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The Economic Crisis of 2008: Cause and Aftermath
The Economic Crisis of 2008: Cause and Aftermath
U.S. housing policies are the root cause of the current financial crisis.
Other
players--
greedy
investment
- Peter J. Wallison
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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.
Annual Existing House Price Change
20.0%
15.0%
10.0%
5.0%
0.0%
-5.0%
-10.0%
-15.0%
-20.0%
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The default rate fluctuated, within a narrow range, around 2 percent prior to 2006.
It increased only slightly during the recessions of 1982, 1990, and 2001.
The rate began increasing sharply during the second half of 2006
It reached 5.2 percent during the third quarter of 2008.
Default Rate
6%
5%
4%
3%
2%
1%
0%
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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.
Foreclosure Rate
1.4%
1.2%
1.0%
0.8%
0.6%
0.4%
0.2%
0.0%
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Source: www.standardpoors.com
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The share of all mortgages held by Fannie Mae and Freddie Mac rose from 25 percent
in 1990 to 45 percent in 2001.
Their share has fluctuated modestly around 45 percent since 2001.
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1995
1996
1997
1998
1999
Subprime (FRB)
2000
2001
2002
2003
2004
2005
2006
2007
Subprime (JCHS)
Source: Data from 1994-2003 is from the Federal Reserve Board while 2001-2007 is from the Joint Center for Housing Studies at Harvard University
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Like subprime, Alt-A and home equity loans have increased substantially as a share of
the total since 2000.
In 2006, subprime, Alt-A, and home equity loans accounted for almost half of the
mortgages originated during the year.
1995
1996
Subprime (FRB)
1997
1998
1999
Subprime (JCHS)
2000
2001
2002
2003
Subprime + Alt-A
2004
2005
2006
2007
Source: Data from 1994-2003 is from the Federal Reserve Board while 2001-2007 is from the Joint Center for Housing Studies at Harvard University
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The Fed injected additional reserves and kept short-term interest rates at 2% or less
throughout 2002-2004.
Due to rising inflation in 2005, the Fed pushed interest rates upward.
Interest rates on adjustable rate mortgages rose and the default rate began to increase
rapidly.
Federal Funds
1 year T-bill
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Following the Fed's low interest rate policy of 2002-2004, Adjustable Rate Mortgages
(ARMs) increased sharply.
Measured as a share of total mortgages outstanding, ARMs increased from 10% in
2000 to 21% in 2005.
20%
15%
10%
5%
0%
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The leverage ratios of loans and other investments to capital assets for various
financial institutions are shown here.
When Bear Stearns was acquired by JP Morgan Chase its leverage ratio was 33 to 1.
Note, this was not particularly unusual for the GSEs and large investment banks.
67.9
Fannie Mae
21.5
Brokers/hedge Funds
31.6
Savings institutions
9.4
Commercial banks
9.8
Credit unions
9.1
0
20
40
60
80
Source: The Rise and Fall of the U.S. Mortgage and Credit Markets: A Comprehensive Analysis of the Meltdown, Milken Institute
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Source: www.economagic.com
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Total Debt
Mortgage
Source: www.economagic.com
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Compared to their prime borrower counterparts, the foreclosure rate for subprime
borrowers is approximately 10 times higher for fixed rate mortgages and 7 times higher
for adjustable rate mortgages.
There was no trend in the foreclosure rate prior to 2006 for adjustable rate or fixed rate
mortgages.
Starting in 2006, there was a sharp increase in the adjustable rate mortgage
foreclosure rate.
Foreclosure Rates on Subprime Mortgages
6%
5%
4%
3%
2%
1%
0%
Fixed
Adjustable
Source: Liebowitz, Stan J., Anatomy of a Train Wreck: Causes of the Mortgage Meltdown, Ch. 13 in Randall G. Holcombe and Benjamin Powell, eds, Housing America: Building
Out of a Crisis (New Brunswick, NJ: Transaction Publishers, 2009 (forthcoming) We would like to thank Professor Liebowitz for making this data available to us.
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While the foreclosure rate on fixed rate mortgages was relatively constant, the
foreclosures on adjustable rate mortgages began to soar in the second half of 2006.
This was true for both prime and subprime loans.
Fixed
Adjustable
Source: Liebowitz, Stan J., Anatomy of a Train Wreck: Causes of the Mortgage Meltdown, Ch. 13 in Randall G. Holcombe and Benjamin Powell, eds, Housing America: Building
Out of a Crisis (New Brunswick, NJ: Transaction Publishers, 2009 (forthcoming) We would like to thank Professor Liebowitz for making this data available to us.
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At the end of January 2009, the unemployment rate was 7.6 percent and it will surely
go higher. This is not unprecedented.
The unemployment rate rose to 9.6 percent during the 1974-75 recession, and to 10.8
percent during the 1980-1982 recession.
Even during the relatively short recession of 1990-1991, the unemployment rate rose to
nearly 8 percent and it remained at, or near, 7 percent for almost two years.
Peak Monthly Unemployment Rates in Recent Severe Recessions
12.0%
10.8%
10.0%
9.0%
8.0%
7.8%
7.6%
1990-91
2007-?
6.0%
4.0%
2.0%
0.0%
1973-75
1980-82
Source: www.bls.gov
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24%
25%
22%
20%
20%
19%
16%
14%
15%
10%
17%
17%
9%
5%
0%
1930
1931
1932
1933
1934
1935
1936
1937
1938
1939
Source: Bureau of the Census, The Statistical History of the United States from Colonial Times to the Present (New York: Basic Books, 1976)
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END
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