System

Financial Tsunami
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Greed, fear and uncertainty create the perfect storm

Systemic Approach to a Systemic Crisis
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For months, one-off/ad hoc decision making Worst financial crisis since the Depression Necessitated action: new federal agency to purchase toxic assets

Future U.S. Financial System
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Massive reconsolidation
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Fewer Entities – Fewer Bankers

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Investment banks will disappear More regulations to manage market New government entities

Bank Bank of America Of America Lynch Merril Merril Lynch

Impact of emergency measures on U.S. Economy – Sinking or Swimming
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Fragile Financial System High fiscal deficit High current account deficit Dependence on imported fuel Dependence on foreign capital

Thinking the Unthinkable
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What happens if foreign nations lose their appetite for U.S. dollars?

Is World Growth at Risk?

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U.S. consumer no longer the engine of global growth

Emerging Markets
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Contagion from U.S. economic ills Engines of world growth Commodity price outlook Political stability to support growth?
Shanghai, China

Globalization: At Risk?
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More protectionism Anti free trade Global financial market regulation

Can a Weaker U.S. Lead?

U.S. Ability to Finance ‘Global Cop’ Role
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U.S. defense budget  4.17% of GDP  $570 billion Russian defense budget  $33 billion Chinese defense budget  $47 billion

Rising Geopolitical Tension

Deteriorating relations between Russia and the West

Venezuela’s Chavez: Anti U.S. and Fanning Regional Instability

1. Venezuela-Colombia relations
2. Bolivia – political crisis 3. Ecuador – political strife

Keys to U.S. Economic Future
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1) Education – commitment to excellence 2) Rebuild an aging infrastructure 3) Increase investments in clean energy and life sciences 4) Regain moral compass

The New Global Environment
U.S. will remain first among equals China, India, Brazil, Russia will continue to gain economic power Russia – Iran – Venezuela
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Dependence on hostile oil exporters

The 21st Century Global Imperative
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Improve standard of living of the global disenfranchised


				
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posted:10/11/2008
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