Week in Review: 11/21

Week in Review: 11/21
by Grace Wong

Key terms:

·      The Real Estate Bubble / Housing Crisis

Housing prices were at an all-time high in early 2006 but then rapidly declined through 2006 and 2007. It was caused by a lack of regulation of derivatives, a culture of reckless lending, and really giving credit to non-creditworthy people. Better Markets assessed that the bursting of the real estate bubble led to nearly $12.8 trillion.

·      Glass-Steagall Act

The Glass–Steagall Act was enacted in 1933 in response to the Great Depression and prohibits commercial banks from engaging in investing, and limited the capacity of commercial banks to hold securities. Starting in the 1960s the capacity of commercial banks to participate in securitization activities that culminated in its virtual nonexistence with the Graham–Leach–Biley Act.

·      Graham-Leach-Biley Act

The Graham-Leach-Biley Act of 1999 allowed banking companies, securities firms, and insurance companies to merge. While in the past, the Glass–Stegall Act had prohibited such consolidation, GLBA allowed for the Citigroup mega-merger, that included commercial banking holding company Citicorp and insurance company Travelers Group to create a corporate combination of banking services that includes Citibank, Smith Barney, Primerica, and Travelers.

·      Derivatives

In post-Cold War America, scientists and mathematicians flocked from defense R&D to the financial sector creating derivatives. Derivatives is a contract between two or more parties based on an asset, whose value is determined by the underlying asset value. They were supposed to make the financial sector safer but the complexities of derivatives did not lend itself to the average person understanding derivatives, and thus making it a riskier for many.  

·      CDOs

CDO stands for collateralized debt obligation. Investment banks combined a bunch of different types of debt obligations like mortgages, student loans, and bonds, and then essentially divided up those consolidated debt obligations and sold them off to various investors. The lack of regulation in CDOs allowed banks to bet on and against CDOs. And the lack of underlying asset to determine the exact value of collateral on the CDO made them volatile and a contributor to the failing of the banks.

·      Credit default swaps

When loaning money the lender has to be careful to only lend their money to people they know will pay it back in good faith. The credit default swap attempts to minimize/ eliminate possible loss if the person lending can’t pay back the loan, and often times results in a much higher rate as the person taking the loan has to pay the lenders potential losses as part of the loan. These were used during the Housing Crisis as mortgage brokers issued credit default swaps and people who really weren’t credit worthy.  

·      RMBs

A residential mortgage-backed security is the package of financial agreements between a lender and homeowner on their agreed upon interest rate and principal in cash yield. These securitized RMBs are from the originator and serve as a financial instrument to allow cash that has been received from individuals to  pay cash receipts out with waterfall priorities without cross-collateralizing individual loans and mortgages.

·      Subprime mortgages

Subprime mortgages give people with poor credit scores (less than 600) the opportunity to get a mortgage on a house. This could be seen as a plus because less credit worthy people can become homeowners, but include higher interest rates, poor quality collateral, and less favorable terms in order to compensate for higher credit risk. And at the height of the Real Estate Bubble a lot of non-creditworthy people got credit, and couldn’t pay back their loans which became really problematic really fast.

·      Money

Money is something that is scarce and is valued by people as a certificate to get goods and services. There is not necessarily a backing value for money, for example the U.S. dollar is no longer on the gold standard, but our money works because our society buys into it, people trust it, and it is widely accepted. Money however does not equate wealth, and has the subject to change value with inflation, the creation of more money, or big changes in fiscal and monetary policy.

Current events:

Trump and anti-trust laws

With the incoming Trump administration some have commented on his economic views specifically towards anti-trust laws. We saw this week in economics that the consolidation and conglomeratization of the financial sector led to the banks being ‘too big to fail’ and thus caused a hugely expensive bailout by Congress. Due to a lack of regulation post­–GLBA, the banks came together in serving investment, securitization, and commercial interests. While there is a lot that is unclear about Trump’s plans specifically many think that he will revive an era of anti-monopoly laws. Trump however has had a deep reverence for Ronald Reagan, and has largely capitalized on his ‘Silent Majority’ platform in winning the election; Reagan notoriously got rid of much regulation and specifically anti-trust which allowed for the economy to boom during the Reagan era. Trump has promised to block the AT&T–Time Warner M&A. Given his support base they have probably suffered from a powerful few corporations, thus giving him to greenlight to implement stricter anti-trust laws, while also doubling-down on foreign trade agreements, and gutting all the environmental protection clauses to boost the economy in the short-term (aka just enough to get him reelected).

Source: http://www.theatlantic.com/business/archive/2016/11/donald-trump-vs-big-business/507878/

There is a shortage of houses! 

Following the 2012 low of the housing market, selling a house hasn’t exactly been easy. While housing prices are cheaper, the post-bubble bust housing market has really suffered as banks are not loaning as recklessly and consumers are more timid to invest in the housing market. All of the foreclosed homes from the housing crisis all went back on the market, and the construction of homes practically ground to halt. That being said, as the economy begins to recover, we now have a shortage of homes. The average time for a house on the market this fiscal year is a mere 49 days, five days less than last year, and things are looking up. While October was not a particularly good month for home sales, historically summer is a better time to buy a home anyways, a lot of new housing projects started. The chief economist at the National Association of Realtors has said, “Housing starts soaring past the 1.3 million mark for the first time since 2007 is big and welcoming news. The choke point of the housing market growth potential has been the lack of supply. The consequent tight inventory conditions has been pushing up home values to rise at a faster rate than income growth over the past four years. This, in turn, has hurt affordability and contributed to the homeownership rate dipping to a 50-year low.” Housing starts rose by 25.5% in October and is a promising sign of increased homeownership nationwide.

Source: http://www.forbes.com/sites/troymcmullen/2016/11/17/home-prices-increase-in-october/#1cfb270be52d

Takeaways:

While I initially was set to release this week in review on 11/14, Ralph and I decided to wait until we finished Inside Job so it would be a more comprehensive review, and I think in doing that I got to really see the large scale effects of ivory-tower economics. At the beginning of the semester we talked about economic literacy and the importance of people to understand the financial industry in comparison to the people who actually have a sense of how to use financial tools. It is clear specifically in banking in relation to the population of homeowners during the Real Estate Bubble that down the chain from the investment banker to the mortgage broker to the homeowner that people did not really understand what was going on in the big picture. And those who did like those in the academy, IMF, and even to an extent Washington Post were dismissed as not knowing what they were talking about, or just brushed off as having too many concerns. We saw through the documentary that the top echelons of the financial sector not only control the industry, but also public policy via the SEC and Fed as well as the ivory-tower academic institutions that spit out Wall-St bankers. My biggest takeaway was to stay skeptical of the financial institutions and tools they weld an enormous amount of power. As someone who is really interested in policymaking, I would be interested in learning more about the financial lobby and the power they have vs. the appointed positions like governor/ chairman of the Fed.