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Causes of the Financial Crisis (PREP: Open NPR clip here and load at beginning of lecture) (PREP: Open WSJ video clips “End of Wall Street” series) Main Causes of the Crisis: Risky Home Mortgages Consumer Debt Financial Industry – Risky Investments Failure of Regulation Failure of Ratings Agencies Risky Home Mortgages What is a mortgage? Downpayments – 20% down vs. less down + mortgage insurance Types of Mortgages – Fixed rate vs. variable and step mortgages Encouraging Homeownership vs. Risky Subprime Loans – Clinton and Bush – Fannie Mae and Freddie Mac – Subprime Frenzy – Predatory Lending Knowingly lending more than borrower could repay Unreasonably high interest rates Real Estate Bubble Question: Who is to Blame? (see article) Financial Industry – Risky Investments Mortgages Bundled into Derivatives (Collateralized Debt Obligations) – Mortgages Resold many times – Hard to know what the investment includes Credit Default Swaps Unregulated – What is a credit default swap? (NPR clip 15:00 to 17:00) – Gambling on Risk? – AIG Example – didn’t diversify; didn’t have reserves to cover costs (NPR clip on derivatives 31:35 to 33:40) Exported our debt global crisis Why was this allowed? – Pressure for ever-more profits for shareholders – Lobbying? Campaign Donations? Question: Who is to Blame? (see article) Failure of Regulation Fannie Mae and Freddie Mac CONGRESS: 1999 – Financial Services “Modernization” Act – Gramm-Leach-Bliley Act – Repealed part of Glass-Steagall Act of 1933 – Tore down firewalls b/w banks, securities companies, insurance companies Result? No coincidence that in 1 month we saw… – Failure of largest insurance company in world (AIG insurance) – Largest bank failure in US history (Washington Mutual savings & loan) – Largest bankruptcy in American history (Lehman Brothers investment bank) – Failure of Fannie Mae and Freddie Mac (together owned/guaranteed roughly half of all mortgages in U.S.) Senator Phil Gramm (TX) Failure of Regulation 2000 Commodity Futures “Modernization” Act – Phil Gramm – Slipped into bill at 11th hour in December – Exempted derivatives like credit default swaps from regulation (lNPR clips 10:00 to 12:40 and 18:30 to 20:30) Executive Branch: Mortgages Federal Reserve Securities and Exchange Commission Alan Greenspan, former Chairman of Federal Reserve Failure of Ratings Agencies Conflict of Interest – Ratings agencies are paid by the companies they are rating (not by consumers) – Scrutiny of investments is biased – NPR audio clip (3:40 to 6:30) Consumer Debt Why has consumer debt increased so much? Material culture Cost of Living vs. Stagnating Wages Taxes What kept economy going? – Moving from 1 2 earner families – Increasing consumer debt – credit cards – Housing and stock bubbles mortgages and home equity loans Homeowners taking out loans on homes until stripped of equity (predatory lending by some banks) How Long can an economy be stable when too much wealth is concentrated in too few hands? Who will be the consumers? – Income and wealth Distribution Future Discussions What role did the Media Play? How Could Congress Allow this to Happen? To Bail or not to Bail? How to fix the Financial Crisis A Call to All Americans DISCUSSION QUESTION: What policies would you put in place to prevent such a crisis from happening again?