1. Mortages (simple world) HH gets 100 000 Euros and promises payments over say next 20 years A bank holds this mortgage

2. Mortages (more complicated) HH gets 100 000 Euros and promises payments over say next 20 years A bank holds this mortgage Investment bank buys mortages from many different banks and “repackages” them to “structured products”

3. Why “structured products” (1) Diversify risk -- For example: property market often only turns down in some regions, not nationally so you can reduce risk by selling people “pieces” of many different mortgages from many different regions -- But also diversify other type of risk. For example hold mortages from many different people

4. Why “structured products” (2) Create “speciality products” -- For example, mortages were split into tranches 100 000 Euro mortgage o buy a 1000 Euro house Person will stop paying mortgage if house less than 50 000 Euro, approximately Value of house

5. Why “structured products” (2) Create “speciality products” -- For example, mortages were split into tranches 100 000 Euro mortgage o buy a 1000 Euro house Person will stop paying mortgage if house less than 50 000 Euro, approximately Value of house Structured tranch SAFE Structured tranch RISK

6. What happened “Mortgage originators” did not care as much as in past about credit worthiness of their customers. WHY? -- They would not “hold” the mortages but pass them on -- They were able to pass on even bad mortages at high prices because: - customers did not “understand the products” - the rating agencies did not do a good job (underestimate the risk)

7. What happened Property market did turn down nationally, which the structured products assumed was unlikely to happen

8. Overall situation There was already a lot of risk due to NINJA mortgages (NoIncomeNoJob&Assets) At the aggregate level the bad scenario realized

9. Does that explain the crisis? In a normal year, in the US there are 150 000 million dollars in unpaid mortgages (10% of Spanish GDP) Now there are about 300 000 million dollars according to worst scenario  Difference is not large enough to explain crisis. Only Bear Stern, Lehman, Washington Mutual, and Wachovia have lost 260 000 million Euros.

10. What is the problem? (1) Nobody knows the composition of the structured products Everybody appears to assume that the worst structured products are those for sale Just like with the “lemons problem” of Akerlof, nobody wants to buy the worst products (think about used cars)

11. Consequence Nobody knows how to value structured products Nobody manages to sell any structured products  Banks cannot transform structured products into “liquidity” to cover their payment obligations. And run the risk of going bankrupt!

12. What is the problem? (2) Nobody knows how many bad structured products banks are holding So banks have lost trust in fellow banks. They don’t give them loans or only very expensively

13. And the “real economy”? Banks are unable to make new loans for two reasons -- they cannot sell their structured assets and use the money for new loans -- their own capital is shrinking; to make loans they have to make “provisions” with their own capital. And they have less of this

14. Bank runs? Banks are no trusting banks. What about households? If they lose trust, they will try and get at their savings But banks only hold a small share of savings deposits in liquidity  Their could be a “bank run” driving banks into bankrupcy

15. Solution? Nationalization of banks (losses covered by the tax payers in the short run; maybe there will be gains in the future) Government savings guarantees Question: -- buy banks (and therefore the structured products they are holding) -- buy the bad mortgages directly

16. And Spain? Provisions? For mortages and structured products? (Bank will be able to cover losses with their own capital—which means that only bank shareholders lose) Bad mortgages? Prices have only fallen by 5% and only for used housing Mortgages are personal loans, which generally reduces default risk

17. Still Spanish banks are not managing to sell mortgages internationally anymore  liquidity problem This has reduced the credit to businesses, which could cause the recession (it could also be however that banks see the future less “rosy” than 3 years ago)