The Economy in Crisis Eco 352 Fall 2017

Could it Happen Again. Source: https://www. bloomberg

S&P

NBER Business Cycle Data http://www.nber.org/cycles/cyclesmain.html

Some Economic Indicators

Employment

Unemployment Broadly Defined

Long-term Unemployed

Employment Rate

Inflation Source: Central Bankers Spurn Call for Radical Approach at Jackson Hole. http://www.bloomberg.com/news/articles/2016-08-28/central-bankers-spurn-call-for-radical-approach-at-jackson-hole

Weak Recovery

Inequality and Weak Recovery Rising Inequality Is Holding Back the U.S. Economy http://www.newsweek.com/rising-inequality-holding-back-us-economy-354777

Case-Shiller U.S. Home Price Index, 1890-2016 (January 2000 = 100)

Case-Shiller 10-City Composite Home Price Index

Real Mortgage Rates 30-year conventional mortgage rate-CPI inflation

Time Line (1) November 1999: The Gramm-Leach-Bliley Act (Financial Services Modernization Act) passes. It repeals the Glass-Steagall Act of 1933. August 2005: Raghuram Rajan delivers his paper "Has Financial Development Made the World Riskier?", warning about credit default swaps, at the Jackson Hole Economic Symposium. His arguments are rejected by attendees, including Alan Greenspan, Donald Kohn, and Lawrence Summers

Timeline (2) August 9, 2007: French investment bank BNP Paribas suspends three investment funds that invested in subprime mortgage debt, due to a "complete evaporation of liquidity" in the market. The bank's announcement is the first of many credit-loss and write-down announcements by banks, mortgage lenders and other institutional investors, as subprime assets went bad, due to defaults by subprime mortgage payers. This announcement compels the intervention of the European Central Bank, pumping 95 billion euros into the European banking market. September 15, 2008: Lehman Brothers files for bankruptcy protection.

Diagnoses Panic. A diagnosis preferred by Geithner, et al. Once confidence is restored, normality will follow Debt overhang. A diagnosis preferred by Krugman, et al. Need for debt relief and fiscal stimulus* Shadow banks Insolvency vs. illiquidity Classics: Walter Bagehot, Lombard Street: A description of the Money Market Movie: It’s a Wonderful Life *Does He Pass the Test? Paul Krugman, The New York Review of Books, July 10, 2014, Stress Test: Reflections on Financial Crises, by Timothy F. Geithner. Crown, 580 pp., $35.00

Those who warned about the coming crisis Raghuram Rajan, Professor, University of Chicago, Booth School of Business Nouriel Roubini, Professor, NYU Stern School of Business Paul Krugman, Professor, Princeton University Dean Baker, Center for Economic Policy and Research Med Jones, President, International Institute of Management Peter Schiff, CEO, Euro Pacific Capital, Inc. Bob Shiller, Professor, Yale University Byron Dorgan (http://billmoyers.com/segment/byron-dorgan-on-making-banks-play-by-the-rules/ )

Source: http://econintersect.com/wordpress/?p=2648

Human Behavior

Market Fundamentalism Markets are self-correcting The best government is a small government The financial crisis was an accident Add a few courses on ethics

What to do? Analogies Are markets self regulating? FDA NTSB Sports Hurricanes and other natural disasters Are markets self regulating? Information asymmetry Moral hazard

Regulation Government “size” Is “small” good? Glass-Steagall

Costs and Benefits of the Financial System [Benjamin Friedman] In both instances [the dot.com crash and the housing bubble burst], the cost was not just financial losses but wasted real resources. Moreover, to ask just how efficient a financial system is in allocating capital leads naturally to the question of the price that is paid for such efficiency. The share of the “finance” sector in total corporate profits rose from 10 percent on average from the 1950s through the 1980s, to 22 percent in the 1990s, and an astonishing 34 percent in the first half of this decade.

Friedman [continued] Those profits accruing to the financial sector are part of what the economy pays for the mechanism that allocates its investment capital (as well as providing other services, like checking accounts and savings deposits). The finance industry’s share of US wages and salaries has likewise been rising, from 3 percent in the early 1950s to 7 percent in the current decade. An important question …is what fraction of the economy’s total returns to productively invested capital is absorbed up front by the financial industry as the costs of allocating that capital.

Friedman [continued] the Financial Accounting Standards Board … recently changed its rules to allow banks more latitude to claim that assets on their balance sheets are worth more than what anyone is willing to pay for them.

TARP Troubled Asset Relief Program a program of the United States government to purchase assets and equity from financial institutions to strengthen its financial sector that was signed into law by U.S. President George W. Bush on October 3, 2008. It was a component of the government's measures in 2008 to address the subprime mortgage crisis.

American Recovery and Reinvestment Act of 2009 Emergency Economic Stabilization Act, 2008 Home Affordable Modification Program

Dodd–Frank Wall Street Reform and Consumer Protection Act (7/2/2010) an Act to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end "too big to fail", to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.

Dodd-Frank The Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub.L. 111-203, H.R. 4173; commonly referred to as Dodd-Frank) was signed into federal law by President Barack Obama on July 21, 2010 at the Ronald Reagan Building in Washington, DC.

Dodd-Frank (cont’d) Long title an Act to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end "too big to fail", to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.

Fed Funds Rate (1)

Fed Funds Rate (2)

Source: Confer Thomas Philippon: "The future of the financial industry", Finance Department of the New York University Stern School of Business at New York University

The Robo-Signing Issue The robo-signing largely involved assignments of mortgage notes to mortgage servicers or trusts representing the investors who put up the loan money.  Assignment was necessary to give the trusts legal title to the loans.  But assignment was delayed until it was necessary to foreclose on the homes, when it had to be done through the forgery and fraud of robo-signing.  Why had it been delayed?  Why did the banks not assign the mortgages to the trusts when and as required by law?

Robo-Signing A working hypothesis, suggested by Martin Andelman: securitized mortgages are the “pawns” used in the pawn shop known as the “repo market.”  “Repos” are overnight sales and repurchases of collateral.  Yale economist Gary Gorton explains that repos are the “deposit insurance” for the shadow banking system, which is now larger than the conventional banking system and is necessary for the conventional system to operate.  The problem is that repos require “sales,” which means the mortgage notes have to remain free to be bought and sold.  The mortgages are left unendorsed so they can be used in this repo market.

SPVs and MERS The shadow banking system evolved in response to the need for large institutional investors to park their money securely and earn some interest. The “special purpose vehicle” (SPV), which acts as the shadow bank, evolved in response to this need.

MERS The housing shell game was made possible because it was all concealed behind an electronic smokescreen called MERS (an acronym for Mortgage Electronic Registration Systems, Inc.).  MERS allowed houses to be shuffled around among multiple, rapidly changing owners while circumventing local recording laws.  Title would be recorded in the name of MERS as a place holder for the investors, and MERS would foreclose on behalf of the investors.

Robo-signing (references) Martin Andelman http://4closurefraud.org/2010/10/10/mandelman-the-signin-or-pardon-me-mr-banker-but-your-remic-is-showing/ Ellen Brown (primary) http://www.nationofchange.org/why-all-robo-signing-shedding-light-shadow-banking-system-1327846780 Gary Gorton (more general) http://online.wsj.com/public/resources/documents/crisisqa0210.pdf

Six Films on the Financial Crisis Margin Call (2011) Too Big To Fail (2011) Inside Job (2010) Frontline: The Warning (2009) The Flaw (2010) Enron: The Smartest Guys in the Room (2005)

“They should have known …” Not everyone regards a house as an “investment.” We do not make this statement about Cars [NTSB] Medicines [FDA] Appliances [Consumer Union] Food [Dept. of Agriculture] Just about anything

“They should have known …” Externalities Neighborhood level Macroeconomic level Global level

“They should have known …” Top financial firms do not believe in this Too big to fail Too big to jail To what purpose?

“People demand much higher standards of evidence for unpopular or unexpected findings than for comfortably familiar findings.” George Stigler, Nobel Laureate, Economics Memoirs of an Unregulated Economist (Chicago, 2003)

Asset Concentration

Top 5 Banks as of end of 2014 JPMorgan Chase $2.60 Bank of America $2.10 Citigroup $1.89 Wells Fargo $1.69 The Bank of NY Mellon $0.374

As of the latest data availability 1 JPMorgan Chase & Co. $2.55 trillion 2 Bank of America Corp. $2.25 trillion 3 Wells Fargo & Co. $1.95 trillion 4 Citigroup Inc. $1.82 trillion 5 Goldman Sachs Group Inc. $894.09 billion 6 Morgan Stanley $832.39 billion 7 U.S. Bancorp $449.52 billion 8 PNC Financial Services Group Inc. $371.28 billion 9 TD Group US Holdings LLC $353.62 billion 10 Capital One Financial Corp. $348.55 billion

Stress Test (Kugman, Paul, “Does He Pass the Test Stress Test (Kugman, Paul, “Does He Pass the Test?” New York Review of Books, July 10, 2014, pp. 6-10.)

Subprime Mortgages and Race (Source: http://www. huffingtonpost

Subprime Mortgages and Race (2)

Robosigning Wells Fargo's Master Spin Job http://www.rollingstone.com/politics/news/wells-fargos-master-spin-job-20151002

Rating Agencies The Last Mystery of the Financial Crisis http://www.rollingstone.com/politics/news/the-last-mystery-of-the-financial-crisis-20130619

Too big to fail, too big to jail Ben Bernanke: More execs should have gone to jail for causing Great Recession http://www.usatoday.com/story/news/politics/2015/10/04/ben-bernanke-execs-jail-great-recession-federal-reserve/72959402/ Gangster Bankers: Too Big to Jail http://www.rollingstone.com/politics/news/gangster-bankers-too-big-to-jail-20130214

Rev W12

Measures of Recession Depth and Duration Duration (months) Real GDP Real GDI Unemployment Rate Average, 1948-2001 10 -2.05 -2.20 2.85 Current Episode 16 -1.73 -0.36 3.67 Current + SPF Forecast 20-22 -2.83 NA 4.60 Great Depression 43 -26.50 -26.70 24.60 NOTE: Depth measures the average percent change from peak to trough for real GDP and real GDI and the average percentage-point change from trough to peak for the unemployment rate. Changes in real GDP and real GDI during the Great Depression are based on annual data. SOURCE: Kevin L. Kliesen’s calculations based on quarterly data. Economic Synopses, Federal Reserve Bank of St. Louis, March 23, 2009.

The housing market began to falter in the spring of 2006.

The Outstanding Public Debt as of 20 April 2009 is: U.S. NATIONAL DEBT CLOCK The Outstanding Public Debt as of 20 April 2009 is: $ 1 1 , 197, 726, 249, 988 The estimated population of the United States is 306,038,582, so each citizen's share of this debt is $36,589.26 The National Debt has continued to increase an average of $3.84 billion per day since September 28, 2007! Source: U.S. National Debt Clock, http://www.brillig.com/debt_clock/

http://zfacts.com/p/318.html

U. S. International Indebtedness (Net U. S U.S. International Indebtedness (Net U.S. asset position as a % of GDP) Source: Calculations by Eshragh Motahar based on data from the Fed and the BEA)

History of U.S. Gov’t Bailouts http://www.propublica.org/special/government-bailouts

Downloaded: April 22, 2009. http://news. bbc. co

Universal HealthCare $104 billion per year could implement the Obama healthcare plan The above is equal to 15% of U.S.’s 2008 military budget (Source: Paul Krugman, “Kealthcare Now,” The Newy York Times, 1/30/2009, citing research from The Commonwealth Fund.)

US military spending accounts for 48 percent, or almost half, of the world’s total military spending US military spending is more than the next 46 highest spending countries in the world combined US military spending is 5.8 times more than China, 10.2 times more than Russia, and 98.6 times more than Iran. US military spending is almost 55 times the spending on the six “rogue” states (Cuba, Iran, Libya, North Korea, Sudan and Syria) whose spending amounts to around $13 billion, maximum. (Tabulated data does not include four of the six, as the data only lists nations that have spent over 1 billion in the year, so their budget is assumed to be $1 billion each) US spending is more than the combined spending of the next 45 countries. The United States and its strongest allies (the NATO countries, Japan, South Korea and Australia) spend $1.1 trillion on their militaries combined, representing 72 percent of the world’s total. The six potential “enemies,” Russia, and China together account for about $205 billion or 29% of the US military budget. Source: http://www.globalissues.org/article/75/world-military-spending#USMilitarySpending

U. S. population: 4% of World population U. S. Military Spending vs U.S. population: 4% of World population U.S. Military Spending vs. the Rest of the World

More Economic Indicators Median household income, adjusted for inflation, lower in 2007 than in 2000

The Wealth Inequality Problem in One Chart Source: http://www