Prepared forDr. Ramon Castillo

Econ 462

CALIFORNIA STATE UNIVERSITY, LOS ANGELES

Spring 2011

U.S Financial Crisis U.S Financial Crisis

2007-20092007-2009

Present by

Huan He

Eric Le

Grace Peng

U.S Crisis 2007-2009

• Referred as a Financial and Real Estate Crisis

Stock prices decreased

Prestigious financial institutions failed

Lending was disrupted

Unemployment rose to near 10%

U.S Crisis 2007-2009 (cont.)• Governments, central banks, and

international organizations implemented various plans to combat the crisis.

Fiscal expansion

Monetary expansion

Institutional bailouts

Causes of the Crisis

• Growth of the housing bubble

• Easy credit conditions

• Subprime lending

• Deregulation and lax regulation

• Collapse of the shadow banking system

Growth of the housing bubble During the housing bubble, the growth of home prices outpaced

income growth. The price of the house increased 124% in 2006 . At the peak of the bubble in 2006, the home price was 4.6 times the

median household income. After the peak in 2006, housing prices declined over 20% by the end of

2008

Growth of the housing bubble (Cont.)• The U.S. residential properties subject to

foreclosure actions from 2007 to 2010.

Easy credit conditions

• Low interest rates made credit more accessible, enable consumers to increase borrowing

• Less manageable loans coupled with the inverse relationship between interest rates and asset prices made speculation in the housing market more risky

Subprime Lending

A greater risk of default than conventional loans. In March 2007, 7.5 million first-lien subprime

mortgage loans were outstanding $1.3 trillion. High risk subprime lending increased due to

government policies and competition among financial institutions

2008: The poorer loan screening increased to 25% in subprime defaults

Insufficient Regulation and Deregulation

Regulation did not keep pace with financial innovations

The central bank had not federal supervision over:

Investment banks

Hedge funds

Other firms involved in derivatives or complex financial

products.

About half of the subprime loans were written by state-chartered mortgage companies with minimum supervision.

Impact on the Aggregate Economy

Crisis began with:

Assets price declined and Financial institution

collapseCrisis reduced

aggregate demand

causing economic activity

investment

>>>Aggregate economy decreased

Impact on the Aggregate Economy (Cont.)

2008 -2009: Real GDP decreased 6 % Average hours per workweek declined to 33%

The Collapses of Major Bank & Investment Bank

Jan 2008 – Countrywide Financial Institution March 2008 – Bear StearnsSept 2008 – Lehman Brother Sept 2008 – Merrill Lynch Sept 2008 – Washington MutualDec 2008 – Fannie Mae & Freddie Mac

US Unemployment Rate

US Unemployment Rate

1) Total Unemployment Rate – 4.6 in 2006 increase

to 9.6 in 2010

2) Major sector:

Financial Sector – 2.7 in 2006 to 6.9 in 2010

Construction Sector – 6.7 in 2006 to 20.6 2010

Manufacturing Sector – 4.3 in 2007 to 10.6 2010

GDP (Purchasing Power Parity)

Response of Policy Makers

1) “Too big to fail” Limit the size of institutions to prevent them from

becoming TBTF Firms that arrange risky transactions must take on

some of the risk. Reduce incentive for executives to take risky gambles

in hopes of high short-run gain.2) Financial regulation

Inconsistencies and gaps in regulation contributed to the 2007-2009 financial crisis

Consolidate regulators of add an agency that oversees and coordinates regulators

Monetary Policy

1) Federal Reserve System Repair commercial paper market – Buying

back unsecured and asset-backed commercial paper directly from issuers.

Restore securitizations Reduce mortgage interest rates – Reduced of

Interest rate 6.41 (2006) to 4.69 (2007) Federal Fund Rate – Reduced of Fed funds from

5.02% to near 0.18%

Fix Rate Mortgage Rate

Federal Fund Rates

Fiscal Policies

1) Economic Stimulus Act of 2008 Government spent about $152 billion on the

stimulus package. Tax rebates – gear toward low & middle-income Tax incentives for businesses.

2) Emergency Economic Stabilization Act of 2008 Mortgage-backed securities

Fiscal Policy (Cont.)

3) Troubled Asset Relief Program (TARP) AIG – Sept 2008 they received about $85 billion;

May 2009 they received another $97 billion.

Big Four Banks:Citigroup – received $45 Billion in bailout money

Bank of American – Guarantee $118 billion of the bailout money, but used only $45 billion

JP Morgan Chase – Received $25 billion in bailout money

Wells Fargo - Received $25 billion in bailout money

Outcome of monetary and fiscal policies

• Outcome from “too big to fail policy”

• Taxpayer subsidy

• Cost of funds for small and large institutions before and during the bailout

• Cost-of-funds spread between small & large banks increased to 0.69%

Economic Stimulus Packages

Fisical Stimulus package – by borrowing and

spending to offset the reduction in private sector

demand caused by the crisis. In 2008 and 2009, the

U.S. excuted total of $1 trillion. 

Recovering from the Crisis & international institution Intervention

• Global Implications: The stimulus reduced the risk of a sharper Reduced more sustained global downturn.

FRS – interest rate cuts make money cheaper.

State and local revenue recovering

tax receipts up 5% on the annual basis

Thank You!