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Poli Sci 2J03 - Feb 26, 2014

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Political Science
Robert O' Brien

Started on: Wednesday, February 26, 2014 C LASS N OTES FOR : McMaster University, Winter 2014 W EDNESDAY , FEBRUARY 26, Y Subprime Solution - Till 1990s the US government did not guarantee loans to “red-lined” communities labeled subprime - In 1990s US government policy to encourage extension of credit to underserved, largely poor minority communities - Homeownership rates increased to 69% in mid-2000s - The Greenspan put & zero Interest rate monetary policy o Federal reserve response to burst of tech stock bubble and 9/11 cheap credit Asian Savings Glut - Asian savings provided liquidity for the US financial system - High Asian savings rates resulting from - (a) Trade imbalances (Chinese manufacturing; oil price per barrel from 10 in ’99 to 147 in 2008) - (b) Lessons learned from 1990s financial crisis - Putting savings back into the America - Chimerica phenomenon? - China relied on America as a source of exports and US relied on China for savings and cheap manufacturing. - Further causes of the Crisis o Financialization: extension of credit into everyday life to maintain living standards o “The great stagnation: tiny increases in real wages o Became normal for households to borrow massively to sustain their lifestyle o The entire economy relied heavily on the “FIRE” sector (Finance, Insurance, Real Estate). Households that took on debt to stimulate the economy. o Causes of the crisis: overextension of Credit  Declining lending standards: NINJA Loans, “liar loans”, “low-doc”, and “no- doc” loans • No jobs, those who lied about their income, etc.  Predatory lending and crony capitalism: complex mortgages sold to poorest borrowers • Mortgages were pushed to the poorest and least educated in society • Fraud • Households were encouraged to refinance their homes - Causes of the crisis: o Financial innovation o Banks originating risky loans and then selling them off, making fees on as many transactions as possible. o The financial innovation was the pooling of batches of loans called into securities, traded in markets and passed off to investors who were more willing to bear on the risk Angie © McMaster University 1 Winter 2014 Started on: Wednesday, February 26, 2014 - Investment in piles of risky mortgages? o IBG-YBG: I’ll be gone and you’ll be gone, by the time the game collapses o Interconnected global financial system: o Many knew that there was no way that American borrowers would be able to pay things back, but continued because they were making high fees and returns. Enablers of the Crisis - Credit rating Agencies paid by Banks and gave top ratings - Central banks o Maintained risky securities o Even after the 9/11 issue o Did not want to spoil the situation even if there were high housing bubbles - Prominent mainstream economics o Massively overconfident and believed that they obtained business cycle “Great moderation” o The greatest enables were the financial regulators  In the US there is this Alphabet Soup of the SEC, the CFTC, the OCC, the OTS, FDIC, FED  Different types of regulations allowed financial institutions to play regulators off each other to get the most relaxed regulation - REGULATORY CAPTURE o Revolving door - staffing of regulators by experts from private sectors  Golden Sachs  Government sachs? o Intellectual capture  There is a blurring of the distinction between private and public interest! Fall 2005 - Bursting of the housing bubble - Mortgage default lead to financial institutions to heat up. - Fist institution was New Century Financial - largest lending in America, collapsed in 2006. - Collapse of two hedge funds there was a massive freeze and financial institutions stopped lending to one another. - Outbreak of the Crisis o British customers lined up to get their funds out of the mortgage lender “Northern Rock” Initial response - Private sector consolidation - Jan 2008 bank of America takes over countrywide financial - March 2008 JP Morgan Cha
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