2007-2010 financial crisis

8/13/2019 2007-2010 Financial Crisis

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THE US SUBPRIME MORTGAGE CRISIS

The US subprime mortgage crisiswas one of the first indicators of the 20072010financial crisis, characterized by a rise in subprie ort!a!e delin"uencies andforeclosures, and the resultin! decline of securities bac#in! said ort!a!es$

%ppro&iately '0( of U$S$ ort!a!es issued to subprie borrowers weread)ustable*rate ort!a!es$+1%fter U$S$ house prices pea#ed in id*200- and be!antheir steep decline thereafter, refinancin!becae ore difficult$ %s ad)ustable*rateort!a!es be!an to reset at hi!her rates, ort!a!e delin"uencies soared$ Securitiesbac#ed with ort!a!es, includin! subprie ort!a!es, widely held by financial firs,lost ost of their .alue$ /lobal in.estors also drastically reduced purchases ofort!a!e*bac#ed debt and other securities$ n addition to causin! increaseddelin"uencies and foreclosures in subprie ort!a!es alon! with all other types ofort!a!es includin! %lt*% and conforin!, the 20072010 financial crisiscaused adecline in the capacity and willin!ness of the pri.ate financial syste to supportlendin!, ti!htenin! credit around the world and slowin! econoic !rowth in the U$S$and Europe$

BACKGROUND AND TIMELINE O E!ENTS

Main articles: Subprime crisis background information, Subprime crisis impacttimeline,United States housing bubble, and United States housing market correction

3actors contributin! to housin! bubble

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Domi"o e##ectas $ousi"g prices %ec&i"e%

The iediate cause or tri!!er of the crisis was the burstin! of the United Stateshousin! bubblewhich pea#ed in appro&iately 2004200-$ +2+5Hi!h default rates on6subprie6 and ad)ustable rate ort!a!es %8, be!an to increase "uic#ly

thereafter$ %n increase in loan incenti.es such as easy initial ters and a lon!*tertrend of risin! housin! prices had encoura!ed borrowers to assue difficultort!a!es in the belief they would be able to "uic#ly refinance at ore fa.orableters$ %dditionally, the econoic incenti.es pro.ided to the ori!inators of subprieort!a!es, alon! with outri!ht fraud, increased the nuber of subprie ort!a!espro.ided to consuers who would ha.e otherwise "ualified for conforin! loans$Howe.er, once interest rates be!an to rise and housin! prices started to dropoderately in 200-2007 in any parts of the U$S$, refinancin! becae oredifficult$ 9efaultsand foreclosureacti.ity increased draatically as easy initial terse&pired, hoe prices failed to !o up as anticipated, and %8 interest rates resethi!her$ 3allin! prices also resulted in 25( of U$S$ hoes worth less than the

ort!a!e loan by Septeber 2010, pro.idin! a financial incenti.e for borrowers toenter foreclosure$+:The on!oin! foreclosure epideic, of which subprie loans areone part, that be!an in late 200- in the U$S$ continues to be a #ey factor in the !lobaleconoic crisis, because it drains wealth fro consuers and erodes the financialstren!th of ban#in! institutions$

n the years leadin! up to the crisis, si!nificant aounts of forei!n oney flowed intothe U$S$ fro fast*!rowin! econoies in %sia and oil*producin! countries$ This inflowof funds cobined with low U$S$ interest rates fro 2002*200: contributed to easycredit conditions, which fueled both housin! and credit bubbles$ ;oans of .arioustypes e$!$, ort!a!e, credit card, and auto were easy to obtain and consuersassued an unprecedented debt load$+4+-%s part of the housin! and credit boos,the aount of financial a!reeents called ort!a!e*bac#ed securities8


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/o.ernents also bailed out#ey financial institutions, assuin! si!nificant additionalfinancial coitents$

The ris#s to the broader econoy created by the housin! ar#et downturn andsubse"uent financial ar#et crisis were priary factors in se.eral decisions by

central ban#s around the world to cut interest rates and !o.ernents to ipleenteconoic stiulus pac#a!es$ Effects on !lobal stoc# ar#ets due to the crisis ha.ebeen draatic$


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foreclosure proceedin!s, rou!hly triple the rate of 2004$ +22


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syste that contributed to the crisis$ These assuptions includedF 1 Housin! priceswould not fall draatically+:1 2 3ree and open financial ar#ets supported bysophisticated financial en!ineerin! would ost effecti.ely support ar#et efficiencyand stability, directin! funds to the ost profitable and producti.e uses 5 @onceptsebedded in atheatics and physics could be directly adapted to ar#ets, in the

for of .arious financial odels used to e.aluate credit ris# : Econoicibalances, such as lar!e trade deficits and low sa.in!s rates indicati.e of o.er*consuption, were sustainable and 4 Stron!er re!ulation of the shadow ban#in!systeand deri.ati.es ar#ets was not needed$ +:2

Boom a"% bust i" t$e $ousi"g mar'et

Main articles: United States housing bubble and United States housing marketcorrection

Existing homes sales, inventory, and months supply, by quarter

!icious "ycles in the #ousing $ %inancial Markets

;ow interest rates and lar!e inflows of forei!n funds created easy credit conditionsfor a nuber of years prior to the crisis, fuelin! a housin! ar#et boo andencoura!in! debt*financed consuption$+:5The US% hoe ownership rate increasedfro -:( in 1??: about where it had been since 1?'0 to an all*tie hi!h of -?$2(

in 200:$

+::

Subprie lendin! was a a)or contributor to this increase in hoeownership rates and in the o.erall deand for housin!, which dro.e prices hi!her$

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200'$ He concluded that the e&tent of e"uity in the hoe was the #ey factor inforeclosure, rather than the type of loan, credit worthiness of the borrower, or abilityto pay$+-1

ncreasin! foreclosure rates increases the in.entory of houses offered for sale$ The

nuber of new hoes sold in 2007 was 2-$:( less than in the precedin! year$


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officeand ore are e&ainin! how ban#s created, rated, sold and traded ort!a!esecurities that turned out to be soe of the worst in.estents e.er de.ised$ n 2010,.irtually all of the in.esti!ations, criinalas well as ci.il, are in their early sta!es$+7:

=arren


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ha.in! to pro.e or e.en state any owned assets$ %ll that was re"uired for a ort!a!ewas a credit score$+':

%nother e&aple is the interest*only ad)ustable*rate ort!a!e %8, which allowsthe hoeowner to pay )ust the interest not principal durin! an initial period$ Still

another is a 6payent option6 loan, in which the hoeowner can pay a .ariableaount, but any interest not paid is added to the principal$ %n estiated one*third of%8s ori!inated between 200: and 200- had 6teaser6 rates below :(, which thenincreased si!nificantly after soe initial period, as uch as doublin! the onthlypayent$+7'

The proportion of subprie %8 loans ade to people with credit scores hi!henou!h to "ualify for con.entional ort!a!es with better ters increased fro :1(in 2000 to -1( by 200-$ Howe.er, there are any factors other than credit score thataffect lendin!$ n addition, ort!a!e bro#ers in soe cases recei.ed incenti.es frolenders to offer subprie %8s e.en to those with credit ratin!s that erited a

conforin! i$e$, non*subprie loan$+'4

8ort!a!e underwritin!standards declined precipitously durin! the boo period$ Theuse of autoated loan appro.als allowed loans to be ade without appropriatere.iew and docuentation$+'- n 2007, :0( of all subprie loans resulted froautoated underwritin!$+'7+'' The chairan of the 8ort!a!e


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becae$ Do atter how la& lendin! standards !ot, no atter how any e&oticort!a!e products were created to shoehorn people into hoes they couldntpossibly afford, no atter what the ort!a!e achine tried, the people )ust couldntswin! it$ eople would close on ahouse, si!n all the ort!a!e papers, and then default on their .ery first payent$ Doloss of a )ob, no edical eer!ency, they were underwater before they e.en started$%nd althou!h no one could really hear it, that was probably the oent when one ofthe bi!!est speculati.e bubbles in %erican history popped$

Securiti,atio" practices

orro'ing under a securiti-ation structure$%urther information: Securiti-ationand Mortgage.backed security

The traditional ort!a!e odel in.ol.ed a ban# ori!inatin! a loan to theborrowerOhoeowner and retainin! the credit default ris#$ =ith the ad.ent ofsecuritization, the traditional odel has !i.en way to the 6ori!inate to distribute6odel, in which ban#s essentially sell the ort!a!es and distribute credit ris# toin.estors throu!h ort!a!e*bac#ed securities$ Securitization eant that those

issuin! ort!a!es were no lon!er re"uired to hold the to aturity$


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C10 trillion cae fro the securitization ar#ets$ The securitization ar#ets startedto close down in the sprin! of 2007 and nearly shut*down in the fall of 200'$ 8orethan a third of the pri.ate credit ar#ets thus becae una.ailable as a source offunds$+?'+?? n 3ebruary 200?,


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there are also indications that soe in.ol.ed in ratin! subprie*related securities#new at the tie that the ratin! process was faulty$+105

@ritics alle!e that the ratin! a!encies suffered fro conflicts of interest, as they werepaid by in.estent ban#s and other firs that or!anize and sell structured securities

to in.estors$+10:

Bn 11 Aune 200', the SE@proposed rules desi!ned to iti!atepercei.ed conflicts of interest between ratin! a!encies and issuers of structuredsecurities$+104Bn 5 9eceber 200', the SE@ appro.ed easures to stren!theno.ersi!ht of credit ratin! a!encies, followin! a ten*onth in.esti!ation that found6si!nificant wea#nesses in ratin!s practices,6 includin! conflicts of interest$+10-


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@on!ress failed to enact re!ulations that would ha.e pre.ented e&ploitations bythese loan types$ Subse"uent widespread abuses of predatory lendin! occurred withthe use of ad)ustable*rate ort!a!es$+1+5'+111 %ppro&iately '0( of subprieort!a!es are ad)ustable*rate ort!a!es$+1

n 1??4, the /SEs li#e 3annie 8ae be!an recei.in! !o.ernent ta& incenti.es forpurchasin! ort!a!e bac#ed securities which included loans to low incoeborrowers$ Thus be!an the in.ol.eent of the 3annie 8ae and 3reddie 8ac with thesubprie ar#et$+112n 1??-, HU9set a !oal for 3annie 8ae and 3reddie 8ac thatat least :2( of the ort!a!es they purchase be issued to borrowers whosehousehold incoe was below the edian in their area$ This tar!et was increased to40( in 2000 and 42( in 2004$+1153ro 2002 to 200-, as the U$S$ subprie ar#et!rew 2?2( o.er pre.ious years, 3annie 8ae and 3reddie 8ac cobined purchasesof subprie securities rose fro C5' billion to around C174 billion per year beforedroppin! to C?0 billion per year, which included C540 billion of %lt*% securities$3annie 8ae had stopped buyin! %lt*% products in the early 1??0s because of the

hi!h ris# of default$


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Econoist >aul Jru!anar!ued in Aanuary 2010 that the siultaneous !rowth ofthe residential and coercial real estate pricin! bubbles underines the caseade by those who ar!ue that 3annie 8ae, 3reddie 8ac, @% or predatory lendin!were priary causes of the crisis$ n other words, bubbles in both ar#ets de.elopede.en thou!h only the residential ar#et was affected by these potential causes$+152

Po&icies o# ce"tra& ba"'s

%ederal %unds +ate and !arious Mortgage +ates

@entral ban#sana!e onetary policy and ay tar!et the rate of inflation$ They

ha.e soe authority o.er coercial ban#sand possibly other financial institutions$They are less concerned with a.oidin! asset price bubbles, such as the housin!bubbleand dot*co bubble$ @entral ban#s ha.e !enerally chosen to react after suchbubbles burst so as to iniize collateral daa!e to the econoy, rather than tryin!to pre.ent or stop the bubble itself$ This is because identifyin! an asset bubble anddeterinin! the proper onetary policy to deflate it are atters of debate aon!econoists$+155+15:

Soe ar#et obser.ers ha.e been concerned that 3ederal eser.eactions could!i.e rise to oral hazard$+5?% /o.ernent %ccountability Bfficecritic said that the3ederal eser.e


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9urin! 200', three of the lar!est U$S$ in.estent ban#s either went ban#rupt;ehan


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.olue of @9S outstandin! increased 100*fold fro 1??' to 200', with estiates ofthe debt co.ered by @9S contracts, as of Do.eber 200', ran!in! fro USC55 toC:7 trillion$ @9S are li!htly re!ulated$ %s of 200', there was no central clearin!houseto honor @9S in the e.ent a party to a @9S pro.ed unable to perfor hisobli!ations under the @9S contract$ e"uired disclosure of @9S*related obli!ations

has been criticized as inade"uate$ nsurance copanies such as %ericannternational /roup %/, 8 reported that 8a!netar encoura!ed in.estors to purchase @9Bswhile siultaneously bettin! a!ainst the, without disclosin! the latter bet$ +147+14'+14?

nstruents called synthetic @9B, which are portfolios of credit default swaps, werealso in.ol.ed in alle!ations by the SE@ a!ainst /oldan*Sachs in %pril 2010$+1-0

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http://en.wikipedia.org/wiki/Clearing_house_(finance)http://en.wikipedia.org/wiki/Clearing_house_(finance)http://en.wikipedia.org/wiki/American_International_Grouphttp://en.wikipedia.org/wiki/American_International_Grouphttp://en.wikipedia.org/wiki/MBIAhttp://en.wikipedia.org/wiki/MBIAhttp://en.wikipedia.org/wiki/Ambachttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-149http://en.wikipedia.org/wiki/Lehman_Brothershttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-150http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-150http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-151http://en.wikipedia.org/wiki/Merrill_Lynchhttp://en.wikipedia.org/wiki/Collateralized_debt_obligationhttp://en.wikipedia.org/wiki/AIGhttp://en.wikipedia.org/wiki/Bank_of_Americahttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-NYT-Morgenson-2008-11-08-152http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-Bloomberg-Paulden-2008-08-26-153http://en.wikipedia.org/wiki/Joseph_Stiglitzhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-154http://en.wikipedia.org/wiki/Michael_Lewis_(author)http://en.wikipedia.org/wiki/AIGhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-155http://en.wikipedia.org/wiki/Magnetar_Capitalhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-156http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-157http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-158http://en.wikipedia.org/wiki/Synthetic_CDOhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-159http://en.wikipedia.org/wiki/Clearing_house_(finance)http://en.wikipedia.org/wiki/Clearing_house_(finance)http://en.wikipedia.org/wiki/American_International_Grouphttp://en.wikipedia.org/wiki/American_International_Grouphttp://en.wikipedia.org/wiki/MBIAhttp://en.wikipedia.org/wiki/Ambachttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-149http://en.wikipedia.org/wiki/Lehman_Brothershttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-150http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-151http://en.wikipedia.org/wiki/Merrill_Lynchhttp://en.wikipedia.org/wiki/Collateralized_debt_obligationhttp://en.wikipedia.org/wiki/AIGhttp://en.wikipedia.org/wiki/Bank_of_Americahttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-NYT-Morgenson-2008-11-08-152http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-Bloomberg-Paulden-2008-08-26-153http://en.wikipedia.org/wiki/Joseph_Stiglitzhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-154http://en.wikipedia.org/wiki/Michael_Lewis_(author)http://en.wikipedia.org/wiki/AIGhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-155http://en.wikipedia.org/wiki/Magnetar_Capitalhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-156http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-157http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-158http://en.wikipedia.org/wiki/Synthetic_CDOhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-159


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US Ba&a"ce o# Pa.me"ts

US "urrent *ccount or )rade (eficit

n 2004,


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Boom a"% co&&apse o# t$e s$a%o) ba"'i"g s.stem

Securiti-ation markets 'ere impaired during the crisis

n a Aune 200' speech, >resident of the DK 3ederal eser.e aul Jru!andescribed the run on the shadow ban#in! syste asthe 6core of what happened6 to cause the crisis$ 6%s the shadow ban#in! systee&panded to ri.al or e.en surpass con.entional ban#in! in iportance, politiciansand !o.ernent officials should ha.e realized that they were re*creatin! the #ind offinancial .ulnerability that ade the /reat 9epression possibleIand they shouldha.e responded by e&tendin! re!ulations and the financial safety net to co.er thesenew institutions$ nfluential fi!ures should ha.e proclaied a siple ruleF anythin!that does what a ban# does, anythin! that has to be rescued in crises the way ban#sare, should be re!ulated li#e a ban#$6 He referred to this lac# of controls as 6ali!nne!lect$6+1-:+1-4

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http://en.wikipedia.org/wiki/Timothy_Geithnerhttp://en.wikipedia.org/wiki/Timothy_Geithnerhttp://en.wikipedia.org/wiki/Shadow_banking_systemhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-newyorkfed.org-7http://en.wikipedia.org/wiki/Paul_Krugmanhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-Krugman_2009-163http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-164http://en.wikipedia.org/wiki/File:Securitization_Market_Activity.pnghttp://en.wikipedia.org/wiki/File:Securitization_Market_Activity.pnghttp://en.wikipedia.org/wiki/Timothy_Geithnerhttp://en.wikipedia.org/wiki/Timothy_Geithnerhttp://en.wikipedia.org/wiki/Shadow_banking_systemhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-newyorkfed.org-7http://en.wikipedia.org/wiki/Paul_Krugmanhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-Krugman_2009-163http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-164


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e"uity in the United States, which was .alued at C15 trillion at its pea# in 200-, haddropped to C'$' trillion by id*200' and was still fallin! in late 200'$ Total retireentassets, %ericans second*lar!est household asset, dropped by 22 percent, froC10$5 trillion in 200- to C' trillion in id*200'$ 9urin! the sae period, sa.in!s andin.estent assets apart fro retireent sa.in!s lost C1$2 trillion and pension

assets lost C1$5 trillion$ Ta#en to!ether, these losses total a sta!!erin! C'$5 trillion$+1-' 8ebers of US% inority !roups recei.ed a disproportionate nuber ofsubprie ort!a!es, and so ha.e e&perienced a disproportionate le.el of theresultin! foreclosures$+1-?+170+171

i"a"cia& mar'et impacts0 1223

%urther information: 3ist of 'ritedo'ns due to subprime crisis

%(4" &raph . US ank $ )hrift ;rofitability y


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worst ban# and thrift "uarterly perforance since 1??0$ n all of 2007, insureddepository institutions earned appro&iately C100 billion, down 51( fro a recordprofit of C1:4 billion in 200-$ >rofits declined fro C54$- billion in 2007 Q1 to C1?$5billion in 200' Q1, a decline of :-($+1'0+1'1

i"a"cia& mar'et impacts0 1224

)he )E( spread 6 an indicator of credit risk 6 increased dramatically duringSeptember /00=%urther information: 4ndirect economic effects of the subprime mortgage crisis

%s of %u!ust 200', financial firsaround the !lobe ha.e written downtheir holdin!sof subprie related securities by USC401 billion$ +1'2The 83 estiates that financial

institutions around the !lobe will e.entually ha.e to write off C1$4 trillion of theirholdin!s of subprie 8


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Howe.er, soe econoists state that Third*=orldeconoies, such as the


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credit "uality$ These include the Ter %uction 3acilityT%3 and Ter %sset*resident lan$ +1?7

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http://en.wikipedia.org/wiki/Term_Auction_Facilityhttp://en.wikipedia.org/wiki/TALFhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-postversion1-190http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-191http://en.wikipedia.org/wiki/FOMChttp://en.wikipedia.org/wiki/Government-sponsored_enterprisehttp://en.wikipedia.org/wiki/Agency_debthttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-192http://en.wikipedia.org/wiki/Ben_Bernankehttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-193http://en.wikipedia.org/wiki/Economic_Stimulus_Act_of_2008http://en.wikipedia.org/wiki/American_Recovery_and_Reinvestment_Act_of_2009http://en.wikipedia.org/wiki/American_Recovery_and_Reinvestment_Act_of_2009http://en.wikipedia.org/wiki/George_W._Bushhttp://en.wikipedia.org/wiki/Income_taxhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-Yahoo-mail-194http://en.wikipedia.org/wiki/Oil_price_increases_since_2003http://en.wikipedia.org/wiki/Barack_Obamahttp://en.wikipedia.org/wiki/American_Recovery_and_Reinvestment_Act_of_2009http://en.wikipedia.org/wiki/American_Recovery_and_Reinvestment_Act_of_2009http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-195http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-196http://en.wikipedia.org/wiki/Term_Auction_Facilityhttp://en.wikipedia.org/wiki/TALFhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-postversion1-190http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-191http://en.wikipedia.org/wiki/FOMChttp://en.wikipedia.org/wiki/Government-sponsored_enterprisehttp://en.wikipedia.org/wiki/Agency_debthttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-192http://en.wikipedia.org/wiki/Ben_Bernankehttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-193http://en.wikipedia.org/wiki/Economic_Stimulus_Act_of_2008http://en.wikipedia.org/wiki/American_Recovery_and_Reinvestment_Act_of_2009http://en.wikipedia.org/wiki/American_Recovery_and_Reinvestment_Act_of_2009http://en.wikipedia.org/wiki/George_W._Bushhttp://en.wikipedia.org/wiki/Income_taxhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-Yahoo-mail-194http://en.wikipedia.org/wiki/Oil_price_increases_since_2003http://en.wikipedia.org/wiki/Barack_Obamahttp://en.wikipedia.org/wiki/American_Recovery_and_Reinvestment_Act_of_2009http://en.wikipedia.org/wiki/American_Recovery_and_Reinvestment_Act_of_2009http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-195http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-196


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Ba"' so&-e"c. a"% capita& rep&e"is$me"t

Main article: Emergency Economic Stabili-ation *ct of /00=

"ommon Equity to )otal *ssets +atios for Ma?or US* anks

;osses on ort!a!e*bac#ed securities and other assets purchased with borrowedoney ha.e draatically reduced the capital base of financial institutions, renderin!any either insol.ent or less capable of lendin!$ /o.ernents ha.e pro.ided fundsto ban#s$ Soe ban#s ha.e ta#en si!nificant steps to ac"uire additional capital fropri.ate sources$

The U$S$ !o.ernent passed the Eer!ency Econoic Stabilization %ct of 200'EES% or T%> durin! Bctober 200'$ This law included C700 billion in fundin! for

the 6Troubled %ssets elief >ro!ra6 T%>, which was used to lend funds toban#s in e&chan!e for di.idend*payin! preferred stoc#$+1?'+1??

%nother ethod of recapitalizin! ban#s is for !o.ernent and pri.ate in.estors topro.ide cash in e&chan!e for ort!a!e*related assets i$e$, 6to&ic6 or 6le!acy6assets, ipro.in! the "uality of ban# capital while reducin! uncertainty re!ardin! thefinancial position of ban#s$ U$S$ Treasury Secretary Tiothy /eithnerannounced aplan durin! 8arch 200? to purchase 6le!acy6 or 6to&ic6 assets fro ban#s$ The>ublic*>ri.ate >artnership n.estent >ro!ra in.ol.es !o.ernent loans and!uarantees to encoura!e pri.ate in.estors to pro.ide funds to purchase to&ic assetsfro ban#s$+200

3or a suary of U$S$ !o.ernent financial coitents and in.estents related tothe crisis, see @DD * funds pro.ided to U$S$ ban#s as of 9eceber 200', seeeuters*T%> 3unds$

Bai&outs a"% #ai&ures o# #i"a"cia& #irms

25
http://en.wikipedia.org/wiki/Emergency_Economic_Stabilization_Act_of_2008http://en.wikipedia.org/wiki/Emergency_Economic_Stabilization_Act_of_2008http://en.wikipedia.org/wiki/Troubled_Assets_Relief_Programhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-197http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-198http://en.wikipedia.org/wiki/Timothy_Geithnerhttp://en.wikipedia.org/wiki/Timothy_Geithnerhttp://en.wikipedia.org/w/index.php?title=Public-Private_Partnership_Investment_Program&action=edit&redlink=1http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-199http://money.cnn.com/news/specials/storysupplement/bailout_scorecard/index.htmlhttp://www.reuters.com/article/marketsNews/idUSN1752684920081216http://en.wikipedia.org/wiki/File:Bank_Common_Equity_to_Assets_Ratios_2004_-_2008.pnghttp://en.wikipedia.org/wiki/File:Bank_Common_Equity_to_Assets_Ratios_2004_-_2008.pnghttp://en.wikipedia.org/wiki/Emergency_Economic_Stabilization_Act_of_2008http://en.wikipedia.org/wiki/Emergency_Economic_Stabilization_Act_of_2008http://en.wikipedia.org/wiki/Troubled_Assets_Relief_Programhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-197http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-198http://en.wikipedia.org/wiki/Timothy_Geithnerhttp://en.wikipedia.org/w/index.php?title=Public-Private_Partnership_Investment_Program&action=edit&redlink=1http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#cite_note-199http://money.cnn.com/news/specials/storysupplement/bailout_scorecard/index.htmlhttp://www.reuters.com/article/marketsNews/idUSN1752684920081216


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%urther information: 3ist of bankrupt or acquired banks during the financial crisis of/0076/00=, %ederal takeover of %annie Mae and %reddie Mac, &overnmentintervention during the subprime mortgage crisis, and ailout

>eople "ueuin! outside a Dorthern oc# ban# branch in or C700 billion bailout$ +20?

%s a result of the financial crisis in 200', twenty fi.e U$S$ ban#s becae insol.entand were ta#en o.er by the 39@$+210%s of %u!ust 1:, 200?, an additional 77 ban#s

becae insol.ent$+211 This se.en onth tally surpasses the 40 ban#s that wereseized in all of 1??5, but is still uch saller than the nuber of failed ban#in!institutions in 1??2, 1??1, and 1??0$+212The United States has lost o.er - illion )obssince the recession be!an in 9eceber 2007$+215

The 39@ deposit insurance fund, supported by fees on insured ban#s, fell to C15billion in the first "uarter of 200?$ +21:That is the lowest total since Septeber, 1??5$+21:

%ccordin! to soe, the bailouts could be traced directly to %lan /reenspans effortsto reflate the stoc# ar#et and the econoy after the tech stoc# bust, and specificallyto a 3ebruary 25, 200: speech 8r$ /reenspan ade to the 8ort!a!e


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borrowers into ore e&otic loans with .ariable rates, or deferred interest$ +214 Thisar!uent su!!ests that 8r$ /reenspan sou!ht to enlist ban#s to e&pand lendin! anddebt to stiulate asset prices and that the 3ederal eser.e and US Treasury9epartent would bac# any losses that i!ht result$ %s early as 8arch 2007 soecoentators predicted that a bailout of the ban#s would e&ceed C1 trillion, at a tie

when


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also address an estiated 20 illion hoeowners that ay ha.e a financial incenti.eto enter .oluntary foreclosure because they are 6underwater6 i$e$, the ort!a!ebalance is lar!er than the hoe .alue$ +22'+22?

% study by the 3ederal eser.e resident


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>resident


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>aul 8c@ulley ad.ocated 6counter.cyclical regulatory policy to help modulatehuman nature6 He cited the wor# of econoist Hyan 8ins#y, who belie.edthat huan beha.ior is pro*cyclical, eanin! it aplifies the e&tent of boosand busts$ n other words, huans are oentu in.estors rather than .aluein.estors$ @ounter*cyclical policies would include increasin! capital

re"uireents durin! boo periods and reducin! the durin! busts$+2:'

U$S$ Treasury Secretary Tiothy /eithnertestified before @on!ress on Bctober 2?,200?$ His testiony included #i-e e&eme"tshe stated as critical to effecti.e reforF1 E&pand the 39@ ban# resolution echanis to include non*ban# financialinstitutions 2 Ensure that a fir is allowed to fail in an orderly way and not be6rescued6 5 Ensure ta&payers are not on the hoo# for any losses, by applyin!losses to the firs in.estors and creatin! a onetary pool funded by the lar!estfinancial institutions : %pply appropriate chec#s and balances to the 39@ and3ederal eser.e in this resolution process 4 e"uire stron!er capital and li"uiditypositions for financial firs and related re!ulatory authority$+2:?

The U$S$ Senate passed a re!ulatory refor bill in 8ay 2010, followin! the Housewhich passed a bill in 9eceber 200?$ These bills ust now be reconciled$ The DewKor# Ties has pro.ided a coparati.e suary of the features of the two bills,which address to .aryin! e&tent the principles enuerated by Secretary /eithner$ +240

La) i"-estigatio"s0 6u%icia& a"% ot$er respo"ses

Si!nificant law enforceent action and liti!ation is resultin! fro the crisis$ The U$S$3ederal


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!o.ernent, and lower ta&es$ Si!nificant financial sector re!ulatory chan!es aree&pected as a result of the crisis$+24?

3areed a#ariabelie.es that the crisis ay force %ericans and their !o.ernent toli.e within their eans$ 3urther, soe of the best inds ay be redeployed fro

financial en!ineerin! to ore .aluable business acti.ities, or to science andtechnolo!y$+2-0

o!er %ltanwrote that 6the crash of 200' has inflicted profound daa!e on +theU$S$ financial syste, its econoy, and its standin! in the world the crisis is aniportant !eopolitical setbac#$$$the crisis has coincided with historical forces thatwere already shiftin! the worlds focus away fro the United States$ B.er theediu ter, the United States will ha.e to operate fro a saller !lobal platfor **while others, especially @hina, will ha.e a chance to rise faster$6 +1'5

/E@EB Aeffrey elthas ar!ued that U$S$ trade deficits and bud!et deficits are

unsustainable$ %erica ust re!ain its copetiti.eness throu!h inno.ati.e products,trainin! of production wor#ers, and business leadership$ He ad.ocates specificnational !oals related to ener!y security or independence, specific technolo!ies,e&pansion of the anufacturin! )ob base, and net e&porter status$ +2-16The world hasbeen reset$ Dow we ust lead an a!!ressi.e %erican renewal to win in the future$6Bf critical iportance, he said, is the need to focus on technolo!y and anufacturin!$R8any bou!ht into the idea that %erica could !o fro a technolo!y*based, e&port*oriented powerhouse to a ser.ices*led, consuption*based econoy I andsoehow still e&pect to prosper, Aeff said$ RThat idea was flat wron!$+2-2

Econoist >aul Jru!anwrote in 200?F 6The prosperity of a few years a!o, such asit wasIprofits were terrific, wa!es not so uchIdepended on a hu!e bubble inhousin!, which replaced an earlier hu!e bubble in stoc#s$ %nd since the housin!bubble isnLt coin! bac#, the spendin! that sustained the econoy in the pre*crisisyears isnLt coin! bac# either$6+2-5Diall 3er!usonstated that e&cludin! the effect ofhoe e"uity e&traction, the U$S$ econoy !rew at a 1( rate durin! the


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will be to default by stealth, by lettin! their currencies depreciate$ n.estors areincreasin!ly ali.e to this dan!er$$$6+2-'

Thoas 3riedan wrote in 8ay 2010 that technolo!ical and financial inno.ationha.e ade us ore !lobally interdependent, but that ethics and .alues ha.e not #ept

up$ He supported the ideas of author 9o. Seidan, that 6sustainable .alues6 thatreflect our interdependence should replace 6situational .alues6 that optiizeoutcoes for one at the e&pense of any others$+2-?

The crisis has cast doubt on the le!acy of %lan /reenspan, the @hairan of the3ederal eser.e Syste fro 1?'- to Aanuary 200-$ Senator @hris 9oddclaiedthat /reenspan created the 6perfect stor6$+270=hen as#ed to coent on the crisis,/reenspan spo#e as followsF+155

The current credit crisis will coe to an end when the o.erhan! of in.entories ofnewly built hoes is lar!ely li"uidated, and hoe price deflation coes to an end$

That will stabilize the now*uncertain .alue of the hoe e"uity that acts as a buffer forall hoe ort!a!es, but ost iportantly for those held as collateral for residentialort!a!e*bac#ed securities$ Gery lar!e losses will, no doubt, be ta#en as aconse"uence of the crisis$


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crisis has propted in soe "uarters fears of a !lobal econoic collapsealthou!hthere are now any cautiously optiistic forecasters in addition to soe proinentsources who reain ne!ati.e$+277The financial crisis is li#ely to yield the bi!!estban#in! sha#eout since the sa.in!s*and*loan eltdown$ +27' n.estent ban# U


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the crisis in e&ceptionally stron! positions$ This !i.es the a si!nificant cushiona!ainst the !lobal downturn$ The !reatest ipact of the !lobal econoic crisis willcoe in the for of lower oil prices, which reains the sin!le ost iportantdeterinant of econoic perforance$ Steadily declinin! oil prices would force theto draw down reser.es and cut down on in.estents$ Si!nificantly lower oil prices

could cause a re.ersal of econoic perforance as has been the case in past oilshoc#s$ nitial ipact will be seen on public finances and eployent for forei!nwor#ers$+2''

O##icia& eco"omic pro6ectio"s

Bn Do.eber 5, 200', the European @oission at , by 0$1(, for the countries of the Eurozone3rance,/erany, taly, of 2*5( in 2010 an uneployentplateau in 200? and 2010 around 10( with oderation in 2011 and inflation thatreains at typical le.els around 1*2($ +2?0

1272 Europea" so-ereig" %ebt crisis

Main article: /080 European sovereign debt crisis

Bne of the lon!*ter worldwide conse"uences of the econoic brea#down is the2010 European so.erei!n debt crisis$ This crisis priarily ipacted fi.e countriesF/reece, reland, >ortu!al, taly, and Spain$ The !o.ernents of these nationshabitually run lar!e !o.ernent bud!et deficits$ Bther Eurozonecountries includeF3rance,


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lenders to stop loanin! oney to the other >/S >ortu!al, relandOtaly, /reece andSpain as well, with the result that they would also e.entually default on theirso.erei!n debt$ % so.erei!n defaultby Spain, >ortu!al, taly and /reece would resultin ban# losses so lar!e that alost e.ery ban# in Europe would becoe insol.entdue to the now uncollectible outstandin! loans to those four countries$

Bn 3riday, 8ay 7, 2010 a lon!*desired financial aid pac#a!e for /reece wasconstructed howe.er, it was ob.ious that other states, because of their e&treelylar!e debts, would ha.e * or already had * financial difficulties$ Therefore, thefollowin! Sunday a lar!e !roup of inisters of Eurozone !athered in anic of 1'57 >anic of 1?07 >redatory lendin!

Sa.in!s and loan crisis of the late1?'0s$

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Securitization Shadow ban#in! syste Subprie ort!a!e crisis solutionsdebate To&ic security

Troubled %ssets elief >ro!ra United States housin! bubble

4ndian property bubble 4rish property bubble

@apanese asset price bubble

Spanish property bubble S'edish banking rescue

United 9ingdom housing bubble

1?2? stoc# ar#et crash

200? /*20 ;ondon suit protests

200' /ree# riots

200? celandic financial crisisprotests

200? 8ay 9ay protests

200? 8oldo.a ci.il unrest

200? i!a riot

200'2010 ban# failures in theUnited States

@auses of the financial crisis of2007*2010

@risis 8ar&ian

9ot*co bubble

Europeans for 3inancial efor

Jeynesian resur!ence of 200'

;ist of ac"uired or ban#rupt ban#s inthe late 2000s financial crisis

;ist of ac"uired or ban#rupt UnitedStates ban#s in the late 2000sfinancial crisis

;ist of econoic crises

;ist of entities in.ol.ed in 2007

36
http://en.wikipedia.org/wiki/Securitizationhttp://en.wikipedia.org/wiki/Shadow_banking_systemhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis_solutions_debatehttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis_solutions_debatehttp://en.wikipedia.org/wiki/Toxic_securityhttp://en.wikipedia.org/wiki/Troubled_Assets_Relief_Programhttp://en.wikipedia.org/wiki/United_States_housing_bubblehttp://en.wikipedia.org/wiki/Indian_property_bubblehttp://en.wikipedia.org/wiki/Irish_property_bubblehttp://en.wikipedia.org/wiki/Japanese_asset_price_bubblehttp://en.wikipedia.org/wiki/Spanish_property_bubblehttp://en.wikipedia.org/wiki/Swedish_banking_rescuehttp://en.wikipedia.org/wiki/United_Kingdom_housing_bubblehttp://en.wikipedia.org/wiki/1929_stock_market_crashhttp://en.wikipedia.org/wiki/2009_G-20_London_summit_protestshttp://en.wikipedia.org/wiki/2008_Greek_riotshttp://en.wikipedia.org/wiki/2009_Icelandic_financial_crisis_protestshttp://en.wikipedia.org/wiki/2009_Icelandic_financial_crisis_protestshttp://en.wikipedia.org/wiki/2009_May_Day_protestshttp://en.wikipedia.org/wiki/2009_Moldova_civil_unresthttp://en.wikipedia.org/wiki/2009_Riga_riothttp://en.wikipedia.org/wiki/2008%E2%80%932010_bank_failures_in_the_United_Stateshttp://en.wikipedia.org/wiki/2008%E2%80%932010_bank_failures_in_the_United_Stateshttp://en.wikipedia.org/wiki/Causes_of_the_financial_crisis_of_2007-2010http://en.wikipedia.org/wiki/Causes_of_the_financial_crisis_of_2007-2010http://en.wikipedia.org/wiki/Crisis_(Marxian)http://en.wikipedia.org/wiki/Dot-com_bubblehttp://en.wikipedia.org/wiki/Europeans_for_Financial_Reformhttp://en.wikipedia.org/wiki/2008%E2%80%932009_Keynesian_resurgencehttp://en.wikipedia.org/wiki/List_of_acquired_or_bankrupt_banks_in_the_late_2000s_financial_crisishttp://en.wikipedia.org/wiki/List_of_acquired_or_bankrupt_banks_in_the_late_2000s_financial_crisishttp://en.wikipedia.org/wiki/List_of_acquired_or_bankrupt_United_States_banks_in_the_late_2000s_financial_crisishttp://en.wikipedia.org/wiki/List_of_acquired_or_bankrupt_United_States_banks_in_the_late_2000s_financial_crisishttp://en.wikipedia.org/wiki/List_of_acquired_or_bankrupt_United_States_banks_in_the_late_2000s_financial_crisishttp://en.wikipedia.org/wiki/List_of_economic_criseshttp://en.wikipedia.org/wiki/List_of_entities_involved_in_2007%E2%80%932008_financial_criseshttp://en.wikipedia.org/wiki/Securitizationhttp://en.wikipedia.org/wiki/Shadow_banking_systemhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis_solutions_debatehttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis_solutions_debatehttp://en.wikipedia.org/wiki/Toxic_securityhttp://en.wikipedia.org/wiki/Troubled_Assets_Relief_Programhttp://en.wikipedia.org/wiki/United_States_housing_bubblehttp://en.wikipedia.org/wiki/Indian_property_bubblehttp://en.wikipedia.org/wiki/Irish_property_bubblehttp://en.wikipedia.org/wiki/Japanese_asset_price_bubblehttp://en.wikipedia.org/wiki/Spanish_property_bubblehttp://en.wikipedia.org/wiki/Swedish_banking_rescuehttp://en.wikipedia.org/wiki/United_Kingdom_housing_bubblehttp://en.wikipedia.org/wiki/1929_stock_market_crashhttp://en.wikipedia.org/wiki/2009_G-20_London_summit_protestshttp://en.wikipedia.org/wiki/2008_Greek_riotshttp://en.wikipedia.org/wiki/2009_Icelandic_financial_crisis_protestshttp://en.wikipedia.org/wiki/2009_Icelandic_financial_crisis_protestshttp://en.wikipedia.org/wiki/2009_May_Day_protestshttp://en.wikipedia.org/wiki/2009_Moldova_civil_unresthttp://en.wikipedia.org/wiki/2009_Riga_riothttp://en.wikipedia.org/wiki/2008%E2%80%932010_bank_failures_in_the_United_Stateshttp://en.wikipedia.org/wiki/2008%E2%80%932010_bank_failures_in_the_United_Stateshttp://en.wikipedia.org/wiki/Causes_of_the_financial_crisis_of_2007-2010http://en.wikipedia.org/wiki/Causes_of_the_financial_crisis_of_2007-2010http://en.wikipedia.org/wiki/Crisis_(Marxian)http://en.wikipedia.org/wiki/Dot-com_bubblehttp://en.wikipedia.org/wiki/Europeans_for_Financial_Reformhttp://en.wikipedia.org/wiki/2008%E2%80%932009_Keynesian_resurgencehttp://en.wikipedia.org/wiki/List_of_acquired_or_bankrupt_banks_in_the_late_2000s_financial_crisishttp://en.wikipedia.org/wiki/List_of_acquired_or_bankrupt_banks_in_the_late_2000s_financial_crisishttp://en.wikipedia.org/wiki/List_of_acquired_or_bankrupt_United_States_banks_in_the_late_2000s_financial_crisishttp://en.wikipedia.org/wiki/List_of_acquired_or_bankrupt_United_States_banks_in_the_late_2000s_financial_crisishttp://en.wikipedia.org/wiki/List_of_acquired_or_bankrupt_United_States_banks_in_the_late_2000s_financial_crisishttp://en.wikipedia.org/wiki/List_of_economic_criseshttp://en.wikipedia.org/wiki/List_of_entities_involved_in_2007%E2%80%932008_financial_crises


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12.8 6/*20 @alls for %ction on /rowth, B.erhaul of 3inancial ules6$


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27$ 8 6ealtyTrac >ress elease 200'3K6$ ealtytrac$co$ 200?*01*14$httpFOOwww$realtytrac$coO@ontent8ana!eentOpressrelease$asp&N@hannel9X?Mte9X4-'1MaccntX-:':7$ etrie.ed 200?*02*27$

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38.W ab6The downturn in facts and fi!ures6$


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:2$ 8 >aul Golc#er 8ay 2010$ 6The Tie =e Ha.e s /rowin! Short6$ The DKT e.iewof resident 93$httpFOOwww2$standardandpoors$coOspfOpdfOinde&O@SHoe>riceYeleaseY1250-2$pdf$ etrie.ed 2010*10*05$

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74$ 8 Jirchhoff, Sue Jeen, Audy 2007*0:*24$ 68inorities hit hard by risin! costs ofsubprie loans * US%TB9%K$co6$ US* )oday$httpFOOwww$usatoday$coOoneyOeconoyOhousin!O2007*0:*24*subprie*inorities*

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121$ 8 Husoc#, Howard Aanuary 01, 2000$ 6The Trillion*9ollar


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17?$ 8 6The tradin! frenzy that sent prices soarin!6$Ae' Statesman$httpFOOwww$newstatesan$coOworld*affairsO200'O0:Ohaiti*food*price*coodities$etrie.ed 200'*0:*2'$

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foridable econoic and fiscal challen!es$

URT(ER READING

3en!bo han! 200'F 1$ >erspecti.e on the United States Sub*prie8ort!a!e @risis, 2$%ccurately 3orecastin! Trends of the 3inancial @risis, 5$Stop %r!uin! about Socialis .ersus @apitalis$

%rchaya and ichardson$ %inancial Stability: #o' to +epair a %ailed SystemDKU Stern >ro)ect*E&ecuti.e Suaries of 1' @risis*elated >apers

@oittee for a esponsible 3ederal


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Ely, olicy@auses of the U$S$ 3inancial @risis, "ato @ournal2?1$

/old, /erry, and 3eldan, >aul 2007* #ouse of "ards . %rom fantasyfinance to global crash$ ;ondon, ;upus


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3inancial Ties * n depthF Subprie fall*out

The @risis of @redit Gisualized * nfo!raphic by Aonathan Aar.is

The Econoic @risisF ts Bri!ins and the =ay 3orward Gideo of lecture !i.enby 8arshall @arter, chairan of the Dew Kor# Stoc# E&chan!e, at

2007-2010 financial crisis

Documents