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Speculative Bubbles
2002 - 2007Holland 1634 - 1637
1996 - 2000
1925-29
The Housing Market Crisis
• What Happened?
“The Economist” Magazine Covers During the Economic Crisis
The Housing Market Crisis
• What Happened?
Consumers were required to put a 20% down payment
• For a $500,000 home: – $100,000 down payment & borrow $400,000 (mortgage)– loan is paid back over 30-years at a fixed interest rate (ex: 6%/year)
• The loan is less than the value of the house– So banks are taking very little/no risk of default
PRIME MORTGAGES ONLY!!!
Buying a house (before 2000):
New Sub-prime Mortgages
• Sub-prime mortgages were introduced in the year 2000
• These mortgages required no down payment to borrowers with poor credit history
• Mortgages often had low initial interest rates which adjusted up later– Known as ARMs (Adjustable Rate Mortgage) or variable rate loans– Example: 2% interest rate/year for the first 3 years; after that the
interest rate changes to 9%/year– Personal example
Housing Bubble Analysis
Subprime Mortgage Example• Price Paid: $1,000,000• Down Payment: 0
• You owe: $1,000,000
Initial Value of House $1,000,000
Housing Bubble Bursts: New Value of House: $900,000
Homeowner now owes 1 million but only has a house worth $900,000. • Now he can’t refinance his loan and his house payments skyrocket when the loan resets.• If he can’t pay his monthly mortgage, the Bank will foreclose on his house!• Huge incentive to just walk away from the house.
Major Problem!
Subprime Mortgage Analysis
The Binge• Banks made loans to consumers who were not qualified with zero down
payments
• In the short run, this caused home prices to rise
• In the long run, this led to “inflated” home prices & people unable to pay their mortgage
• The Hangover: – home prices have fallen substantially – consumers are losing their homes to foreclosure– banks are failing (as they take the losses on foreclosures)
House of Cards
Caused by
Credit Bubble
Led to
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