economic bubbles how the housing market led to the great recession
TRANSCRIPT
Economic BubblesHow the housing market led to the Great Recession
Econnomic Bubbles
USA 2002 - 2007Holland 1634 - 16371996 - 2000
https://www.youtube.com/watch?v=I5ZR0jMlxX0
Economic Bubbles (speculative bubbles) are when the price of an asset (stock, bonds, or even tulips!) strongly differs from the true economic value of an asset
Economic bubbles have happened throughout history and reflect both “greed” and “fear” in human nature.
Buying a $500,000 home
A $400,000 loan at a 4% fixed rate mortgage cost $1,908 per month over 30-years•fixed rate loan paying back all principal & interest over 30 years
With property taxes, full Payment is $2,408 per month •Property Taxes in California = $500 per month on $500,000 home •Both interest & property taxes are tax deductible (lower your income tax)
Assume you buy a $500,000 house in Marin CountyYou put up a $100,000 down payment (20%)
Loan Balance
Total interest paid
Total principal paid
Buying a house (Before 2000)
• Consumers were required to put a 20% down payment
• For a $500,000 home: – $100,000 down payment & borrow $400,000 (mortgage)– loan is paid back over 30-years at a Fixed interest rate– (This meant the monthly payment stayed the same for 30-years)
• The loan was always less than the value of the house– So banks are taking very little/no risk of default– Consumers would not “walk away”
New Subprime Mortgages
• Subprime mortgages were introduced in the year 2000– Required no down payment
– Borrowers had poor credit history
– Had very low initial interest rates
– Interest rates eventually adjusted upward• Called Adjustable Rate Mortgages
• led to rapidly rising monthly payments in the future
Housing Bubble Analysis
Subprime Mortgage Example• Price Paid: $1,000,000• Down Payment: 0
• You owe: $1,000,000
Initial Value of House $1,000,000
New Value: $700,000
Homeowner still owes 1 million but owns a house worth only $700,000If they can’t pay their monthly mortgage, the Bank will foreclose on their house!
Major Problem!
End Result of Subprime Mortgages
• In the short run they caused home prices to rise
• In the long run left people unable to pay their mortgage– consumers lost their homes to foreclosure
• Housing Bubble reached the peak in 2006 – home prices declined 30%-50% from the peak in 2006
– Banks had to be “bailed out” by the U.S. Government• Banks had huge losses on foreclosed homes & subprime mortgages
Home Loans Bring Losses To Bank of America
January 21, 2011 Bank of America on Fridayreported a loss of $1.6 billion in the 4th quarter after its costs related to soured home loans increased.
http://www.cbsnews.com/stories/2008/01/25/60minutes/main3752515.shtml
House of Cards60 minutes video link
Economist
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Inside JobWant to learn
more about the financial crisis?
Good documentary on housing/banking crisis
Housing Bubble Analysis
Caused by
Credit Bubble
Too easy to get loans
Loans turned intoMortgage Backed Securities
Banks Makes Home Loans
Banks sell Loans to Wall Street
Wall Street turnsthem into securities
Securities became worthless and Banks went Bankrupt
FNMA & FHLMC
Government takeover
AIG Insurance Company
Government Takeover
Wall Street Firms Bankrupt or Bought
Bear StearnsMerrill LynchLehman Brothers
Government Takeover of Subprime Mortgages
Interest Rate Worksheet1) You never pay of the credit card bill! $5,000 X 20% = $1,000 per year in interest
2) $11,000 $10,000 = principal (loan) + $1,000 in interest
3) $10,200 +$200 in interest (but prices of goods rose => are you better off?)
4) Borrowers = LOW Savers = High 5) Borrowers love the Fed
6) a) @ 4% = $477 X 4 = $1,908 per month for 30-years (fixed rate loan paying back all principal & interest in 30 years)
b) @ 8% = $734 X 4 = $2,936 per month for 30-years
7) $500,000 X 1.2% = $6,000 per year in taxes or $500 per month
Full Payment for $500,000 home is $2,408 per month at 4.0% loan