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U.S. housing policies are the root cause of the current 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

GDP in 2006.Note: Financial services and insurance accounted for 7.8% of U.S. .

The Wharton Schoo . Guillén.Originate-andDistribute Model Excess Global Liquidity Scant Regulatory Oversight Mortgage Securitization Mispricing of Risk Credit Default Swaps Deterioration of Underwriting Standards Rising Real Estate Prices Low Interest Rates Excessive Financial Leverage Crisis Drive to Increase Investment Returns © Mauro F.

0% 15. Housing prices were relatively stable during the 1990s. housing prices were approximately 25 percent below their 2006 peak.0% -15.0% 0. and the housing price declines continued throughout 2007 and 2008. housing prices increased by a whopping 87 percent.com.0% 5. S and P Case-Schiller Housing Price Index.  By the third quarter of 2008.0% Source: www. but they began to rise toward the end of the decade.  The boom had turned to a bust.0% -5.0% -10.standardpoors.0% -20.  Between January 2002 and mid-year 2006.0% 10. Annual Existing House Price Change 20. 19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 .

 The default rate fluctuated.2 percent during the third quarter of 2008. around 2 percent prior to 2006.  It increased only slightly during the recessions of 1982. within a narrow range. 1990. National Delinquency Survey.org. Default Rate 6% 5% 4% 3% 2% 1% 0% 19 79 19 80 19 81 19 82 19 84 19 85 19 86 19 87 19 89 19 90 19 91 19 92 19 94 19 95 19 96 19 97 19 99 20 00 20 01 20 02 20 04 20 05 20 06 20 07 Source: mbaa. and 2001.  The rate began increasing sharply during the second half of 2006  It reached 5. .

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.  UK story : specific developments.  Global finance without global government: faultiness in regulatory approach. The global story : macro imbalances meet financial innovations.  Fundamental theoretical issues: market efficiency and rationality.

.2007: crisis in markets for mortgage related assets.  Some institutions were unable to raise needed funds.  Credit rating downgrades of subprime products  Prices of mortgage-backed securities fell and demand dried up.  Large losses at hedge funds for credit default swaps.  Banks began to write down mortgage related assets.

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.Two key crisis events were outside the U. • UK bank Northern Rock bailed out in sep. Fed and other Central Banks began aggressive response.S • August 2007.2007.French Bank BNP Paribas froze redemptions saying couldn’t value underlying securities.

2008:credit conditions continued to worsen • March : bear sterns • Sep : Fannie Mae and Freddie Mac • Sep 15 : Lehman Brothers • Sep 16 : AIG • Sep 25 : WAMU Credit markets froze up.S. . and the world entered the most severe recession since 1930’s. U.

. large margins are required-> must reduce leverage -> asset sales -> as in loss spiral.Borrower ’s balance sheet effects  Loss spiral : asset prices fall->must sell assets to correct BS -> asset sales cause further price decline.  Margin/haircut spiral: with increases assessment of risk. 2. L ending channel  Precautionary hoarding by banks and non banks.• Why did a crisis in a relatively limited part of the market turn into a full blown crisis? 1.

4. Hedge funds pulling money out of Bear sterns . AIG forced to post more collaterals.3. . Runs on non bank financial institutions. Networking effects  Counterparty risk : the argument for saving AIG  The gridlock risk.  Eg.

What we need and what we do not need .

time varying loan to value ratios?  Raises cost of borrowing.  Can drive business off-shore  Increase information burden  Off-load assets onto associated off-balance sheet entities.  Capital and liquidity requirements .  liquidity support.• The crisis was foreseen so the problem is not lack of information but lack of instruments. .?  Stigma issue  Moral hazard. • What do we need?  Countercyclical instruments:  interest rates?  Revise definition  Not enough to flatten a strong bubble.

 so commit to vary lending rate  Special resolution scheme(carrot and stick policy)  Devise time varying liquidity scheme. . • construct proper tools to make financial system potent.• Banks should disclose all associated off balance sheet business • Central banks to lend almost invariably in case of real crisis.

 CP1 : price stability  CP2 : financial stability  Short term interest rate as the only instrument:CP1 and CP2 in conflict. .  To maintain gold standard and avoid liquidity panic: two instruments namely  LOLR lending  keep interest rates high.

4.reduction of financial crime  suggestion: follow Twin peaks approach ~The twin peaks is )and not banking supervision.market confidence 2. characterized by separate prudential and market conduct regulators. Lead role of central banks in financial regulation(Financial Service Authority  The aim of financial regulators are: 1. . Since equal weight is given to prudential and market conduct regulation.  Overall conclusion: look for instruments to settle CP2 along with CP1. it is regarded as the optimal way to ensure that consumer protection and market integrity receive sufficient priority and are not routinely presumed to be subservient to prudential concerns.  CP1 settled but exaggerated financial turmoil of 2007.financial stability 3.consumer protection protection for consumers.

PRESENTED BY: CYRIL .PRAKASH .JASLEEN.