Financial Collapse 2008

Background 1997: Global economic community suffered severe downturn 1998: Strain continues with financial crisis in Russia 2001: U.S. recession following “ dot-com ” stock collapse.

Background 1980s: Global economy sees rapid expansion of availability of savings –Economic growth of E. Asian economies –U.S. viewed as “ safe haven ” --> Foreign citizens invest in our banks. Significantly increase financial base of U.S. U.S. Govt. & FED act as global guarantor of economic stability.

Background 1990s: U.S. runs large trade deficits --> balanced by new inflow of financial capital from abroad. –Significant movement towards deregulation of U.S. economy: Rapid change in how banks do business –Partial revocation of the Glass-Steagall Act in 1980 &1999 »Increase range of activities banks could engage in »Decrease personal connections b/w banks and borrowers »Weakens oversight of banks Loose domestic policy

Housing Price Run-Up (BUBBLE) : Average price of single family home increased 200% –Fuel: 1. Inexpensive mortgage rates. 2. Reduced adherence to bank rules in mortgage industry. 3. Change in consumer expectations. *Homes = complimentary good (house + mortgage)

Deregulation Hurts Mortgage Industry 1. Information Channel Eroded --> Banks have little stake in debt. –Financial derivatives allow for mortgages to be repackaged and resold. 2. Mortgage debt easily available –New buyer = subprime 3. Consumers expect prices will continue to increase. –Encourages speculators (flipping)

Credit Crisis Banks must have capital assets backing loans (cash, real estate, stocks, bonds, derivatives?… all fall…) –1. Must tighten credit-> further fall demand housing prices –2. Recent buyers owe more than worth (negative equity)--> walk-away or foreclose –3. Value of homes near foreclosed fall As credit conditions tighten: consumer loans, loans for bus. operations, and loans for expansion fall… –Drives down sale of everything –Well functioning firms fail and UE increases Direct outgrowth of housing crisis

Confidence 2006: Loss of international confidence in U.S. –Dries up some of foreign savings = Higher pressure on mortgage interest July 2006: Housing Prices fall 21%