Project (Macro Economics)

Inside Job – Subprime Crises

Presented by
Ajay Kr Pandey -MPE 23
(Under the Supervision of Dr. Akshaya Dhume)
Executive Summary
Directed by Charles Ferguson and narrated by Matt Damon, this film dissects the causes and implications
of the downturn and analyses the role played by several key financial and political figures.

The beauty of Inside Job is that it makes the potentially daunting topic of the meltdown completely
accessible to the masses. One don’t need to be a banker or an economist, nor have heard of credit default
swaps and collateralized debt obligations, to follow it. The film clearly explains the developments with
the aid of graphical illustrations and Damon’s narration, in an easy to digest manner. It is enjoyable to
watch for both a finance layperson and a well-versed professional.

Inside Job demonstrates how the American financial sector brought the country to the brink through
reckless risk taking, complex financial structures, and sheer greed. Banks provided mortgages to people
who were unable to afford them in order to earn greater fees. Through financial engineering, these ‘toxic’
mortgages were then sliced, diced and bundled up into fancy packages and sold off to outside investors,
who later lost out when house prices declined and borrowers defaulted. The repercussions were severe
and spread throughout the economy. People lost their homes and investors and pension funds suffered
heavy losses. The information one learns in this film will inspire both anger and outrage.

Amongst the people interviewed for Inside Job are billionaire investor and philanthropist George Soros,
NYU professor Nouriel Roubini who predicted the crisis back in 2006, US Representative Barney Frank,
and Eliot Spitzer who sued the major investment banks while serving as the New York State Attorney
General. Also, there is Glenn Hubbard, Bush’s former economic advisor, who turns defensive and prickly
in response to the interviewer’s pointed questions. Furthermore, the colourful insights of former Wall
Street madam Kristin Davis are particularly intriguing. She claims that the Street’s corporate culture
involves abundant sex and drugs for bankers and their top clients, with large sums of money spent on
prostitutes and cocaine.

All in all, Inside Job is a well-argued and comprehensive critique of the factors leading to the financial
crisis. The director has done a masterful job of explaining things in a simplified manner. It is an eye-
opener and will leave you enthralled, fascinated and infuriated.

The subprime mortgage crisis, popularly known as the “mortgage mess” or “mortgage meltdown,” came
to the public’s attention when a steep rise in home foreclosures in 2006 spiraled seemingly out of control
in 2007, triggering a national financial crisis that went global within the year. Consumer spending went
down, the housing market had plummeted, foreclosure numbers continued to rise and the stock market
had been shaken. The subprime crisis and resulting foreclosure fallout had caused dissension among
consumers, lenders and legislators and spawned furious debate over the causes and possible fixes of the
“mess.”

ROOTS OF THE SUBPRIME CRISIS-

Housing Bubble - It is defined by rapid increases in the valuations of real property until unsustainable
levels are reached in relation to incomes and other indicators of affordability. Following the rapid
increases are decreases in home prices and mortgage debt that is higher than the value of the property.
The current mortgage meltdown actually began with the bursting of the U.S. housing “bubble” that began
in 2001 and reached its peak in 2005

Historically Low Interest Rates

The Bubble Bursts- Between 2004 and 2006, the Federal Reserve Board raised interest rates 17 times,
increasing them from 1 percent to 5.25 percent. The Fed stopped raising rates because of fears that an
accelerating downturn in the housing market could undermine the overall economy.

Declining Risk Premiums- A Federal Reserve study in 2007 reported that the average difference in
mortgage interest rates between subprime and prime mortgages declined from 2.8 percentage points in
2001 to 1.3 percentage points in 2007.

Mortgage Brokers and Underwriters- Because mortgage brokers do not lend their own money, there is
no direct correlation between loan performance and compensation for them.

Legislators Blame Fed-Regulators said that they lacked full authority to prevent the crisis that began with
the soaring housing boom. Many mortgage lenders had not been under the Fed’s supervision because their
primary regulators were state banking authorities. Dodd and others argued, however, that the central bank
does have authority under federal law to exert jurisdiction over these lenders and to broaden lending
regulations to cover them.

Credit Rating Agencies- Credit rating agencies are now under scrutiny for giving investment-grade
ratings to securitization transactions holding subprime mortgages. Higher ratings theoretically were due to
the multiple, independent mortgages held in the mortgage-backed securities, according to the agencies.

Conclusion

In conclusion, the causes of the subprime mortgage crisis were lax lending standards, falsification
of mortgage documents, poor decisions on part of the borrower, ripple effect of the dot-com crisis,
flooding of the housing market with excess numbers of new homes, and poor management on part of the
Federal Reserve.