U.S Financial Crisis 2007-2009 Present by Huan He Prepared for Dr. Ramon Castillo Econ 462 CALIFORNIA STATE UNIVERSITY, LOS ANGELES Spring 2011 Eric Le Grace Peng U.S Crisis 2007-2009 • Referred as a Financial and Real Estate Crisis Stock prices decreased Prestigious financial institutions failed Lending was disrupted Unemployment rose to near 10% U.S Crisis 2007-2009 (cont.) • Governments, central banks, and international organizations implemented various plans to combat the crisis. Fiscal expansion Monetary expansion Institutional bailouts Causes of the Crisis • Growth of the housing bubble • Easy credit conditions • Subprime lending • Deregulation and lax regulation • Collapse of the shadow banking system Growth of the housing bubble During the housing bubble, the growth of home prices outpaced income growth. The price of the house increased 124% in 2006 . At the peak of the bubble in 2006, the home price was 4.6 times the median household income. After the peak in 2006, housing prices declined over 20% by the end of 2008 Growth of the housing bubble (Cont.) • The U.S. residential properties subject to foreclosure actions from 2007 to 2010. Easy credit conditions • Low interest rates made credit more accessible, enable consumers to increase borrowing • Less manageable loans coupled with the inverse relationship between interest rates and asset prices made speculation in the housing market more risky Subprime Lending A greater risk of default than conventional loans. In March 2007, 7.5 million first-lien subprime mortgage loans were outstanding $1.3 trillion. High risk subprime lending increased due to government policies and competition among financial institutions 2008: The poorer loan screening increased to 25% in subprime defaults Insufficient Regulation and Deregulation Regulation did not keep pace with financial innovations The central bank had not federal supervision over: Investment banks Hedge funds Other firms involved in derivatives or complex financial products. About half of the subprime loans were written by statechartered mortgage companies with minimum supervision. Impact on the Aggregate Economy Crisis began with: Assets price declined and Financial institution collapse Crisis reduced aggregate demand causing economic activity investment >>>Aggregate economy decreased Impact on the Aggregate Economy (Cont.) 2008 -2009: Real GDP decreased 6 % Average hours per workweek declined to 33% The Collapses of Major Bank & Investment Bank Jan 2008 – Countrywide Financial Institution March 2008 – Bear Stearns Sept 2008 – Lehman Brother Sept 2008 – Merrill Lynch Sept 2008 – Washington Mutual Dec 2008 – Fannie Mae & Freddie Mac US Unemployment Rate US Unemployment Rate 1) Total Unemployment Rate – 4.6 in 2006 increase to 9.6 in 2010 2) Major sector: Financial Sector – 2.7 in 2006 to 6.9 in 2010 Construction Sector – 6.7 in 2006 to 20.6 2010 Manufacturing Sector – 4.3 in 2007 to 10.6 2010 GDP (Purchasing Power Parity) Response of Policy Makers 1) “Too big to fail” Limit the size of institutions to prevent them from becoming TBTF Firms that arrange risky transactions must take on some of the risk. Reduce incentive for executives to take risky gambles in hopes of high short-run gain. 2) Financial regulation Inconsistencies and gaps in regulation contributed to the 2007-2009 financial crisis Consolidate regulators of add an agency that oversees and coordinates regulators Monetary Policy 1) Federal Reserve System Repair commercial paper market – Buying back unsecured and asset-backed commercial paper directly from issuers. Restore securitizations Reduce mortgage interest rates – Reduced of Interest rate 6.41 (2006) to 4.69 (2007) Federal Fund Rate – Reduced of Fed funds from 5.02% to near 0.18% Fix Rate Mortgage Rate Federal Fund Rates Fiscal Policies 1) Economic Stimulus Act of 2008 Government spent about $152 billion on the stimulus package. Tax rebates – gear toward low & middle-income Tax incentives for businesses. 2) Emergency Economic Stabilization Act of 2008 Mortgage-backed securities Fiscal Policy (Cont.) 3) Troubled Asset Relief Program (TARP) AIG – Sept 2008 they received about $85 billion; May 2009 they received another $97 billion. Big Four Banks: Citigroup – received $45 Billion in bailout money Bank of American – Guarantee $118 billion of the bailout money, but used only $45 billion JP Morgan Chase – Received $25 billion in bailout money Wells Fargo - Received $25 billion in bailout money Outcome of monetary and fiscal policies • Outcome from “too big to fail policy” • Taxpayer subsidy • Cost of funds for small and large institutions before and during the bailout • Cost-of-funds spread between small & large banks increased to 0.69% Economic Stimulus Packages Fisical Stimulus package – by borrowing and spending to offset the reduction in private sector demand caused by the crisis. In 2008 and 2009, the U.S. excuted total of $1 trillion. Recovering from the Crisis & international institution Intervention • Global Implications: The stimulus reduced the risk of a sharper Reduced more sustained global downturn. FRS – interest rate cuts make money cheaper. State and local revenue recovering tax receipts up 5% on the annual basis Thank You!