DO THIS NOW… Sit in assigned groups Then, take out your homework reading, questions, and answers As a group, compare your answered to the questions Make sure everybody agrees on the answers Resolve any differences You have five minutes

Does the implementation of government financial regulations do more to help or hurt the economy?

What is the “Great Recession?” Decline of speculative markets in 2007 Bursting of the real estate bubble Decline in credit, even with cheap money Decline in circulating money Drop in production & job losses High unemployment Low growth & growing government debts

Let’s go back to the beginning Consumption in the U.S. has been subsidized by low-cost imports from China Wages had more buying power & hardly grew In 2000, Fed lowered interest rates This made loans cheap Cheap money seeks to earn high returns Real estate looked good

Economy grows via increases in consumption of goods & services Real estate became focus of investment & cheap loans Low interest rates & high growth in housing prices Homeowners could take out cheap loans to consume Speculators could realize high returns from flipping houses

Mortgages used to be held by lenders Home buyer went to bank to borrow funds Bank held a lien on the house to secure loan Mortgage owned by bank But bank can only loan out 10x its deposits If it can sell mortgage, it gets new money to loan And it can further leverage its assets

When money is cheap, highly-secure mortgages don’t return much But they can return more if they are high-risk Sub-prime mortgages Lenders can borrow low and sell high (8-10%) To mitigate risk, they bundle them with low-risk mortgages These packages are sold to investors as CDOs “Collateralized Debt Obligations”

This is how a CDO works…

So investors, speculators, pension funds, hedge funds, banks, etc So investors, speculators, pension funds, hedge funds, banks, etc. bought CDOs The market in CDOs took off and their prices rose Each CDO is made of layers of low- & high risk mortgages Combined return can be high But what happens if the high risk mortgages go bad? No one wants to buy them—so their “real” value is uncertain If there is no market, there is no price As assets, CDOs suddenly become worthless Banks don’t know how much money they have

The Great Recession is the result of a sudden collapse in the global money supply The “real” economy was supported by cheap money Speculative economy took up excess money supply Inflation & interest rates were low When securities markets froze up, paper had no clear value This made financial actors insolvent Money stopped moving

What happens next? Speculators continue to look for places to invest Investment in such markets does not create jobs Governments (UK) seek ways to reduce budget deficits They lay off large numbers of employees Consumption & wages are stagnant, so little growth Prices could begin to decline: deflation Even less consumer spending What is to be done?

Exhibit 1: House Price Change Housing prices were relatively stable during the 1990s, but they began to rise toward the end of the decade. Between January 2002 and mid-year 2006, housing prices increased by a whopping 87 percent. The boom had turned to a bust, and the housing price declines continued throughout 2007 and 2008. By the third quarter of 2008, housing prices were approximately 25 percent below their 2006 peak. Annual Existing House Price Change Source: www.standardpoors.com, S and P Case-Schiller Housing Price Index. rev200902 The Economic Crisis of 2008: Cause and Aftermath

Exhibit 2a: The Default Rate The default rate fluctuated, within a narrow range, around 2 percent prior to 2006. It increased only slightly during the recessions of 1982, 1990, and 2001. The rate began increasing sharply during the second half of 2006 It reached 5.2 percent during the third quarter of 2008. Default Rate Source: mbaa.org, National Delinquency Survey. rev200902 The Economic Crisis of 2008: Cause and Aftermath

Exhibit 2b: Foreclosure Rate Housing prices were relatively stable during the 1990s, but they began to rise toward the end of the decade. Between January 2002 and mid-year 2006, housing prices increased by a whopping 87 percent. The boom had turned to a bust, and the housing price declines continued throughout 2007 and 2008. By the third quarter of 2008, housing prices were approximately 25 percent below their 2006 peak. Foreclosure Rate Source: www.mbaa.org, National Delinquency Survey. rev200902 The Economic Crisis of 2008: Cause and Aftermath

Exhibit 3: Stock Market Returns As of mid-December of 2008, stock returns were down by 37 percent since the beginning of the year. This is nearly twice the magnitude of any year since 1950. This collapse eroded the wealth and endangered the retirement savings of many Americans. S and P 500 Total Return Source: www.standardpoors.com rev200902 The Economic Crisis of 2008: Cause and Aftermath

Does the implementation of government financial regulations do more to help or hurt the economy?

Question Creation Your group will be provided with a brief definition and defining purpose of the concept discussed in the article you DID NOT read Then, your group will be provided with the question matrix You will create as many questions as your can about the concept using the question matrix Each person needs to create his or her own questions Leave room under each question for answers You have 15 minutes

Refining Questions Look through your questions Identify the ones that can realistically be answered and circle them You have 5 minutes

Interview Panels Form new assigned groups Using your questions interview the other team about the concept you did not read about Experts – answer the questions of the interviewers Interviewers – write answers to your questions and ask probing questions is something is unclear Switch roles when finished asking questions You have 20 minutes – about 10 minutes for each side to conduct an interview If you finish early, debate whether or not you think the government should make use of financial regulations

Should the U.S. government institute financial regulations? Discussion Should the U.S. government institute financial regulations?

Arguments for Financial Regulations Creates stability in financial sector Prevents risk taking behavior in economic matters Protects consumer money Provides more accurate reading of health of economy Limits bad loans Limits social costs

Arguments Against Financial Regulations Makes it harder for businesses to grow and compete Makes things less efficient Leads to increase in expenses Expenses are usually passed off on to consumers Can make it more difficult for earnings to grow

Remainder of class to complete reflection journal

Finish journal entry if you did not do so in class Reminders Finish journal entry if you did not do so in class  Have a great weekend