4. SUMEET BASSI The financial crisis. How did this all happen?? Let’s start with the Borrowers, from their point of view… Things were going swell with the US economy. With low interest rates people can borrow money easily (it’s cheap to pay it back) When people borrow money, that puts lots of money in the system, lots of ‘liquidity’ There was a general shift. The banks feel OK offering lots of people a loan….even those that may not normally qualify. These are called Sub prime borrowers. Banks offer more loans, with lots of different terms. Adjustable rates, interest only for a while, etc. The buyers were encouraged by mortgage lenders, the terms were doable, at least until the rates adjusted, and overall, people were confident. When House values go up, my house increases in value. I will be able to renegotiate my loan for a better rate from someone else.. The economy is still growing! The buyer isn’t worried about their mortgage. Interest rates were historically low.
5. SUMEET BASSI So what happened? So things were good. The economy was growing fast, and then 2 things happened. The Fed decided it was time to raise interest rates. They wanted to prevent inflation, which happens as a result of lots of money in the system. So it went from 1% to 5.2% over a period of time. And…overall the number of people (or the demand) for houses went down. So less people bought houses,. With less people buying houses, the price of homes fell. People who had these loans out and thought they would be able to refinance their home, when the value of their home went up, were stuck paying a much larger payment than they agreed on. And subsequently…couldn’t make their payment. So lots of people defaulted,. When the borrower doesn’t make payments …someone still has to come up with the money. . 1 2
6. . These loans were no longer with the banks that had made them. Instead they were held by investors around the world. And because these banks can’t borrow, they are left needing money, and wanting to sell their securities..* But…no one really wants to buy these.. Here’s where it gets sticky. Remember the bank.s…: In this case, the fear that drives the word “crisis” is that no one will lend money (bank to bank, or otherwise). People are afraid of the default risk…and it simply becomes ridiculously expensive to borrow money. … And we have a credit crisis. Hence the necessity to give banks money…or Bail them out with money. Bankers didn’t count on this perfect storm, everyone defaulting at the same time. There were big models of risk…none of which predicted this. It became harder for banks for borrow. The impact wasn’t just the mortgage market. It trickled into the corporate market and overall drove down the appetitive for investment. SO….the price of borrowing went up and the value of debt goes down. What this means is that Banks had to write down their assets. How much? People were unsure. When people don’t know, they don’t trust. And when you don’t trust someone, you’re not going to want to lend them money. This is called a liquidity crisis.. Imagine if you had a gold necklace that you thought was worth mega money., and you bet it in a game of poker. You lose. Then, the next day, you find out the necklace is worth a lot less. Yikes! You still owe that person money, but now can’t sell the gold necklace to get the money. The banks had a lot of gold necklaces they couldn’t sell, and needed money *Securities.. are any form of ownership that can be easily traded on a secondary market…bonds, stocks, mutual funds. SUMEET BASSI
16. LEHMAN: became the largest corporate bankruptcy in United States history.
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18. AIG: Former AIG CEO Edward Liddy testifies before the U.S. House Financial Services Committee in March 2009 as protesters decry the federal government's bailout of the troubled insurer
19. DOW DROPS 778 POINTS: A trader reacts as the Dow Jones Industrial Average sank 777.68 points
20. THE TREASURY CHIEF: Former Treasury Sec. Henry Paulson spoke to the media at the White House in Washington on Sept. 15, 2008 regarding the financial crisis