A quick look at the US Economy FIN 30220: Macroeconomic Analysis

Let’s look at the unemployment rate over the past few years… 2001 Recession 2007 Recession Current = 7.6%

Suppose we add in “marginally attached workers”… 2001 Recession 2007 Recession Current = 9.6% Haven’t looked for work in 12 months

Now, lets add in the “underemployed”… 2001 Recession 2007 Recession Current = 14.3% Working Part time but would like to be full time

Unemployment rates that near 10% are not uncommon during recessions, but… Average = 5.7% October 2009 June 1992 November/December 1982 May 1975

Currently Unemployed = 14M The composition of our unemployed is shifting more and more towards long term! Mean = 40.5 weeks Median = 21.2 weeks Percentage of Unemployed

While Duration of unemployment has been rising for years, it has accelerated recently

This current downturn is largely (but not entirely) a housing problem! Currently:  2-3 Million Homes considered “excess supply”  600,000 New Homes Per Year Being built (Average = 1.6M) At this pace, it will take until approximately 2014 before our excess stock of housing is sold off and house prices will rise faster than inflation!!!

SectorJobs Lost Financial (Real Estate)100,000 Residential Construction1,200,000 Manufacturing (Furniture)200,000 Manufacturing (Electrical & Appliances)100,000 Manufacturing (Wood Products)200,000 Manufacturing (Fabricated Metal)300,000 Retail (Home Furnishings)200,000 Retail (Building/Gardening Supplies)200,000 Total2,500,000 Let’s See if we can estimate job loss from housing… This represents 1.6% of the labor force!

So…how did we get here?

Under the National Housing Act of 1934, the Federal Housing Authority was created Federal National Mortgage Association (Fannie Mae) created to provide liquidity to mortgage market Fannie Mae converted to a stand alone publicly traded company (Actually, a Government Sponsored Enterprise) Fannie Mae begins securitization of mortgages Government National Mortgage Association (Ginnie Mae) takes over Fannie Mae’s previous duties. Federal Home Loan Mortgage Corporation (Freddie Mac) created by congress as another GSE to compete with Fannie Mae in newly created mortgage securities market 1970 Since the 1930’s, the government has been active in helping people clear hurdles in the loan market.

Mortgage Backed Securities: A quick example You purchase a $200,000 house by taking out a 30yr mortgage with a 6% fixed annual interest rate. Your monthly payment will be $1200 Year MonthPayment Principal AppliedInterest Remaining Balance 11$1,199.10$199.10$1,000.00$199, $1,199.10$200.10$999.00$199, $1,199.10$201.10$998.00$199, $1,199.10$202.10$997.00$199, $1,199.10$203.11$995.99$198, $1,199.10$204.13$994.97$198, $1,199.10$205.15$993.95$198, $1,199.10$206.17$992.93$198, $1,199.10$207.21$991.90$198,171.83

Fannie Mae Purchases your loan plus 19 other identical loans $200, Year, 6% APR Payment = $1200/mo $24,000/Mo Available Funds

$24,000/Mo Available Funds These funds are then divided up into Tranches (Claims to different parts of the available funds) A B C D E F A B F E D C Each Tranche becomes the basis for a mortgage backed security

As a homeowner, nothing changes… Each month, you make your $1,200 payment to your bank Your bank passes the payment along to Fannie Mae (and collects a processing fee) Fannie Mae passes the payment to the individual MBS investor (and collects a processing fee)

Equal Credit Opportunity Act passed – imposes heavy sanctions on financial institutions found guilty of discrimination Community Reinvestment Act mandates banks to offer credit to low income areas and defines discrimination under ECO by neighborhoods Federal Reserve Banks establish a community affairs office to ensure compliance with CRA Alternative Mortgage Transaction Act allows banks to originate mortgages with several features such as adjustable rates and balloon payments 1982 Hmmm…..can you see how the subprime collapse is coming?? The apparatus is in place…now, we need some motivation!

Tax reform Act ends the tax deduction of consumer debt, but retains the tax deductibility of home mortgages Federal Housing Enterprises Financial Soundness Act required Fannie Mae to devote a minimum percentage of their lending to affordable housing and increase their sales of mortgage backed securities Federal Reserve Bank of Boston publishes a guide to better serve low income households – measures include loosening income thresholds for mortgages New Community Reinvestment act allows community groups that market mortgages to collect a brokers fee Let’s add some more fuel to the fire!

In 1995, mortgage rate denial for conventional home purchases was 29%. Investors purchased $60B in Subprime mortgages. Taxpayer relief act expanded the capital gains tax exemption on home purchases from $125,000 to $500,000. This encouraged housing as an investment Federal Reserve of New York rescues hedge fund Long Term Capital Management – assumption is created that government will bail out “too big to fail” institutions. Gramm Leach Bliley Act deregulates finance, banking, and insurance – allows financial institutions to grow very large! 1999 Dot com bubble and collapse…we have the powder keg. All we need is a match! 1997 Fannie Mae required by HUD to devote 50% of its business to low/moderate income households

The Fed lowers interest rates from 6.25% to 1.75%. President Bush sets goal of increasing minority homeowners by at least 5.5 Million by 2010 through tax credits, subsidies and Fannie Mae commitment. Mortgage denial rate down to 14% (half of 1995 value). Homeownership peaks at 70%. Many lenders follow Countrywide’s lead in adopting automated loan approvals HUD increases Fannie Mae’s housing goals to 56%. From 2004 – 2006, Fannie Mae buys $434B in subprime debt 2004 Fannie Mae and Freddie Mac subprime securities purchases rise from $172B to $500B. Lenders begin offering loans to higher risk buyers (including illegal immigrants). Speculation in real estate rises (40% of homes purchased were either investment properties or second homes SEC suspends net capital rule for five firms: Goldman Sachs, Merrill Lynch, Lehman, Bear Stearns, and Morgan Stanley 2001

2005 Sept 2007 May 2006 Booming housing market ends abruptly. Prices fall 3.5% and home construction begins to fall Merit Financial Inc. files bankruptcy – the first casualty of the mortgage crisis. Ownit Mortgage Solutions files for bankruptcy Mortgage Lenders Network files bankruptcy (15 th largest lender with 3.3B in loans). Mid 2007 The beginning of the end... January 2007 Subprime market collapses: $1.3T in debt (20% of overall mortgage market) 13% delinquency rate (2% for conventional market) August 2006 Home construction down 40% from February 2007 BLS announces first decline in payrolls since 2003 (- 4,000)

Oct 2007 Sept 2007 October 15, 2007 Merrill Lynch announces $8.4B loss as a result of subprime market Consortium of banks announce $100B “superfund” to buy troubled mortgage assets. President Bush announces plan to freeze rates on some adjustable rate mortgages National Association of Realtors announces largest drop in home sales in 25 years March 16 th Losses begin to mount! December 6,2007 Bear Stearns acquired by JP Morgan for $2 per share. Fed provides up to $30B in “insurance” Nov 1, 2007 January 24, 2008 Indymac placed in receivership by FDIC – 4 th largest bank failure in history. Fed injects $41B into financial markets

July 30 th September 29 th September 7 th, 2008 President Bush signs into law the Housing and Economic Recovery Act – FHA will guarantee up to $300B in refinancing for subprime borrowers Federal Government takeover of Fannie Mae/Freddie Mac Lehman Brothers file for bankruptcy AIG’s credit rating is downgraded – Fed loans AIG $85B September 25 th, 2008 The Financial landscape changes forever! September 15 th, 2008 Washington Mutual seized by FDIC- its assets are sold to JPMorgan for $1.9B September 14 th, 2008 September 16th, 2008 FDIC announces Citigroup would acquire banking operations of Wachovia Merrill Lynch sold to Bank of America Troubled Asset Relief Program (TARP) passed. $700B made available to purchase troubled assets October Reserve Primary Fund “Breaks the Buck”

Oct 3rd October 28th October th Wells Fargo makes a better offer and scoops Wachovia away from Citigroup. Dow Jones average loses 22% of its value. Worst week in 75 years Fed makes emergency move to lend $1.3T to companies outside financial sector Central Banks worldwide cut interest rates in coordinated effort to save global economy October 14th, 2008 Trying to put humpty dumpty back together again!! October 7 th, 2008 US taps $700B TARP fund to take an equity position in nine largest banks in US October 6 th, 2008 October 8 th, 2008 Fed announces the availability of $540B in additional funds to purchase short term assets from money market mutual funds Fed announces an additional $900B in loans to banks US Government rescues Citigroup with an additional $20B November 24 th November 25 th Fed pledges $800B more to shore up financial system