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
March – shares in subprime mortgage lenders drop sharply
April New Century Financial in Chapter 11
May – Goldman Sachs cites concerns about Bear Stearns heavy exposure to mortgage securitization market
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
July – Bear Stearns informs investors in its two struggling hedge funds that the funds have little value
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
July 31 – American Home mortgages shares drop 90% they are an Alt-A lender
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
August 9 BNP Paribas halts withdrawals from 3 investments funds; Fed and ECB inject liquidity into the financial system
August 14 Goldman struggles with three of its hedge funds
August 15 – Merrill Lynch predicts Countrywide Financial could go bankrupt
August 17 – Fed cuts discount rate 50 bps, keeps federal funds rate at 5.25, extends to 30 days the lending period
September 18 – cuts federal funds rate 50 bps at regular FOMC meeting
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
Decrease in the gap between the discount rate and federal funds rate from 100 bps to 25bps
Creation and growth of the Term Auction Facility
Extension of credit to other centrals banks -- ECB and the Swiss National Bank
Term Securities Lending Facility
Primary Dealer Credit Facility
Loan to JPMorgan Chase to purchase Bear Stearns
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
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
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
United States Economic Stress
Assumption that home prices would continue to soar Lax supervision and regulation of banking industry
Bursting of U.S. Housing Market
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
Who pays when the U.S. government intervenes?
Moral hazard: Government rescue of risk takers
Current U.S. Financial System
Financial Tsunami
Greed, fear and uncertainty create the perfect storm
Systemic Approach to a Systemic Crisis
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
Massive reconsolidation
Fewer Entities – Fewer Bankers
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
Fragile Financial System High fiscal deficit High current account deficit Dependence on imported fuel Dependence on foreign capital
Thinking the Unthinkable
What happens if foreign nations lose their appetite for U.S. dollars?
Is World Growth at Risk?
U.S. consumer no longer the engine of global growth
Emerging Markets
Contagion from U.S. economic ills Engines of world growth Commodity price outlook Political stability to support growth?
Shanghai, China
Globalization: At Risk?
More protectionism Anti free trade Global financial market regulation
Can a Weaker U.S. Lead?
U.S. Ability to Finance ‘Global Cop’ Role
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
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
Dependence on hostile oil exporters
The 21st Century Global Imperative
Improve standard of living of the global disenfranchised