Speculative Bubbles 1996 - 2000 2002 - 2007 Holland 1634 - 1637 1925-29

The Housing Market Crisis What Happened?

“The Economist” Magazine Covers During the Economic Crisis

The Housing Market Crisis What Happened?

Buying a house (before 2000): PRIME MORTGAGES ONLY!!! Consumers were required to put a 20% down payment For a $500,000 home: $100,000 down payment & borrow $400,000 (mortgage) loan is paid back over 30-years at a fixed interest rate (ex: 6%/year) The loan is less than the value of the house So banks are taking very little/no risk of default

New Sub-prime Mortgages Sub-prime mortgages were introduced in the year 2000 These mortgages required no down payment to borrowers with poor credit history Mortgages often had low initial interest rates which adjusted up later Known as ARMs (Adjustable Rate Mortgage) or variable rate loans Example: 2% interest rate/year for the first 3 years; after that the interest rate changes to 9%/year Personal example

Housing Bubble Analysis Subprime Mortgage Example Price Paid: $1,000,000 Down Payment: 0 You owe: $1,000,000 Major Problem! Initial Value of House $1,000,000 Housing Bubble Bursts: New Value of House: $900,000 Homeowner now owes 1 million but only has a house worth $900,000. Now he can’t refinance his loan and his house payments skyrocket when the loan resets. If he can’t pay his monthly mortgage, the Bank will foreclose on his house! Huge incentive to just walk away from the house.

Subprime Mortgage Analysis The Binge Banks made loans to consumers who were not qualified with zero down payments In the short run, this caused home prices to rise In the long run, this led to “inflated” home prices & people unable to pay their mortgage The Hangover: home prices fell substantially consumers lost their homes to foreclosure banks failed (as they took the losses on foreclosures)

House of Cards Led to Caused by Credit Bubble