1. Presentation given on Monday, 13 October 2008. Some images have been removed to reduce the file size.

2. The housing and financial crises are complex and still unfolding. Here we will match some of the ideas discussed in class with events from the news. Some simplification will be necessary. Some other courses useful in understanding current conditions: ECON 1102 Principles of Macroeconomics ECON 3102 Intermediate Macroeconomics ECON 3701 Money and Banking ECON 4751 Financial Economics Courses from Carlson’s Finance Department (3001, 4121, 4122…)

3. S&P/Case Schiller Home Price Index, 1989-2005 Starting the late 1990s, residential real estate prices increased.

4. One may think of the price increase as resulting from two consecutive demand shifts. P Q D0D0 D1D1 S 1. Low interest rates made other investments (substitutes) less attractive and made mortgage finances (a complement) less expensive. D2D2 2. Expectations about future prices change. Specifically, many believe the earlier price increases will continue.

5. Most housing purchases are financed by mortgages. Mortgage – a special loan that is collateralized by real estate Default – failure of the borrower to repay a loan Collateral – an asset to which the lender gains title if the borrower defaults Foreclosure – the process that transfers a house to a lender after the borrower defaults

6. Under expectations that house prices will continue to rise… Home buyers bought expensive houses with large mortgages. Many mortgages were structured in a way that payments increased over time. Borrowers reasoned that if they ever fell behind in a mortgage, they could sell the house for profit, repay the loan, and start over. Lenders were willing to give risky loans to anyone, even those with poor credit history. Lenders reasoned that even if a borrower defaulted, the lender would get a house at least as valuable as the amount of the loan.

7. S&P/Case Schiller Home Price Index, 1989- However, house prices stopped increasing after interest rates rose.

8. Plans aft agley Plans under expectations of rising house prices Consequences of falling house prices Borrowers in trouble sell houses for a profit, repay loans Borrowers owe more on a mortgage than the resale value of the home Lenders take a profit even on foreclosures by gaining a house worth more than the mortgage principle Lenders take a loss on foreclosures by gaining a house worth less than the mortgage principle

9. Newspapers headlines reveal that column happened. “Neighborhoods Crumble in Wake of Foreclosures.” San Francisco Chronicle. 14 Oct 2007. “Subprime Debacle Traps Even Very Credit Worthy.” Wall Street Journal. 3 Dec 2007. “Foreclosures: No End in Sight.” San Francisco Chronicle. 27 Oct 2007. “Real-Estate Woes of Banks Mount.” Wall Street Journal. 6 Jun 2008. “Federal Regulators Seize Crippled IndyMac Bank.” Los Angeles Times. 12 Jun 2008. “Impact of Mortgage Crisis Spreads.” Wall Street Journal. 10 Aug 2007. (Discusses how Europe banks lost money on MBS.)

10. Securitization of mortgages Mortgage-backed security (MBS) – pools of mortgages repackaged into tradable bonds Collateralized mortgage obligation (CMO) – a special type of mortgage- backed security in which the bond holder is entitled to specific parts of the revenue stream of the mortgage pool

11. Bank failures and near failures Source: Wikipedia: List of bankrupt or acquired banks during the financial crisis of 2007–2008Wikipedia: List of bankrupt or acquired banks during the financial crisis of 2007–2008 2 Feb 2007Metropolitan Savings Bank 28 Sep 2007NetBank 4 Oct 2007Miami Valley Bank 25 Jan 2008Douglass National Bank 7 Mar 2008Hume Bank 9 May 2008ANB Financial 30 May 2008First Integrity Bank 11 Jul 2008IndyMac Bank 25 Jul 2008First National Bank of Nevada 1 Aug 2008First Priority Bank 22 Aug 2008The Columbian Bank & Trust Co. 29 Aug 2008Integrity Bank 5 Sep 2008Silver State Bank 15 Sep 2008Lehman Brothers 19 Sep 2008AmeriBank 25 Sep 2008Washington Mutual 10 Oct 2008Main Street Bank 10 Oct 2008Meridian Bank US Bank Failures, 2007-2008Selected Near Failures Bear Stearns Countrywide Financial

12. Federal Governmental Responses Chris Dodd Ben Bernanke Henry Paulson Congress Economic Stimulus Act of 2008 Housing and Economic Recovery Act of 2008 Authorized Treasury Department to buy mortgages Treasury Department Took over management of Fannie May and Freddie Mac Federal Reserve Lowered interest rates repeatedly Guaranteed loans to buy Bear Stearns Emergency loans to AIG, others

13. Stock market reaction Google Finance: S&P 500