UW-Madison ECON 102 - Derivatives and Risk in the Housing Market (4 pages)

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Derivatives and Risk in the Housing Market



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Derivatives and Risk in the Housing Market

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Derivatives, Making a Loan, Risk in the Housing Market, Securitization, The Inside Job Part III: The Crisis, How we got the Financial Crisis


Lecture number:
22
Pages:
4
Type:
Lecture Note
School:
University of Wisconsin, Madison
Course:
Econ 102 - Principles of Macroeconomics
Edition:
1
Documents in this Packet
Unformatted text preview:

Econ 102 1st Edition Lecture 22 Outline of Last Lecture I The Inside Job Outline of Current Lecture I Derivatives II Making a Loan III Risk in the Housing Market IV Securitization V The Inside Job Part III The Crisis VI How we got the Financial Crisis Current Lecture I Derivatives a an agreement between two parties that is contingent on a future outcome i In Finance a derivative is a financial contract with a value linked to the expected future price movements II Making a Loan a Make a loan i 100k loan 3k equity ii 110 owed end year iii 50 chance borrower wont make payment b Debtor can t pay These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute c Final Loan value III Risk in the Housing Market a diversifying the investments lowers the risk IV Securitization a Expected worst case scenario collapse in one region of the US i 1 000 mortgages in the SW US 50 chance of repayment 1 collapse in house prices in SW UW losses to lenders ii 1 000 mortgages in NE US 50 chance of repayment 1 house prices just fine lenders are repaid iii 50 fail which is what was expected and what was priced into the rate charged for the loan 1 half is going to pay off an you re getting the best half 2 Changing financial markets changed the housing market so each region was dependent on others a lesson dont be stupid Don t just look at the data need to analyze it without mistakes b Still hard to prevent it from happening again V The Inside Job Part III The Crisis a What is the worst case scenario i 2009 Bernanke became CEO of Federal Reserve 1 greatest year for subprime lending ii only at the last meeting did he suggest there was a problem iii 2008 Home foreclosures were skyrocketing iv Market for CDO s to collapse 1 leaving investment banks with tons of loans CDOs and real estate that they could not sell 2 A lot of concern about rating agencies a had they been bought out to give positive reviews b or some kind of incentive VI How we got the Financial Crisis a 1980 s investment banks go public less vigilance by owners b 30 years of deregulation including i Gramm Leach Bailey act ii Commodity Futures Modernization Act iii Opening of international capital markets c Housing boom d Security Food Chain i CDO collateralized debt obligations 1 Very large ii Such a small historical probability of a national housing slump 1 but it happened 2 EX low probability of tornado but if it happens it is disastrous iii Efficient Market Hypothesis 1 very little change in regulation since the great recession 2 most agree something needs to be done but WHAT We still do not know iv Ongoing Issues 1 Tax into an insurance fund 2 make it harder to declare bankruptcy a individuals and large firms b make people and companies more careful about what they choose to do 3 Took 5 years for international money flows to return to the level of 2008


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