Our recession

How did we get here ?

Part of the problem was your beautiful house

Housing prices

• The price of homes had been rising steadily throughout the 1990s (from 1997 to 2006 the price of the typical American home rose 124%)

• More and more new homes were being built creating jobs, even during a small recession in 2000-2001

• 1.7 million new homes were built in 2005– 622,000 in 2008

Government policy helps

• The government either encouraged (or at least didn’t discourage) banks from lending money because it wanted to increase the # of Americans who owned their own homes (64% in 1994 to 69% in 2004)

• The government also liked the jobs being created

• Government kept interest rates low

• Foreign investment flowed in

Subprime loans

• People who traditionally couldn’t buy homes (not enough income, not enough savings, bad credit) began to buy homes

• People began to buy second and third homes as investments

• Not all of those people were considered a good risk – banks gave them loans at higher interest rates or with Adjustable Rate Mortgages– these loans were called subprime loans

Why would banks make these loans?

• The higher interest rates were more profitable

• If the investors defaulted and the bank foreclosed on the home, the house’s value had likely risen in the meantime (because housing values kept rising) and so the bank could cover its investment

Why would people take loans they couldn’t afford?

• Some people apparently took loans they didn’t understand

• Some banks allegedly lied to borrowers about the cost of the loan

• Most people assumed that since the value of their home would keep rising, they could still sell the house for a profit if they couldn’t keep up with the mortgage

And then the stock market got into the act

• Investors in the stock market became interested in the profits that the banks were making

• Investment banks began to “bundle” together mortgages and sell them as securities (just like stocks) so investors could buy a portion of a bunch of mortgages – these were called mortgage-backed securities

• These securities tripled in sales from 1997 to 2007, reaching $7,3 trillion

And insurance companies got into the act

• Some investors were concerned about how safe these mortgage-backed securities were

• So insurance companies and investment banks offered “credit default swaps” that promised investors that if these “bundled” mortgages went bad, their investment would be insured

What’s a credit-default swap?

• They were new and a lot of people didn’t understand them

• They were new and unregulated so the government wasn’t keeping an eye on them

• Because they were unregulated, the companies selling the swaps were not required to have the money on hand in case the mortgages actually went into default

• By 2008 there were up to $47 trillion in Credit Default Swaps (the gdp that year was $14 trillion), a 100 fold increase in 10 years

So at this point

• Home buyers, banks, investment banks, and insurance companies had all bet that home prices would keep rising – forever

So when prices fell

• Homeowners found themselves with mortgages worth more than the homes that bought them

• Housing prices dropped 20% from their 2006 peak

Foreclosures

• Banks began to see millions of foreclosures, flooding the housing market with homes and causing banks to fail

• In 2007, the number of homes in foreclsoure jumps 97%, with 1% of all homes at some point in the process – by 2009 some states were at 17% (Oregon is at 5.5%)

• ARMs make up 48% of mortgage defaults ( but make up 7% of the mortgage market)

And then

• The mortgage-backed securities began to plummet in value and investors turned to the companies who sold them the “credit default swaps”

• Those companies had nowhere near the money to cover what they had promised and they begin to go out of business

• By early November 2008, the S&P 500, was down 45 percent from its 2007 high.

The economy freezes

• Banks stop loaning money because they’re not sure how much assets they have and how much they have lost from bad mortgage loans

• Massive investment bank Lehman Brothers collapses in a few weeks

• People lose their homes• Builders stop building• People stop spending as much• Between June 2007 and November 2008, Americans

lost more than a quarter of their net worth.

The Government responds

• The government buys millions in bank and insurance company stocks, becoming the controlling owner AIG ($70 billion), CitiGroup ($25 billion) and Bank of America ($27.5 billion) much of the money pumped into the companies is paid out to other companies for credit-default swaps

• About $40 billion spent to cover deposits to smaller banks that failed

• The government begins to spend $1.2 trillion to create jobs to spark consumption

• The government begins to give tax credits to buy homes ($8,500) and cars ($4,500)

Right now

• Congress is considering reforms regarding subprime loans, mortgage-backed securities, and credit-default swaps

• The government has lowered interest rates to near zero• Unemployment is still high (as of September 2009

national: 10.2% Oregon 11.5%)• But the Stock market is recovering: NYSE at 7,119 in

November 2009 from 10, 311 in 2007 (low of 4,658 in November 2008)