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Y376 International Political Economy, Lecture #15

Y376 International Political Economy, Lecture #15
March 10, 2011

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    Ipe15 Ipe15 Presentation Transcript

    • Y376 International Political Economy March 10, 2011
    • Global Financial Crisis 2007-8
      • Led by bursting of the housing bubble in the US in 2007
      • Made worse by near collapse of US financial markets connected with mortgage-backed securities , synthetic collateralized debt obligations (CDOs), and credit default swaps
      • Response to the crisis revived the debate over regulation of financial markets and Keynesian approaches to preventing deep recessions
    • Bursting of the Housing Price Bubble 1890-2005 1963-2008 The Bubble Bursts
    • Contributing Factors
      • Subprime mortgages
      • Unethical mortgage brokers
      • Low interest rates set by the Federal Reserve
      • Credit Rating Agencies (conflicts of interest)
      • Insufficient regulation of financial markets
        • Mortgages and related markets
        • Derivatives, including credit default swaps
    • Subprime Mortgages
      • Definition: a type of mortgage granted to individuals with low credit ratings (FICO less than 600)
      • Subprime mortgages feature higher interest rates than conventional mortgages because of the higher risk of default
      • Subprime borrowers were offered adjustable rate mortgages (ARMs)
      • US policy from the 1990s on was to encourage the growth of this market to make home ownership available to a wider spectrum of the population
    • Expansion of Subprime Market
    • Unethical Mortgage Brokers
      • Exaggerated expected earnings of borrowers
      • Sold more expensive loans when less expensive loans were available
      • Conspired with real estate brokers to raise the sale price of properties above market value
      • As a result, subprime delinquency rates began to increase rapidly after 2007
    • The Role of Low Interest Rates
      • Investors were looking for ways to obtain higher rates of return for low-risk investments
      • Treasury Bonds became less attractive for this purpose
      • Mortgage Backed Securities (MBSs) and Collaterized Debt Obligations (CDOs) expanded rapidly to fill the void
    • Credit Rating Agencies
      • These firms (e.g. Fitch Group, Moody’s, Standard and Poor’s) establish credit ratings for issuers of certain types of debt obligations.
      • The highest rating is AAA which denotes low risk and high liquidity.
      • They sometimes compete for business by offering better ratings (a clear conflict of interest).
    • Fun with Credit Rating Agencies
    • Insufficient Regulation
      • Securities and Exchange Commission (SEC) was supposed to regulate the mortgage market and apparently failed to do so
      • The Federal Reserve (especially when headed by Alan Greenspan) chose not to regulate derivatives markets
      • Government financial regulators relied too much on the private credit rating agencies and business journalist to expose malfeasance and overly risky investments
    • Short-Term US Government Responses
      • “ Rescue” of Bear Stearns
      • Decision not to rescue Lehman Brothers
      • Takeover of Fannie Mae and Freddie Mac
      • Troubled Asset Relief Program (TARP)
        • Bailouts of AIG and GM
        • $245 billion invested in US banks
      • Obama’s economic stimulus package
    • Medium and Long-Term Measures
      • Capital Adequacy Requirements and Deleveraging
      • Regulation of previously unregulated markets (derivatives, but especially credit default swaps)
      • Improved protection for consumers
      • Mortgage renegotiation incentives
    • Global Responses
      • Reworking of international capital adequacy requirements (Basel Accords)
      • Structural adjustment programs for Iceland, Ireland, Greece, Spain, and other countries – often involving austerity measures
      • Debates in each country about what to do to return the domestic economy to health
    • A Quick and Dirty Guide to Books on the Crisis
      • The Financial Crisis Inquiry Report
      • Andrew Ross Sorkin, Too Big to Fail
      • Carmen Reinhart and Kenneth Rogoff, This Time is Different
      • Michael Lewis, The Big Short
      • William Cohan, House of Cards
      • Lawrence McDonald & Patrick Robinson, A Colossal Failure of Common Sense