• Group D – 1AK
• Omar Farouk
• Fatma alzharaa Hassan
• Ayat Mohamed Kamal
• Nadeen Tarek Elfiki
• Bemen Vector
• Ahmed Hosam
1. History
2. factors led to 2008 crisis
AGENDA 3. effect of the crisis inside USA
4. effects of the crisis outside
5. GDP
6. what was the government rule
3
HISTORY
4
•Banks and mortgage lenders became increasingly predatory with their
lending practices in the years leading up to the Great Recession. Mortgages
became easier to get, with fewer standards in place to ensure borrowers
could repay them. With more people suddenly getting access to buying
power, there was a construction boom and prices increased substantially.
•This new type of mortgage, called subprime, was offered to borrowers with
impaired credit records, insufficient incomes and suboptimal credit scores.
These mortgages typically featured low or no down payments and low initial
monthly payments to entice borrowers. These borrowers typically didn’t
understand the complex features of their loans and the nature of their
interest rates.
•Most subprime mortgages, in addition to having balloon payment features
and subpar underwriting standards, were also adjustable rate mortgages (
ARMs).
•From 2004 to 2006, the U.S. Federal Reserve raised the federal funds rate
from 1% to 5.25%, and the rates on subprime ARMs rose at the same time
as those low introductory payments were increasing. This sudden jump in
monthly payment was more than many borrowers were able to pay and a
wave of foreclosures started.
THE SUBPRIME MORTGAGE CRISIS
During the housing market boom, banks were also securitizing subprime mortgages
by bundling hundreds or thousands of mortgages together and selling them to
investors as mortgage-backed securities (MBSs), a form of bonds consisting
primarily of mortgage loans.
Any investor looking to have relatively safe investments in their portfolio would
historically gravitate towards mortgages, as a low-risk, low-reward option. Banks,
hedge funds, pension funds and accredited investors bought these MBSs. They
didn’t understand that the new lending paradigm had shifted and these mortgages
would experience unprecedented foreclosure rates.
Brian Colvert, certified financial planner (CFP) and chief executive officer of Bonfire
Financial, says the combination of risky subprime mortgage issuance coupled with
lack of regulatory oversight set the table for the financial crisis that followed.
“The use of complex financial instruments such as credit default swaps, which
allowed investors to take on large amounts of risk without fully understanding the
potential consequences, contributed to the crisis,” Culvert says.
CREDIT DEFAULT SWAPS
Credit default swaps, or CDSs, are like insurance policies for bondholders.
Lenders purchase CDSs from investors who agree to pay the lender if the
borrower defaults on its obligations.
Dr. William Procasky, a chartered financial analyst (CFA) and assistant professor
of finance at Texas A&M University-Kingsville, says the proliferation of CDSs
exacerbated the leverage in the housing bubble.
“Because these credit default swaps created ‘synthetic exposure,’ meaning you
didn’t have to actually own the physical bond to bear the risk of non-performance,
they could be created in theoretically unlimited amounts, resulting in a multiplier
effect in subprime credit risk held by banks and investors,” Procasky says.
When homeowners began to default on their mortgages, the mortgage backed
securities market tanked, triggering massive losses for banks and investment
firms. At the same time, insurance companies that had sold these institutions
CDSs were also on the hook to cover billions of dollars in losses.
7
HOUSE PRICE CHANGE
• Housing prices were relatively stable during the 1990s, but they began to rise toward the end of the decade.
• Between January 2002 and mid-year 2006, housing prices increased by a whopping 87 percent.
• The boom had turned to a bust, and the housing price declines continued throughout 2007 and 2008.
• By the third quarter of 2008, housing prices were approximately 25 percent below their 2006 peak.
20.0%
15.0%
10.0%
5.0%
0.0%
-5.0%
-10.0%
-15.0%
-20.0%
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
20
20
20
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FORECLOSURE RATE
• Housing prices were relatively stable during the 1990s, but they began to rise toward the end of the decade.
• Between January 2002 and mid-year 2006, housing prices increased by a whopping 87 percent.
• The boom had turned to a bust, and the housing price declines continued throughout 2007 and 2008.
• By the third quarter of 2008, housing prices were approximately 25 percent below their 2006 peak.
1.4%
1.2%
1.0%
0.8%
0.6%
0.4%
0.2%
0.0%
79
80
81
82
84
85
86
87
89
90
91
92
94
95
96
97
99
00
01
02
04
05
06
07
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
20
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SUBPRIME MORTGAGES
• Subprime mortgages as a share of total mortgages originated during the year, increased from 5% in 1994
to 13% in 2000 and on to 20% in 2004-2006.
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Subprime (FRB) Subprime (JCHS)
FACTORS
The Great Depression that was one of the world’s largest downturns in economic history, this crisis
started from the American Housing. It spread to other economic sectors and influenced other
countries with respect to their dependence on American’s economy.
1- MORTGAGE LENDING
• "a house for every American" that was a policy of the American President of that era in the years
before the crisis, the Federal Reserve's expansionary monetary policy reduced interest rate which
increased real assets prices such as land and building.
• economic institution and firm such as banks and credit and finance foundations want to maximize
own profit. So, banks and financial foundations invested more and more in mortgages backed
securities for gaining more profit.
• So, they made loans to people with low income and poor credit which called sub-prime
mortgages, banks gave them mortgage with low interest rate, at first borrowers can afford it but
quickly they default and banks could take ownership of their houses and could sell for more than
one through this gain more profits
2. HOUSING BUBBLE
. Bubble is a rapid increase in housing prices, driven by irrational decisions and this bubble burst when people couldn’t pay for their houses
or keep mortgage payments. So, borrower started defaulting and put more houses on the market to sell but there weren’t buyers so supply
increase and demand decrease and home prices started collapsing. a large percentage of people that owned houses and could not to pay
the bank interest, they began to sell houses but there weren’t buyers.
.. The housing bubble began in 1998, peaked in 2006 and burst in 2007. With its easy money policies, the Federal Reserve
allowed housing prices to rise to unsustainable levels.
3. PERVERSE INCENTIVES
one key factor that led to 2008 crisis a perverse incentives are
when policy ends up and having negative effect like mortgages
brokers got bonuses for lending more money that encouraged
them to make risky loans which hurts profits that lead to moral
hazard because someone else bears the burden of that risk.
4. RATING AGENCIES
It was for rating agencies, and other participants, each maximizing his
or her own gain, The credit rating agencies gave AAA ratings to
numerous issues of subprime mortgage-backed securities, many of
which were subsequently downgraded to junk status.
16
IMPACTS OF THE 2008 CRISIS
INSIDE USA
WHAT STARTED THE GREAT RECESSION? WHO WAS MOST AFFECTED?
• THE RED-HOT U.S. HOUSING MARKET ACCOUNTED FOR NEARLY HALF OF ALL NEW JOBS CREATED IN THE EARLY 2000S—IT
SEEMED LIKE NOTHING COULD GO WRONG IN THE HOUSING SECTOR, BEFORE EVERYTHING QUICKLY DID. HOUSING
PRICES HAD DOUBLED SINCE THE 90S, FIRST-TIME HOMEOWNERSHIP RATES WERE SOARING, AND INVESTMENT BANKS
WERE TRADING MORTGAGE DEBT FOR PROFITS AROUND THE WORLD. AN ASSET BUBBLE HAD FORMED IN THE HOUSING
SECTOR, AND WHEN THAT BUBBLE BURST, IT SET OFF A SERIES OF EVENTS WITH DIRE CONSEQUENCES.
Subprime Mortgages Imploded
Subprime mortgages—a new category of mortgage that
was introduced in this period—allowed consumers with
less than perfect credit to purchase homes of their own.
These mortgages reset at higher rates—often every year
—in accordance with their loan terms or whenever
prevailing interest rates rose.
Subprime loans were often poorly explained and targeted
toward low-income buyers who did not understand just
what they were getting into by predatory lenders. In
addition, between 2004 and 2006, the Fed raised the Fed
funds rate from 1.0% to 5.25%, and as a result, millions
of subprime borrowers were unable to make their home
payments and thus defaulted on their loans.
• THE MORTGAGE INDUSTRY ENTERED CRISIS MODE
WITH MOUNTING LOSSES ON THEIR BALANCE SHEETS, DOZENS OF SUBPRIME MORTGAGE LENDERS WENT INTO BANKRUPTCY. IN
ADDITION, GOVERNMENT-SPONSORED ENTERPRISES FANNIE MAE AND FREDDIE MAC HAD TAKEN ON TRILLIONS OF DOLLARS OF
LEVERAGED LOAN GUARANTEES—THEY TEETERED ON THE BRINK OF INSOLVENCY BEFORE THE U.S. GOVERNMENT SENT THEM
EMERGENCY FUNDING AND PLACED THEM UNDER CONSERVATORSHIP.
• FINANCIAL FIRMS COLLAPSED AFTER TAKING ON EXCESSIVE RISK
BANKS HAD POOLED TOGETHER THOUSANDS OF HOME LOANS INTO MORTGAGE-BACKED SECURITIES, WITH THE RISKIEST POOLS,
OR TRANCHES, CONTAINING SUBPRIME MORTGAGES. TO OFFSET THEIR INCREASED RISK, THESE SECURITIES BOASTED HIGH
YIELDS, WHICH ENTICED INSTITUTIONAL INVESTORS LIKE HEDGE FUNDS, MONEY MARKET FUNDS, AND INSURANCE COMPANIES.
CLEARLY, TOXIC SUBPRIME DEBT HAD INVADED THE ECONOMY AT EVERY LEVEL, AND WHEN THE BUBBLE BURST, A PANIC BROKE
OUT, FOLLOWED BY A WAVE OF CAPITULATION. MANY MORTGAGE-BACKED SECURITIES BECAME WORTHLESS, AND THEIR BOND
FUNDING COLLAPSED. BANKS EXPERIENCED A CREDIT CRUNCH, WHICH MEANT THEY NO LONGER HAD THE FUNDS TO LEND TO ONE
ANOTHER, LEAVING MANY ON THE BRINK OF FAILURE.
On September 15, 2008, Lehman Brothers, one of the world’s largest
investment banks, declared bankruptcy. It was heavily leveraged in subprime
debt, and its failure would be the largest in U.S. history. President George W.
Bush coined the term “too big to fail,” as he called for the U.S. government to
step in with emergency aid to prevent other companies from going under and
avoid a global financial meltdown. The U.S. government also bailed out AIG,
an insurance behemoth, and Bear Stearns, another large investment bank.
In response to the collapse of Lehman Brothers, the Dow Jones Industrial
Average fell more than 500 points in September 2008, which resulted in its
largest single-day point decline in almost a decade. On December 1, 2008,
the National Bureau of Economic Research officially declared that the U.S.
economy had entered a recession as of December 2007.
IMPACTS OF THE 2008
CRISIS ON WORLD
ECONOMY
Some of the key impacts of the crisis on the world economy include:
Global recession: The crisis triggered a severe economic downturn, with economies around the world
experiencing a contraction in output and declining growth rates. Many countries such as Singapore and
China entered into recession, leading to high levels of unemployment and reduced consumer spending
WORLD MAP SHOWING REAL GDP GROWTH RATES FOR 2009 (COUNTRIES IN BROWN WERE IN RECESSION)
• GLOBAL TRADE: THE CRISIS HAD A NEGATIVE IMPACT ON GLOBAL TRADE, WITH EXPORTS AND IMPORTS FALLING SHARPLY IN MANY
COUNTRIES. THIS LED TO A SLOWDOWN IN ECONOMIC ACTIVITY AND REDUCED OPPORTUNITIES FOR BUSINESSES TO EXPAND
INTERNATIONALLY
• FINANCIAL MARKET INSTABILITY: THE CRISIS EXPOSED WEAKNESSES IN THE GLOBAL FINANCIAL SYSTEM, LEADING TO REDUCED THE
INFLOW OF CAPITAL THROUGH FOREIGN DIRECT INVESTMENT . COLLAPSE OF SEVERAL MAJOR FINANCIAL INSTITUTIONS AND A FREEZE
IN CREDIT MARKETS. THIS INSTABILITY HAD RIPPLE EFFECTS THROUGHOUT THE GLOBAL ECONOMY, CAUSING A DECLINE IN INVESTMENT
AND BUSINESS ACTIVITY.
• STOCK MARKET VOLATILITY: THE CRISIS CAUSED SIGNIFICANT VOLATILITY IN GLOBAL STOCK MARKETS, WITH STOCK PRICES
PLUMMETING AND INVESTORS EXPERIENCING SUBSTANTIAL LOSSES. THIS UNCERTAINTY LED TO A LACK OF CONFIDENCE IN THE
FINANCIAL MARKETS AND A DECREASE IN INVESTMENT.
• EFFECTS ON NON PERFORMING LOANS AS IN RUSSIA AND UKRAINE, THE NUMBER OF NON-PERFORMING LOANS INCREASED IN JULY
2009 BY RESPECTIVELY 300% AND 250% COMPARED TO THE NUMBER IN THE SAME PERIOD IN 2008. IN KAZAKHSTAN AND GEORGIA IT
INCREASED MORE THAN 500%
• UNEMPLOYMENT AND POVERTY: A SIGNIFICANT INCREASE IN UNEMPLOYMENT RATES IN MANY COUNTRIES, AS BUSINESSES CUT BACK
ON HIRING AND LAID OFF WORKERS. THIS RESULTED IN INCREASED POVERTY LEVELS AND SOCIAL UNREST IN SOME REGIONS.
GROSS
DOMESTIC
PRODUCT
(GDP)
In August 2007, pressures emerged in certain financial markets,
particularly the market for asset-backed commercial paper, as money
market investors became wary of exposures to subprime mortgages
(Covitz, Liang, and Suarez 2009). In the spring of 2008, the investment
bank Bear Stearns was acquired by JPMorgan Chase with the assistance
of the Federal Reserve. In September, Lehman Brothers filed for
bankruptcy, and the next day the Federal Reserve provided support to AIG,
a large insurance and financial services company. Citigroup and Bank of
America sought support from the Federal Reserve, the Treasury, and the
Federal Deposit Insurance Corporation.Then: The wide availability of loans
and significant, albeit temporary, increases in home prices led to the
unique economic event of the subprime mortgage crisis.
When the housing bubble burst, 23% of U.S. homeowners were
underwater on their mortgages.The year 2007 was marked by a high
economic growth and high inflation rate worldwide. in that year the
increase in public debt amounted to 978 billion USD and constituted only
13% of the total debt growth in the non-financial sector. The year 2008
witnessed an acute phase of the global financial crisis. That year, the
dynamics of the debt growth in households dropped by 67% to reach the
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amount of 855 bil- lion USD
What is interesting is that the debt of non-financial corporations
increased more than in the previous year and amounted to 3.98 trillion
USD. Due to the public debt growth, which substituted the debt decline of
households, the total debt of the non-financial sector also increased more
than in 2007 and amounted to 7.869 trillion USD. In 2008, the inflation
rate was 3.84%. The Federal Reserve cut interest rates from 5.25% in
September 2007 to 2% in April 2008 in hopes of avoiding a recession.
From the beginning of the recession in December 2007 to its official end
in June 2009, real gross domestic product (GDP) fell 4.3 percent from its
peak in 2007 to its trough in 2009, the largest decline in the postwar era.
The unemployment rate, which was 5 percent in December 2007, rose to
9.5 percent in June 2009, and peaked at 10 percent in October.
Following the outbreak of the global financial crisis, the economic growth
worldwide slowed down from 5.6% in 2007 to –0.1% in 2009 and the
world inflation dropped from 5.3% to 3.1%. The total credit growth for the
non-financial sector worldwide decreased from 7.2 trillion USD in 2007 to
6.1 trillion USD in 2009.
28
USA GOVERNMENT RESPONSE TO 2008 RECESSION
29
US government response:
• Federal deposit insurance corporation (FDIC), FDIC role was to
promote the public confidence in the US financial system by insuring
deposits in banks up to certain amounts, dealing with banks failure
effect
• FDIC brings the systemic risk exception that ignores the least cost law
during bank failure, and it provided assistance to three of the biggest
banking organizations like bank of America for example
• FDIC applied 2 programs
1- the debt guarantee program (DGP), which guarantees the
depositors money
2- Transaction account guarantee program ( TAGP), which provided
unlimited deposit insurance coverage of non-interest-bearing
transaction accounts
Under these programs the government guaranteed approximately 350
billion dollars in newly issued band debts
30
Federal reserve (the fed)
in 2007, the Fed attempted to stabilize the economy using its traditional methods, such as increasing liquidity and lowering interest
rates.
After the September 2008 collapse of Lehman Brothers (the fourth largest investment bank and the first major nonbank to fail), the Fed
used its emergency powers to make unprecedented liquidity facilities widely available. It loaned trillions of dollars to banks and nonbanks
in the U.S. and around the world to maintain the value of the dollar, stabilize the financial systems, and support the economy.
Liquidity with low interest rates encourage the demand again to overcome recession, and when the demand increases the prices will be
increasing
Treasury’s response
The Fed oversees the country’s monetary policy in order to help achieve the congressionally mandated goals to maximize employment,
stabilize prices, and moderate long-term interest rates. The Fed also supervises banks to ensure the safety and soundness of the
banking system, and it helps maintain the stability of the financial system in part by containing financial systemic risk.
31
Throughout the crisis, the Treasury worked closely with the Federal Reserve, and the FRBNY (federal reserve bank of New York),
especially on early liquidity issues. It coordinated with these and other agencies such as the FDIC, and the FHFA (federal housing
finance agency) to coordinate an overall response to save the financial system from collapse and protect the economy.
The Treasury itself had little legal authority to take action itself and very limited funding authority until Congress passed the Troubled
Asset Relief Program (TARP) in October 2008, secretary Paulson (head of the treasury) played a major role in the passage of
TARP, which provided $700 billion for the Treasury to use to fight the crisis.
In addition, Secretary Paulson provided critical assistance in the passage of new legislation (the Housing and Economic Recovery
Act (HERA)) which allowed Fannie Mae and Freddie Mac to be taken into conservatorship. Treasury was also instrumental in
supporting a number of initiatives relating to stabilizing the housing market and other industries such as the auto industries.
32
U.S. housing policies are the root cause of the 2008
financial crisis. Other players-- “greedy” investment
bankers; foolish investors; imprudent bankers; incompetent
rating agencies; irresponsible housing speculators; short
sighted homeowners; and predatory mortgage brokers,
lenders, and borrowers--all played a part, but they were
only following the economic incentives that government
policy laid out for them.
Peter J. Wallison
THANK YOU
