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Monetary Policy: Contemporary Issues ECO 473 - Dr. Dennis Foster W.A. Franke College of Business Financial Crises • Asset price crash The end of a bubble. Subprime housing market. Prime loans with ARMs. • Financial institution insolvency Due to rising loan defaults. Can be banks or others. • Liquidity crisis Runs on otherwise solvent banks. Deterred by FDIC insurance. • Rolled into the Recession of 2008/2009. Anatomy of Financial Crisis What does the Fed Want? • A healthy & strong economy with low unemployment and low inflation. • Policy? Stimulate spending by reducing interest rates. • Why? They are Keynesians. • Effect? Creates housing boom. Federal Funds rate of interest, 1995 to 2004 30 year mortgage rate, 1995 to 2004 Median home prices, 1999 to 2006 Home sales, 1999 to 2006 Sept. 2005 The Bear Stearns Story • $133.20 - 52 week high prior to collapse. • 2007 - Lost billions in collapsing subprime market; slowly recovering. • March 2008 - Assets/equity = 35 Lots of assets in MBS. • Spring 2008 - Clients pulling out funds. • 3/10/08 - Turned down for $2 b. loan $400 b. Assets Continued loss of confidence in Bear all week. • 3/13/08 – Cash from $10 b. to $2 b. The Bear Stearns Story • Tried to get LOC w/JPM for $25 b. • 3/14/08 – Fed lends $13 b. for 3 days. • JP Morgan deal - $2 per share! • Fed creates Maiden Lane LLC – Fed loans ML $30 b. – JPM “sells” bad assets to ML. • 3/24/08 - New stock deal - $10/share. • Cost to the Fed? • Was Bear TBTF? Yes! – What about Lehman? The Three Failures: IndyMac WaMu Lehman • IndyMac $32 b. Assets – Spun off from Countrywide. – Not a “mac” – Overleveraged on “Alt A” loans. • WaMu $300 b. Assets $640 b. Assets – Shut down 100’s of offices 2007-08. – Sub-prime victim. – Final 10 days lost $17 b. in cash w/d • Lehman Brothers – Losses = $7 b. in Q2 & Q3 – Final day: $1 b. in cash Stock prices collapse Did the Fed see this coming? Did the Fed see this coming? What did the Fed do? • Cut interest rates. • Lend to everyone. • Quantitative Easing. Federal Funds rate of interest, 2004 to 2014 Fed Lending Programs: 2008-2010 Term Auction Credit Primary Dealer Credit Commercial Paper MMMF Asset-backed Securities The Quantitative Easing Programs +644% +162% +44% The Fed charts new territory. $4 tr. $2.7 tr. Monetary Base $2.5 tr. US T XS R $1.7 tr. MBS Housing Revisited 30 year mortgage rate, 2004 to 2014 Housing Revisited Median home prices, 1999 to 2014 Housing Revisited Home sales, 1999 to 2014 The Problem with Policy • The FED will have two choices: • Continue policy hyperinflation • Halt policy recession • Or . . . Wage/Price controls? Monetary Policy: Contemporary Issues ECO 473 - Dr. Dennis Foster W.A. Franke College of Business