Econ 102 2014 Worst recession in 80 years How did it happen How was the situation before the crisis Great Moderation Stable growth and low inflation Worst recession in 80 years How did it happen ID: 386798
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Slide1
Financial Crisis of 2008
Econ 102 2014Slide2
Worst recession in 80 years
How did it happen?
How was the situation before the crisis?
‘
Great Moderation’
Stable growth and low inflationSlide3
Worst recession in 80 years
How did it happen?
How was the situation before the crisis?
‘
Great Moderation’
Stable growth and low inflation
Too much saving in Asia,
very low global interest ratesSlide4
Low interest rates
Borrowing
,
Households, businesses, Banks! Purchase Household bought houses, (mortgage) Banks bought ‘securities’ (bond like assets)Slide5
Households
Borrowed from banks for long term, which is called
‘Mortgage’
.
Banks wants some guarantee,
‘collateral’
HH used their houses as collateral,Slide6
House prices were rising
All over in the US.
Hence banks do not hesitated.
They started lending to parties with
‘poor credit histories’, ‘sub prime borrowers’
Slide7
Why did not just hurt the banks which gave the initial loans?
Financial innovations:
Repackage the mortgages, How?
Pool different mortgages, mix them and call it a
new asset
.
Eg
. (10% high income mortgage+30% middle income mortgage+60% low income mortgage) ‘mortgage backed securities’Slide8
Continued to repackage...
Mix them even more and call them...
Eg
. (10% Boston mortgage+30% DC mortgage+60% Texas mortgage)
‘Collateralized Debt Obligations’ : CDOSlide9
Continued to repackage...
Mix them even more and call them...
Eg
. (10% Boston mortgage+30% DC mortgage+60% Texas mortgage)
‘Collateralized Debt Obligations’ : CDO
Ask credit rating agencies to value these
Moody’s or Standard & Poors
triple A (AAA)Slide10
Who purchased these?
All Investors....
in US,
in Europe,
in Asia and in the whole world. To make return higher than the market interest ratesSlide11
Next ....
House prices in the US started declining.
the households can not pay back their debt,
value of the collateral declined,
‘mortgage backed securities’ became worthless Banks lost their assets..., they started selling assets, ‘fire-sales prices’ Slide12
Next ....
House prices in the US started declining.
the households can not pay back their debt,
value of the collateral declined,
‘mortgage backed securities’ became worthless Banks lost their assets..., they started selling assets, Mortgage backed securities, CDO became worthless Slide13
Complete loss of assets
Banks can not find new lenders to pay back their debt.
Banks worth decline,
because of ‘mark-to-market accounting’.Slide14
First Casualty
Northern Rock – British Mortgage lender
(late 2007)
Slide15
Another financial innovation and another casualty...
‘Credit Default Swaps’-
insurance to compensate the buyer of a loan if the 3
rd
party does not pay.
AIG- Insurance company got into trouble.
FED come to rescue with a $ 85 billion help. Slide16
Another real casualty
Lehman Brother went bankrupt.
FED did not rescue them.
Why?
BIG PANIC-
Slide17
Another real casualty
Lehman Brother went bankrupt.
FED did not rescue them.
Why?
BIG PANIC-
No one is lending, no one is borrowing...Slide18
PANIC and financial markets almost stopped working.
Consumption dropped,
Investment dropped,
Exports drastically dropped,
What happened to Aggregate Demand?
GREAT RECESSIONSlide19
What can the policy makers do?
Fiscal Policy,
Monetary Policy, Slide20
What can the policy makers do?
Fiscal Policy,
Monetary Policy, This was challenging because the interest rates were very low,
With expansionary monetary policy they hot zero....
Liquidity trapSlide21
Creative monetary policy
How to increase spending and investment?
Inject money into the system through banks...
How ? Slide22
Creative monetary policy
How to increase spending and investment?
Inject money into the system through banks...
How ?
But their worthless ‘toxic assets’,
reserves increase loans increase,
‘Quantitative Easing’Slide23
US Money growth rateSlide24
Nonconventional monetary policy
FED was buying $85 billion worth of assets each month.
‘Tapered off’...
dropped to
$65 billion worth of assets each month.
Bernanke mentioned in June 2013, then changed his decision in September 2013. $4.1 trillion of QE bond buys,Slide25
Quantitative Easing
Now it is $ 55 billion purchases each month.
Will stop some time in late 2014 or early 2015,
and promised that they will not raise the interest rates until 2015. Slide26
How do they decide?
Unemployment rate: Slide27
GDP growth rate in the US