Download Causes of the Financial Crisis

FED CHALLENGE:
THE CAUSES OF THE
FINANCIAL CRISIS
2011 Kickoff
HOUSING TROUBLES
•Housing bubble: - Price doubled between 2000 and 2006
•Home equity loans:- Home as ATM
•Opinion that prices would always go up:-Home as an
investment, vacancy ratio
•Poor lending standards:- Liars loans, bonus structure,
insurance
Vacancy Ratio: 1.4 to 1.8%
PRICE OF HOMES(2000- PRESENT
U.S. LAWN
FINANCIAL SYSTEM
•Extremely complex system of pipes.
•Lag times
•Interdependent flows, dependencies.
•Not even sure where the water will come out
FINANCIAL PROBLEMS
•Mortgage backed securities (MBS’s)
•Dilution of low quality mortgages
•Insurance against uninsurable
situation
•Even greater complexity of pipes
•Backup water supply doesn’t have
enough capacity to function in an
emergency
THE EMERGENCY…
•Home prices stopped rising in the
beginning of 2006
•People who were depending on
continually rising prices, like those with
large home equity loans, were no longer
able to keep up with their payments.
•Rapidly declining home prices began to
affect financial assets, equity values fell,
and concerns grew over the complexity
and sustainability of financial assets.
•Liquidity freeze, unpricable assets, crisis
in insurance policies
•The pipes freeze
•Although plenty of water is
available, we cannot figure out how
to release it
•The lawn begins to dry up
THE FED COMES ALONG…
FED SOLUTION
•Inject liquidity. Lower Fed Funds,
TAF
•Put more water into the system
EXCESS RESERVES
FED SOLUTION
•TSLF/PDCF
•Interest on reserves
•Increase confidence
•Build more pipes to target the
frozen areas
•Drop water from a helicopter
•Add antifreeze
END OF PRESENTATION