Upload
kamron-winn
View
218
Download
1
Tags:
Embed Size (px)
Citation preview
The Current Credit Crisis
By Dr. Paul Lockard
Professor
Black Hawk College
Brief Summary
• NOT THE FAULT OF THE GOVERNMENT FORCING BANKS TO LEND TO MINORITIES!!!!!!.
Brief Summary:Factors Causing Crises
• Bank deregulation
• Adjustable rate mortgages
• Transformation of lending industry
• Exploding housing prices
• No market checks
• Creation of incredible financial devices
BackgroundOld Style Home Mortgages
Background: Old Style Mortgages
• Traditionally, from the 1930’s to the 1980’s, banks lent money for mortgages in a simple fashion.
• Home mortgage loans were for a fixed time and a fixed rate: 15 to 30 years.
Background: Old Style Mortgages
• A fixed rate mortgage meant that the interest rate was fixed, and therefore, so were the monthly payments.
• Predictable mortgage payments meant predictable revenue for the bank.
Background: Old Style Mortgages
• Predictable mortgage payments meant predictable payments for the homeowner.
• But it was all a bit boring for bankers…
Background: Old Style Mortgages
• Banks and Savings & Loans were careful about who they lent to, since they kept the mortgages themselves.
• Local banks – local lending – more care in lending, and more interest in helping homeowners.
Financial Deregulation
1980’s: Saving and Loan Crisis
• As a result of 1970’s inflation, banks were losing money on most older mortgages.
• In addition, state laws banned usury: excessively high interest rates.
Solution to the Saving and Loan Crisis
• In 1980 and then in 1982, the Savings & Loan industry, and the other banking industries, were deregulated.
• Republicans overwhelmingly in favor, and had large majority of Democrats with them.
Result of Bank Deregulation
• With no legal limit on home mortgage interest rates, mortgage interest rates jumped, up to 15% in a few cases.
• Also, banks could now offer different types of mortgages.
Result of Bank Deregulation:Adjustable Rate Mortgages
• The main type of home mortgage since then is the Adjustable Rate Mortgage (ARM)
• Usually begins with low interest rates, and then the bank is free to raise or lower the interest rate as it sees fit.
Result of Bank Deregulation
• Changing interest rates meant changing monthly mortgage payments: hard for consumers to budget!
• Later, to help homeowners, laws put in place to slow down how fast rates could rise.
1999 Gramm-McCain Bill
• Later, the last remains of Federal regulation were eliminated.
• This was with the support of President Clinton, the Republicans, and plenty of Democrats.
Results:1999 Gramm-McCain Bill
• Banks freed to create all sorts of types of mortgages, and to create all sorts of financial “instruments”.
Transformation of Financial Industries
New Lending Industries
• There was also a tremendous change in home mortgage business, beginning in the late 1980’s, and through the 1990’s.
Old Style to New Style
• The mortgage process was completely taken apart and rebuilt into many different stages, with more companies at each stage.
• Everyone was making a profit up front, and passing the borrower to someone else.
New Style
• Banks no longer generated home mortgages, and no longer kept them.
• They made their money upfront in application fees, and then sold the mortgage down the river to someone else.
New Style
• As long as your business made a profit, you didn’t care at all about the borrower, or whether they could really afford a loan.
New Financial Instruments
• The new technique was (and is) to combine a large number of similar loans (similar in dollar amount, interest rate etc.) into a packet.
• Then you sell the packet to someone else.
• And they sell it to someone else…
New Style
• So your home mortgage could be anywhere in the world.
Get the Government off our Backs!
• Normally, there are a number of credit rating agencies, that are supposed to rate banks, bank loans etc., very carefully.
Get the Government off our Backs!
• In the 1990’s they quit doing their job: everything a bank or a mortgage company did became prime (= top quality).
Get the Government off ourBacks!
• It became a wide open frontier, and all of the normal business checks and balances were thrown out the window, by businesses.
Housing Market
Meanwhile, back at the ranch…
Housing Market
• House prices normally increase at about the rate of inflation.
• But from 1995 to 2007, house prices nation- wide increased 70% more than inflation,
• On average, that is – some places were even worse.
Housing Market
• With the surge in housing prices from the 1990’s on, people became more desperate for a loan to be able to buy a house.
• E.g. $950,000 for a two bedroom ranch in parts of California.
Housing Market
• Lenders came up with ever more creative loans.
• They usually were ARMs of some sort, and the interest rates were set to automatically increase after a couple of years, or even 6 months.
Housing Market
• They also started to go after people that they knew should not borrow money for a house: the sub-prime market.
Housing Market
• Housing prices reached insane levels in many parts of the country.
• In economics, what goes up must come down!!!!
Housing Market
Not good news…
Housing Problems: Double Whammy
• First: Prices started to drop.
• And once they start dropping, they don’t go into reverse for awhile.
Housing Problems
• Once prices started to drop, they dropped almost as fast as they went up.
• Now many people find they have reverse mortgages: a mortgage worth more than the house.
Housing Problems:Double Whammy
• Second: All of those new ARMs started to increase their interest rates, which meant that suddenly, large numbers of mortgage rates jumped.
Housing Problems: Double Whammy
• Very quickly, starting with the subprime loans, large numbers of people found that their monthly mortgage payments were jumping.
• It wasn’t long before increasing numbers of people couldn’t afford the monthly payments.
Housing Problems
• Between rising interest rates, falling house prices and rising difficulties with job market:
• Large number of people defaulted on sub-prime loans.
Housing Problems
• And now in 2008 the problem as moved up through the line to all types of loans, including prime and commercial loans.
Housing Problems
• Suddenly, around the world, lots of US home loans are “non-performing”.
• Lenders around the world have bad loans from US banks, and are losing enormous sums of money.
Banking Crises
Not good news…
Global Financial Crises
• Banks and investors around the world have always trusted the US financial system:
• If Lehman Brothers is selling the product, its American – its safe and it must be good.
Global Financial Crises
• So banks and investors around the world purchased large quantities of home mortgages and other financial instruments from US banks.
Global Financial Crises
• So when the sub-prime crises hit, all of a sudden banks and investors around the world found that their investment bundles contained “toxic waste”.
• Now many of these investment bundles are losing money.
Global Financial Crises
• All of a sudden banks and investors around the world found that they are losing unbelievable sums of money.
• Everyone panicked, and are currently lending as little as they can.
Global Financial Crises
• Global, and local, banking systems are built on trust: if BlackHawk Bank buys something from Kewanee Bank, there is a trust that it isn’t a rattlesnake. (Of course they do their homework).
• Now a lot of that trust has evaporated.
Global Financial Crises
• We have a vicious cycle in place: falling housing prices leads to more falling prices,
• Which leads to more bank losses,
• Which leads to banks not lending to each other or extending credit
Global Financial Crises
• Which leads to financial companies that need help are cut off from other financial lenders,
• Which leads to more failures,
• Which leads to more pullbacks and lack of trust
Main Street Woes
• Meanwhile, a recession has been triggered by high gasoline prices
• Which leads to a fall in consumption
• Which leads to layoffs
• Which leads to more defaults on loans
Brief Summary, Again
• NOT THE FAULT OF THE GOVERNMENT FORCING BANKS TO LEND TO MINORITIES!!!!!!.
Analysis
Community Reinvestment Act
• Many conservatives, and the banks, blame the government for forcing them to lend to unqualified minorities.
• This is blamed on Community Reinvestment Act of 1977.
Logic Question
• Logic question:
• Please explain how a law passed in 1977 could cause the problems of 2007?
Logic Question
• Logic question:
• The financial industries lobbied for deregulation (= no government supervision) and won.
• So how is it the fault of government?
Logic Question
• Logic question:
• The financial industries restructured themselves in the 1990’s.
• How is it the fault of the government?
Logic Question
• Logic question:
• The financial industries had high profit margins through the creation of financial instruments that no one can understand.
• How is it the fault of the government?
Current Situation
• Due to the deregulation of financial industries, the failure of credit rating industry, and easy money we now have a major bank crises.