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University of Toronto Scarborough
Economics for Management Studies
Jack Parkinson

ECMC48 – July 4 th Recent Financial Crisis Aug 18 2007 is when the graphic was posted. Showing that the financial downturn already started before the financial ‘crisis’. American housing market was booming, rising and rising for so long. Then eventually people believed that a home is a great investment all the time. They begin to make irrational decisions. Investors also began to think house prices would irrationally never fall. And that it’s forever a safe loan. Sub prime mortgage: The prime rate is an interest rate which the bank uses for customers that are the most safe. For clients with an outstanding credit report. Prime means best. So, sub prime mortgage is for someone who’s more riskier. If the prime rate is 3%, then the sub prime mortgage will be higher than this. So, often they quote ‘prime + x’, so prime + 3, imply 6% in this case. In America, there is no bank that is truly national. In Canada, the biggest banks are national, in every city. So, in America, generally, banks are concentrated for geographic reasons. Banks in America began to engage in more risky behaviour, which promoted risky behaviours in other firms due to competition. Bankers offered new financial ‘innovation’ to possible mortgage lenders. The 6% sub prime rate was too high, but bankers offered a lower interest rate for the first 2 years, at say 2%. NINJA loan, no income, no job and asset. You are qualified a loan. Banks that gave mortgages eventually had a bunch of mortgages that then sold it to investment banks, because they can’t keep lending forever. But through selling, they’ll get the money to keep on lending. So thanks to investment banks/credit rating, mortgage backed securities were created. It’s a bond like security backed by a mortgage portfolio. So, the investment banks get their fees, and now the risk is onto someone else. The investment banks went to the credit agencies to evaluate the MBS, and eventually the MBS was given a high rating. Credit agencies have a flawed concept because they essentially get money for the things they rate. As houses began to drop, people who were holding the MBS noticed and began to sell because they weren’t sure if people would be able to pay. Adverse selection. If a lot of people selling it, no one would trust it and wouldn’t buy it. So, we get a credit crunch. Eventually cash began to dry up due to fear and uncertainty, stocks markets began to plunge due to volatility. Central banks then stepped in. in hindsight, the dangerous assets were still there, the market did not recover after 2007. Bear Stearns bankrupt in 2008. Lehman Brothers in Fall 2008. They were #5, #4, of the 5 biggest investment banks at the time. Investment banks by nature are aggressive, but Bear Stearns were very aggressive, taking on a lot of risk. Investment banks are not regulated like charted banks by the federal reserve. Bear stearns borrowed daily on the overnight market to run their firm. Jp morgan eventually got funding from the C.B. the buy bear stearns. But before that, bear stearns bought up a lot of the failing hedge funds. Bear stearns was bought at $2/share from JP morgan b/c the government wanted to let everybody know that this is a bailout. Market loan for Canada is different from the united states. The regulatory regime is different here than usa. The interest on the mortgage loan in the usa is tax deductible. If you bought a big house in usa, you can write off your taxes. So, it’s encouraged to 1) take out a mortgage 2) to take out a bigger mortgage because more expensive, the more you can write off 3) the longer the amoritization is encouraged because you can write
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