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Figure 8.1: Subprime Lending Fiasco – Stages

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Presentation on theme: "Figure 8.1: Subprime Lending Fiasco – Stages"— Presentation transcript:

1 Figure 8.1: Subprime Lending Fiasco – Stages
Enabling the Housing Market Securitization starts Credit default swaps Banks can speculate No leverage limits Stimulation starts Building the Housing Bubble More stimulation, low int. Securitization transfers mortgage risk to investor so lender can take poor risks Unlimited investor demand for mortgage-backed securities Competition to loan leads to subprime loans, inflated house prices, more securitizations Credit ratings inflated The Housing Bubble Bursts 2007-8 Economy slows Subprime loan defaults rise Foreclosures rise deflating house prices Walk-aways rise Securitizations default Insurers cannot pay Investors fail Liquidity/credit crisis Bailouts start The Aftermath Subprime mortgage loan defaults rise Economy slows further as failure cycle continues Liquidity/credit crisis continues Investment banks fail TARP bailouts and liquidity support continue Stocks crash Securitization insurers fail Insurance companies fail Contagion spreads worldwide Countries become insolvent Worldwide bailouts start Restrictions start on business and capital markets More quantitative easing (QE2)

2 Figure 8.2: Subprime Lending Fiasco – Key Events
1997 1st Publicly Available Securitization of CRA loans 1999 Gramm-Leach-Bliley Act allows banks to speculate 2000-2 Commodity Futures Modernization Act allows banks to trade in credit default swaps Recession gives rise to stimulus: lower interest rates, housing tax credits, subsidies, liquidity increases 2003-4 Loan standards discarded Securitization grows Bank leverage limits suspended allowing unlimited borrowing to buy subprime mortgage-backed securities 2007 Housing bubble bursts as house prices fall Subprime lending collapses, failures Foreclosures rise Bear Stearns halts redemptions on two funds Stock market peaks Credit crunch begins Liquidity & bailout measures begin 2006 U.S. housing prices fall Subprime lenders start to fail Smartest investors start to reduce subprime exposure (J.P. Morgan, Goldman Sachs) 2005 Credit default swaps allowed as insurance on subprime collateralized debt obligations Housing market boom stops 2008 Home prices plummet Credit default swap insurance fails Bear Stearns sold to J.P. Morgan Banks fail, bailouts start, Fannie Mae & Freddie Mac taken over Bk. of America buys Merrill Lynch Lehman Bros. Bankrupt AIG & Iceland bailed out Washington Mutual & Wachovia taken over. Stocks crash Troubled Asset Relief Progr. (TARP) Massive bailouts, liquidity support 2009 Contagion worldwide Fears over Irish, UK, European banks Short-selling restrict. in Japan UK, France Quantitative easing GM bankrupt Flash crash TARP: exec. comp. restricted & repayments start 2010 European Debt Crisis – Greece, Ireland, others Greece bailout U.S. foreclosure crisis 2nd Quantitative easing wave (QE2) Rating agency reform Fin. Enforcement Task Force created Flash order ban Dodd-Frank Act Sources: Timelines documents from the Federal Reserve Bank of New York and Wikipedia

3 Figure 8.3: Subprime Lending Fiasco – U.S. Housing Bubble
House Prices Crash Very Low Interest Rates U.S. Housing Bubble Unsustainably High House Prices Excessive Foreign Savings Unsuspecting Investors Lose Jobs, Pensions Transfer of Risks From Lenders To Investors Mortgage Securitization & Resale Government Bailouts Bad Mortgage Loans Liar, No doc, Ninja, No deposit Bad Ratings Lack of Transparency Misguided Regulators Greed & Conflicts of Interest Public Pressure

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