Credit Crisis Deck

Credit Crisis Deck - The Financial Meltdown and You Ben J...

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The Financial Meltdown and You Ben J. Sopranzetti, Ph.D. Rutgers Business School
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Dow Plunges 400 to Below 8,000 as S&P Skids to 5- year Low!
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Citi lays off 53,000
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GM files for Bankruptcy
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US unemployment rate soars to 8.5%
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It all started with… The residential real estate bubble
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Debt and real estate returns
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Buy a house with Equity $100K House $0 Debt $100K Equity
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The price doubles $200K House $0 Debt $200K Equity
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What is your rate of return? ($200K-$100K)/$100K = 100%!
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What if you borrowed 80% of the value of the house? $100K House $80K Debt $20K Equity
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And again the house price doubles $200K House $80K Debt $120K Equity
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Now, what is your rate of return? ($120K-$20K)/$20K = 500%!!!!
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Anatomy of a price bubble Lax standards for borrowers and low interest rates after 9/11/2001 expanded the demand for houses which, in turn, inflated prices. Seemingly reliable price increases attracted speculators (flippers), who employed substantial leverage
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Adding to the problem… Total demand drove housing far beyond any sustainable price level. Confidence in ever-increasing housing prices tempted many to cash in their "profits" by taking home equity loans
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Aggressive mortgage brokers… Started to write subprime mortgages with deadly features… No money down No qualifications Interest Only Negative Amortization Exploding ARMs
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By the end of 2006, 30% of new mortgages in the USA were subprime mortgages, up from 2% in 2002
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Why would lenders grant these risky mortgages?
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BECAUSE THEY COULD!!
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Most subprime mortgages were sold off by the banks who originated the loans and converted into CDO's
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CDO? What is that? Collateralized debt obligation.
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This note was uploaded on 02/08/2011 for the course FINANCE 400 taught by Professor Soporzetti during the Spring '11 term at Rutgers.

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Credit Crisis Deck - The Financial Meltdown and You Ben J...

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