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7/29/2019 PA315 Student Lecture 4
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PA 315
Government Business Relations
Lecture 4
The Late-2000s Financial Crisis
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Learning Objectives
Understand the background of the late-2000sfinancial crisis
Understand how government policies interact
with market Understand the implications of corporate social
responsibility in exacerbating financial swings
Apply models of government business relationsto interpret current events
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Factors in the Economic Crisis
Decrease inPersonal
Wealth (i.e.housing prices,stock prices)
Decrease inspending;
Increase inuncertainty (i.e.
investment)
Decrease indemand ofgoods andservices;
Reduced inputsfor production
Rise inunemployment;other social and
economicproblems
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National averages in housing
w
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Housing trends National
Historic growth since 1940
Money moved from dot.com to housing after2000
By 2003 the housing sector started to skyrocketin most places
Bubble started to burst in 2007, dropped
precipitously in 08 and 09, and has continuedsmall decline to date (about 20% nationally)
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California Trends
The national trends disguise the effects on thehot markets: West Coast, AZ, NV, TX, andFlorida which were on boom-bust cycle
In early 2007 the median house in CA was over$500,000. Today southern CA median is$270,000. (7% drop in 2011)
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Background: Supply-side support
by governmentstep 1
Mortgage interest deductions a part of nationalpolicy
Started in 1913
Became very substantial in the 1950s Became one of the major investment strategies of the
American family
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Background: Supply-side support by
governmentstep 2
The creation of mortgage-backed securitiesmarket
1930~1940s Creation of Federal Home Loan Banks
and Federal National Mortgage Association (FannieMae)
1960~1970s Privatization of Fannie Mae and thecreation of Federal Home Loan Mortgage Corporation
(Freddie Mac) 2000s: allowed risk to be disguised in bundled and
securitized arrangements with Fannie and Freddietaking on larger and larger risks; when markets dontfunction primarily on risk, problems will eventually occur
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Background: Other Causes
Push for sub-prime (riskier) lending: for different reasons
Spurred by HUDs affordable housing goal for FannieMae and Freddie Mac (under both D and R) gov
Rose from below 10% to nearly 20% Profits from subprime loan bundles were wonderful
(so lots of private investors held around the world)
Encouraged borrowing (U.S. policy)
The Fed lowered rate from 6.5% to 1.0% (2000 to2003); only went to 5.25% to cool market; againdropped precipitously after crash in 2008
A flood of funds from foreign countries flowed in to
U.S.
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Causes, cont.
Weak and fraudulent underwriting practicesboomed in 2000s and became common practice
Down payments
Income and assets proof Suspicious Activity Reports pertaining to Mortgage
fraud increased by 1,411 percent between 1997 and2005
http://en.wikipedia.org/wiki/Mortgage_fraudhttp://en.wikipedia.org/wiki/Mortgage_fraudhttp://en.wikipedia.org/wiki/Mortgage_fraudhttp://en.wikipedia.org/wiki/Mortgage_fraud7/29/2019 PA315 Student Lecture 4
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Predatory lending:
Bait and switch lending practices
Encouragement of unrealistic loans
Frenzy in housing market (euphoria) and stockmarket
Investors swarmed to housing
Home-owners moved up as much as possible
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Deregulation: Banks were deregulated through:
The Depository Institutions Deregulation andMonetary Control Act of 1980 (allowing similar banks
to merge and set any interest rate). The GarnSt. Germain Depository Institutions Act of
1982 (allowingAdjustable-rate mortgages).
The GrammLeachBliley Act of 1999 (allowing
commercial and investment banks to merge).
http://en.wikipedia.org/wiki/Depository_Institutions_Deregulation_and_Monetary_Control_Acthttp://en.wikipedia.org/wiki/Depository_Institutions_Deregulation_and_Monetary_Control_Acthttp://en.wikipedia.org/wiki/Garn%E2%80%93St._Germain_Depository_Institutions_Acthttp://en.wikipedia.org/wiki/Garn%E2%80%93St._Germain_Depository_Institutions_Acthttp://en.wikipedia.org/wiki/Garn%E2%80%93St._Germain_Depository_Institutions_Acthttp://en.wikipedia.org/wiki/Adjustable-rate_mortgageshttp://en.wikipedia.org/wiki/Gramm%E2%80%93Leach%E2%80%93Bliley_Acthttp://en.wikipedia.org/wiki/Gramm%E2%80%93Leach%E2%80%93Bliley_Acthttp://en.wikipedia.org/wiki/Gramm%E2%80%93Leach%E2%80%93Bliley_Acthttp://en.wikipedia.org/wiki/Gramm%E2%80%93Leach%E2%80%93Bliley_Acthttp://en.wikipedia.org/wiki/Gramm%E2%80%93Leach%E2%80%93Bliley_Acthttp://en.wikipedia.org/wiki/Gramm%E2%80%93Leach%E2%80%93Bliley_Acthttp://en.wikipedia.org/wiki/Gramm%E2%80%93Leach%E2%80%93Bliley_Acthttp://en.wikipedia.org/wiki/Gramm%E2%80%93Leach%E2%80%93Bliley_Acthttp://en.wikipedia.org/wiki/Gramm%E2%80%93Leach%E2%80%93Bliley_Acthttp://en.wikipedia.org/wiki/Gramm%E2%80%93Leach%E2%80%93Bliley_Acthttp://en.wikipedia.org/wiki/Adjustable-rate_mortgageshttp://en.wikipedia.org/wiki/Adjustable-rate_mortgageshttp://en.wikipedia.org/wiki/Adjustable-rate_mortgageshttp://en.wikipedia.org/wiki/Garn%E2%80%93St._Germain_Depository_Institutions_Acthttp://en.wikipedia.org/wiki/Garn%E2%80%93St._Germain_Depository_Institutions_Acthttp://en.wikipedia.org/wiki/Garn%E2%80%93St._Germain_Depository_Institutions_Acthttp://en.wikipedia.org/wiki/Depository_Institutions_Deregulation_and_Monetary_Control_Acthttp://en.wikipedia.org/wiki/Depository_Institutions_Deregulation_and_Monetary_Control_Act7/29/2019 PA315 Student Lecture 4
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Government Response
The Bailout and other support
$700 billion to purchase the toxic assets (borrowing$1.7 trillion: $250 b deficit + $700 b bailout + $800 b
stimulus package of 2009) Housing and Economic Recovery Act of 2008 (300 b)
Some re-regulation
Wall Street Reform and Consumer Protection Act of
2009 (Dodd-Frank legislation)
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Impacts to US Economy
Housing: drop in values; foreclosures; tax revenuereduction at state and local level
Unemployment
From 4.2% to 10.1% Oct. 2009; 8.5 in early 2012 Real GDP Decrease
Stock market drop: Nearly 50% from peak to bottom;currently about 15% from peak
Distribution of wealth worsened: The top 1% whoowned 34.6% of the nation's wealth in 2007 increasedtheir proportional share to 37.1% by 2009
Global effects: hardest hit, Europe; least, Asia
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How the Decision of Bailout Was Made?
Watch the video:
Inside the Meltdown
http://www.pbs.org/wgbh/pages/frontline/meltdown/view/http://www.pbs.org/wgbh/pages/frontline/meltdown/view/7/29/2019 PA315 Student Lecture 4
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Discussion
Do you think the $700 billion bailout is a wisedecision and based on what timeline? (e.g.,short term risk of depression and long-term
moral hazard) Who should be responsible and who should
assume the burden? What are the ethicalimplications? Should government regulate more
than Dodd-Frank or less?
Use the four Government-Business models toexplain your answer(market capitalism, dominance,countervailing forces, corporate social responsibility)