Background to 2008 Meltdown Learn from History?. Background of Great Depression American finance companies in the 1920s were merged. Banks held depositor’s.

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Presentation transcript:

Background to 2008 Meltdown Learn from History?

Background of Great Depression American finance companies in the 1920s were merged. Banks held depositor’s money but also invested in insurance companies, stock brokerage firms and home loan companies.

When stock prices dropped sharply in October, 1929 the interconnected companies crumbled like a house of cards.

Congressional Reforms During the resulting Great Depression, 1929 to World War II, Congress passed the Glass- Steagall Act to prevent this rapid financial crash again. Glass-Steagall restricted what kind of businesses banks could invest in. Banks were not permitted to invest heavily in insurance companies, stock brokerages and home loan companies.

Buying a house before 2000 Buying home worth $100,000 Buyers obtain loan from bank borrowing no more than 80% of purchase price 80,000 Required cash down payment 20,000

Congress Repeals Glass-Steagall In 2000, Congress repealed Glass-Steagall to allow American banks to compete with international banks. American banks are permitted to invest heavily in insurance, stock brokerages and home loan companies.

Congress also reduces down payment requirements After 2000: Buying home worth$100,000 Home loan amountborrowed 90,000 Down payment 10,000

What is a security? A security is any written promise where one person is obligated to repay a price if a certain event happens. One example are stocks. The stock owner is permitted to receive the dollar value of one share of the corporation if the company closes. Another example is a mortgage….

What is a note and mortgage? If I borrow $90,000 from Citizens Bank to buy a house, the Bank wants “security” to insure I will pay them back the $90,000 plus interest. I must sign a note (promising to repay) and I must sign a mortgage document that allows the bank to repossess the house if I don’t pay back the note. Both of these create a security!

Housing Bubble! After 2000 and the relaxed Congressional laws, home sales took off. The number of home sales increased from 2001 to The market value of most homes increased because more people were now able to afford to borrow money to buy a home. No one thought the increase home values would stop climbing.

Bubble Bursts Slowly low income persons we unable to pay their notes back to their home loan lenders. They defaulted on their note and the lenders repossessed the houses. More houses for sale dropped the value of houses everywhere.

Houses “under water” By 2007 many home owners were “under water” because they owed more on their notes than their homes were now worth value of home$80,000 Amount borrowed 90,000 (10,000)