The Great Recession PowerPoint Presentation.ppt by longze569

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									The Great Recession

      Presented by
   Dr. Joshua J. Lewer
    Some Recent Financial Crises
   Theme: Bad Loans
     U.S. Savings and Loans - 1985 to 1989
     Japan‟s Banking Crisis – 1989 to present

     Mexican Banking Crisis of 1995

     Asian Flu of 1997-98 – The “Contagion”

     Russian Implosion of 1998

     Argentina 2001
    Functions of the Financial System
   Essential for overall economic performance, see
    King and Levine (1993)

   Funnel savings to borrowers
     Housing
     Investment

     Short term needs – Baltimore steel framer story

     Exchange assets across generations
    The Roots of the Current Problem
   The current crisis
     A crisis in financial institutions
        Collapse of a speculative bubble in the housing
     Triggered a credit crunch → Recession since Dec „07
The Housing Bubble
           Shiller’s Housing Value Index


        Benchmark = 110



    1985           1990          1995           2000              2005   2010

   Note: Shiller Index Adjusted for Inflation and Based on 1998
           Shiller’s Housing Value Index

                                    Peak = 220 (May 2006)


        Benchmark = 110




    1985           1990          1995           2000             2005   2010

  Note: Shiller Index Adjusted for Inflation and Based on 1998
        Shiller’s Housing Value Index

                                 Peak = 220 (May 2006)


        Benchmark = 110


                                                  Now = 145 (Nov 2008)


    1985            1990        1995           2000            2005      2010

Note: Shiller Index Adjusted for Inflation and Based on 1998
               Housing Outliers








 1985   1990       1995          2000   2005   2010
                              Housing Outliers

                                                          Los Angeles



200                                                U.S.




 1985                  1990               1995             2000           2005              2010

      Note: Tri-county area has observed a 4.85% average annual increase from 2004-2008 (3q).
      Source: Illinois Association of Realtors
    Why Do Mania’s Like This Occur?
   The truth is…we don‟t know

   Investors as Pigeons…we just fly in circles

                        Pigeon investor theory suggests we watch each
                        other rather than focus on fundamentals
Major Housing Boom Factors
               The Savings Tsunami

   Savings glut in Asia → global interest rates low
    since 1991
       Low interest rates stimulate the demand for housing
   Other factors
     Historic low federal funds rate
     Federal policies that promoted homeownership

     Greed, speculation, and the lack of personal
               Enter Subprime
   “SubPrime” -- a loan under conditions which
    make the risk higher than “prime”

   Some Examples
     The borrower could be more risky than one who
      would get the usual 20% down, 30-year fixed rate
     The borrower could get a 0% down mortgage

     Grandma Tesch story
Subprime Issuance and Ratings 2005-07
            U.S.$ Billions
    All             AAA              AA               A              BBB
  (100%)          (80.8%)          (9.6%)          (5.0%)           (3.5%)
    1,421          1,134             134             70               49
 Source: Greenlaw et al. (2008), Inside Mortgage Finance
 Note: 2000-2007 subprime issuance total is $2.71 trillion, before this - minimal
From Wall Street to Main Street:
 How has the Financial Crisis
 Impacted the Real Economy?
             Recession Effects

1. Credit markets have seized up - interest rate
    premiums persist, but some recovery here
2. The decapitalization and failure of financial
    institutions - credit crunch
3. Household bankruptcies and foreclosures
4. U.S. consumer confidence at an all-time low
5. Job losses and insecurity - a recession of fear
      Foreclosure Rates in U.S.

Source: RealtyTrac U.S. Foreclosure Market Report
      Appreciation Rates in U.S.

Source: RealtyTrac
Recession Comparisons
         The Bailouts:

                   Ben Bernanke
                   Aka: “Bailout Ben”
The Bush Stimulus
The Economic Stimulus Act of 2008
   The $152B law was intended to boost the U.S.
    economy in 2008 and avert a recession.

   Signed into law on February 13, 2008.

   The law provides:
     Tax rebates
     Tax incentives to stimulate business investment
     Housing relief by gov‟t sponsored enterprises.
                     Tax Rebates
   $300 per person ($600 for married filing jointly)
   Plus, $300 per dependent child under the age of

   Business tax incentives:
       One-time depreciation tax deduction equal to 50%
        of the cost of specific new investments during 2008.
 Emergency Economic
Stabilization Act of 2008
   Troubled Assets Relief Program
   Goals
    1.   “Provide stability or prevent disruption to the
         financial markets or banking system,”
    2.   “Protecting the taxpayer.”

   The $700B act allows the federal government to:
        Buy and sell MBS
        Buy and sell illiquid whole loans
        TARP I (Oct – Dec 2008): The first $350B was
         applied to a capital purchase program – buy
         preferred stocks in banks
        TARP II (current) – Geitner buying MBS with “Bad
   The program lasts for 2 years
   Funded by government bonds
   National debt cap increases to $11.35t
   Asset managers and contracted firms are to
    conduct transactions on behalf of the Treasury
    Secretary – fiduciary responsibility to U.S.
   To obtain enough votes for passage, additional
    riders were added
     There are two oversight committees over the
      Troubled Assets Relief Program of the Act.
    1. Congressional oversight panel

         Five members appointed by House and Senate
           leadership from both parties.
    2. Financial Stability Board

         Reports to Congressional Panel

         Made up of -- Fed Chair, SEC Chair, Fed Home
           Fin Dir, HUD Sec, Treasury Sec
     Has it Fixed the Problems in the
            Financial Markets?
   With concurrent Federal Reserve actions,…
       Lowering the Federal Funds rate to 0 to 0.25%
       Using MBS as collateral for Term Auction Facility (TAF)
        loans - $900B by end of year.
       Buying commercial paper - $275B since August „08
       Buying MBS - $500B starting in Nov. ‟08
       Buying the spectrum of Treasuries to keep long-term interest
        rates low and increase liquidity - $600B

   …capitalization and liquidity in the financial sector has
    been significantly enhanced, but…

   …credit access still remains a problem in some areas.
Obama’s Stimulus Package
      The American Recovery and
       Reinvestment Act of 2009

 GDP        $14,327,000,000,000
 Amount        $787,000,000,000

   % of GDP 5.5%
             “The” Stimulus Package
    Category                                    Portion   Sum
    (T) Tax Relief for Ind‟s            $246B    31.2     31.2
    (S) Transport and Infra.            $98B     12.4     43.6
    (T) Aid to States & Local Gov‟t     $95B     12.1     55.7
    (T) Aid to Those Effected by Rec.   $62B       7.8    63.5
    (S) Aid to States & Local Gov‟t     $58B       7.4    70.9
    (S) Education                       $48B       6.1    77.0
    (S) Energy                          $41B       5.2    82.2
    (S) Aid to Those Effected by Rec.   $37B       4.7    86.9
    (S) Health Care                     $20B       2.5    89.4
    (T) Renew Energy Tax Credits        $20B       2.5    91.9

    Total                               $787B
    Category (S=Spending, T=Taxation)
       Tax Relief for Individuals
1.   For 2009 and 2010, a refundable tax credit of up to
     $400 ($800 joint return) for working individuals
     ($33 per month or claim on tax return). Phase out
     $75,000 ($150,000 joint return). Cost = $116B
2.   Extension of the alternative minimum tax for 2009
     - extends AMT relief for nonrefundable personal
     credits and increasing the AMT exemption amount
     to $70,950 for joint filers and $46,700 for
     individuals. Cost = $69B
3.   Other components: increase eligibility of child tax
     credit, one-time payment of $250 to retired and
     disabled individuals, tax credit up to $2,500 for
     college, $8,000 for first-time home buyer, etc.
Geitner’s “Vauge”
  Banking Plan
                  3 Part Plan
1.   Geitner proposes to create one or more “bad
     banks” to buy and hold toxic assets.
2.   He proposes a lending program that would
     spend $1 trillion to cover the decline in the
     issuance of securities backed by consumer
3.   He proposes more capital infusions to banks to
     spur lending. In exchange, banks would have
     to cut the salaries and lower dividends.
Housing Bailout
    Obama’s Plan Aides Homeowners
   The $275B plan helps 9 million struggling homeowners
       Refinancing
       Modify existing mortgages

   $200B to refinance: only available through Fannie Mae
    and Freddie Mac

   $75B to encourage lenders to modify loan terms
       Lenders and the gov‟t would jointly lower monthly payments
        to 31% of income
       Lenders receive $1,000 per modification
       Borrowers receive $1,000 principal reduction for up to 5
The Current State of
   the Economy
              Short Run Prognosis
   4th quarter 2008 economic numbers were bad
       Real GDP growth at -6.2% (worst quarter was 1st quarter 1980
        = -7.8%)

   1st half 2009 economic estimates also look negative
       Real GDP growth estimates Q1 = -4.6% and
       Q2 = -1.5%

   Unemployment expected to peak at 9% 1st quarter ‟10

   Global growth slows to 0.5% ‟09 and 3% ‟10 (IMF, 2009)
                What Happens to
   Since World War II

       Each 1% change in GDP has Caused 1.7% Change
        in Manufacturing

       Each 1% change in GDP has Caused 2.2% to 2.5%
        Change in Durables Manufacturing
                 What Happens to
   The 12.3% annualized GDP drop of Q4 ‟08 and
    the First Half of ‟09

       12.3% * 1.7 = 20.91% annualized drop yields a 5.2%
        total drop in Manufacturing

       12.3% * 2.3 = 28.3% annualized drop yields a 7.1%
        total drop in Durables Manufacturing
     Visibility of Recession’s End
   The 3rd Quarter of 2009 has the potential to be
    the initial quarter of the next economic recovery.

   The second half of 2009 should see the US
    economy on a slow recovery track.
     Q3 = 0.7%
     Q4 = 1.9%

   Projected 2009 US GDP decline at 0.9%.
           Why a Slow Recovery?
   “Growth Dynamics: The Myth of Economic Recovery”
    Cerra and Saxena (2008, AER) find:
    “Using panel data for a large set of high-income,
    emerging market, developing, and transition countries,
    we find robust evidence that the large output loss from
    financial crises and some types of political crises is
    highly persistent. The results on financial crises are also
    highly robust to the assumption on exogeneity.
    Moreover, we find strong evidence of growth
    overoptimism before financial crises. We also find a
    distinction between the output impact of civil wars
    versus other crises, in that there is a partial output
    rebound for civil wars but no significant rebound for
    financial crises or the other political crises.”
    What Will Drive the Recovery?
   Thawing of the credit markets
       Some improvement in the financial sector
       Yield curve (in recovery zone) and Ted spread (not yet)

   Keynesian Economics
       Massive stimulus packages by Obama and rest of world

   China recovery underway

   Lower oil and commodity prices
       Stimulates aggregate supply
    Dr. Lewer’s Policy Prescriptions
   Delay Obama‟s tax increases on high-income
   Support open trade...not the time for a trade war
   Combine fiscal and monetary policies efforts
        Like pharmaceuticals, the potency is enhanced
   Provide short-term support to American families
    behind on their mortgages - $275B plan
   Support small business start-ups and cut red tape
    for entrepreneurs
The Sky Has Fallen.
The Sun Also Rises.
End of Presentation
Parking Lot
       Risk Indicators Improving
1. TED spread – the difference between the yield on the 3-
    month Treasury Bill and the 3-month Libor
      Indicator of health of global credit markets
      Excellent measure of fear banks have when lending
      Spread was 465 basis points in October, Jan‟ 09 at 100 now
      Normalized credit conditions spread would be near 50

2. Yield curve – the ten-year treasury less federal funds rate
      Currently at (3.02% = 3.02%-0%)
      Leading recovery spread is above 2.50%
          Transport and Infrastructure
1.        Highway infrastructure investment. Cost = $27B
     1.     Illinois $1.6B

2.        High speed rail capital assistance. Cost = $8B

3.        Defense environmental cleanup. Cost = $5B
     Aid to States and Local Gov’t
1.   Medicaid increase for states. Cost = $87B
2.   State Fiscal Stabilization Fund to avoid
     cutbacks and layoffs (82% must be used for
     education while 18% may be used for public
     safety and other government services. The
     latter part may be used for repairs and
     modernization of K-12 schools and college
     and university buildings.) Cost = $54B
3.   One-time grants to encourage states to
     increase unemployment coverage. Cost = $3B
      Aid to People Affected by the
1.   Extension of emergency unemployment
     compensation. Cost $26B
2.   Premium subsidies for COBRA continuation for
     unemployed workers. Cost = $25B
3.   Temporary increase in benefits under the
     Supplemental Nutrition Assistance Program (food
     stamps) Cost = $20B
4.   Rural Housing Service insurance fund program
     account - direct loans and unsubsidized guaranteed
     loans Cost = $12B
5.   Increases weekly unemployment benefits by an
     additional $25 through 2009. Cost = $8B
1.   Pell grants for higher education (Pell Grant‟s award at
     $5,350 in 2009 and $5,550 in 2010 ). Cost $16B

2.   Special education funding under the Individuals with
     Disabilities Education Act. Cost = $12B

3.   Education for the disadvantaged - elementary and
     secondary education Cost. = $10B
1.   Innovative technology loan guarantee program. Cost

2.   Weatherization Assistance Program (increases
     maximum income level and maximum assistance).
     The Weatherization Assistance Program enables low-
     income families to permanently reduce their energy
     bills by making their homes more energy efficient.
     Cost = $6B

3.   Federal building conversion to “high-performance
     green buildings.” Cost = $5B
                   Health Care
1.   National Institutes of Health fund to support
     scientific research . Cost $7.4B
2.   Construction, renovation, equipment and information
     technology for health centers. Cost = $1.5B
3.   Department of Health and Human Services
     Prevention and Wellness Fund. Cost = $1B
4.   National Institutes of Health grants and contracts to
     renovate non-federal research facilities. Cost = $1B
5.   Increases weekly unemployment benefits by an
     additional $25 through 2009. Cost = $8B
     Renewable Energy Tax Credits
1.    Long-term Extension and Modification of Renewable
      Energy Production Tax Credit. The bill would extend
      the placed-in-service date for wind facilities for three
      years (through Dec. 31, 2012). The bill would also
      extend the placed-in-service date for three years
      (through Dec. 31, 2013) for certain other qualifying
      facilities: closed-loop biomass, open-loop biomass,
      geothermal, small irrigation, hydropower, landfill gas,
      waste-to-energy and marine renewable facilities. Cost
      = $13B
2.    Tax Credits for Energy-Efficient Improvements to
      Existing Homes ($1,500). Cost $2B
3.    Plug-in Electric Car Credit ($2,500). Cost $2B

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