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Some lessons from the financial crisis for the economic analysis
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The stock market crashed in 2008 because too many had people had taken on loans they couldn't afford. Lenders relaxed their strict lending standards to extend credit to people who were less than qualified. This drove up housing prices to levels that many could not otherwise afford.- Steven Spielberg and Jeffrey Katzenberg both are reported to have lost from the funds. So did banks HSBC and Royal Bank of Scotland. Tufts University has written off a $20 million investment with Madoff, and Yeshiva University is another reported victim.
FINANCIAL CRISIS
U.S. Strategy and Outcomes
Introduction
The global ?nancial crisis of 2007-2009 and subsequent Great Recession constituted the worst shocks to the United States
economy in generations. Books have been and will be written about the housing bubble and bust, the ?nancial panic that
followed, the economic devastation that resulted, and the steps that various arms of the U.S. and foreign governments took to
prevent the Great Depression 2.0. But the story can also be told graphically, as these charts aim to do.
What comes quickly into focus is that as the crisis intensi?ed, so did the government"s response. Although the seeds of the
harrowing events of 2007-2009 were sown over decades, and the U.S. government was initially slow to act, the combined e?orts
of the Federal Reserve, Treasury Department, and other agencies were ultimately forceful, ?exible, and e?ective. Federal
regulators greatly expanded their crisis management toolkit as the damage unfolded, moving from traditional and domestic
measures to actions that were innovative and sometimes even international in reach. As panic spread, so too did their e?orts
broaden to quell it. In the end, the government was able to stabilize the system, re-start key ?nancial markets, and limit the
extent of the harm to the economy.No collection of charts, even as extensive as this, can convey all the complexities and details of the crisis and the government"s
interventions. But these ?gures capture the essential features of one of the worst episodes in American economic history and the
ultimately successful, even if politically unpopular, government response. 1Antecedents of the Crisis
2ANTECEDENTS
In the years leading up to the crisis,
the underlying performance of theU.S. economy had eroded in
important ways. 3 0 1 2 4 3 520082005 200019951990198519801975
Sources: Congressional Budget O
ce, "An Update to the Economic Outlook: 2018 to 2028"; internal calculationsANTECEDENTS
Because the growth of productivity and the labor force had slowed in the decade before the crisis, the potential economic growth rate was falling. Average growth in real potential GDP (August 2018 estimate)Productivity growth
Contribution to potential GDP from:
Labor force growth
4 9496
98
100
102
104
106
ANTECEDENTS
Overall prime-age participation in the labor force had been falling, as the participation of women slowed and men's continued a decades-long decline. Civilian labor force participation rates for people ages 25-54, indexed to January 1990=100Women, ages 25-54
All people, ages 25-54
Men, ages 25-54
Source: Bureau of Labor Statistics via Haver Analytics 5 - 50 0 + 50 +100+150
+200
+250
+300%
200820052000199519901985198019751970
ANTECEDENTS
Income growth for the top 1 percent had risen sharply, driving income inequality to levels not seen since the 1920s. Cumulative growth in average income since 1979, before transfers and taxes, by income groupBottom 20 percent
of households81st to 99th
percentiles of householdsTop 1 percent
of householdsMiddle 60 percent
of householdsSource: Congressional Budget O
ce, "The Distribution of Household Income, 2014" 6 0 20 4060
80
100
120
140%
200820052000199519901985198019751970
ANTECEDENTS
Household debt as a share of income had risen to alarming heights. Aggregate household debt as a share of disposable personal income (after taxes)Sources: Federal Reserve Board Financial Accounts of the United States; Federal Reserve Board, "Household
Debt-to-Income Ratios in the Enhanced Financial Accounts"Mortgage debt
Consumer debt
7ANTECEDENTS
Meanwhile, the
nancial system was becoming increasingly fragile. 8 0 8 6 4 2 10%2008200019901980197019601950194019301920
ANTECEDENTS
A "quiet period" of relatively low bank losses had extended for nearly 70 years and created a false sense of strength.Two-year historical loan-loss rates
Sources: Federal Deposit Insurance Corp.; Federal Reserve Board; International Monetary Fund 9 -15 -10 - 5 0 + 5 +10 +15 +20%200820052000199519901985198019751970
ANTECEDENTS
The "Great Moderation" - two decades of more stable economic outcomes with shorter, shallower recessions and lower in ation - had added to complacency.Quarterly real GDP growth
Source: Bureau of Economic Analysis via Federal Reserve Economic Data 10 0 5 10 15 20%200820052000199519901985198019751970
ANTECEDENTS
Long-term interest rates had been falling for decades, re ecting decreasing in ation, an aging workforce, and a substantial rise in global savings.Benchmark interest rates, monthly
30-year
xed mortgage rate10-year
Treasury2-year
Treasury
Sources: Federal Reserve Board and Freddie Mac via Federal Reserve Economic Data 11197019751980198519901995200020052008
0 + 40 + 60 + 80 +100%+ 20
Home prices had increased modestly
through several boom-and-bust cycles since the 1970s, but started a much more dramatic rise in the late 1990s.ANTECEDENTS
Home prices across the country had been rising rapidly for nearly a decade. Real Home Price Index, percentage change from 1890 Source: U.S. Home Price and Related Data, Robert J. Shiller, Irrational Exuberance 12 0 50100
150
200
250
200820052000199519901985198019751970
ANTECEDENTS
Credit and risk had migrated outside the regulated banking system. Credit market debt outstanding, by holder, as a share of nominal GDPInsurers
GSEs ABS MMFSource: Federal Reserve Financial Accounts of the United States Notes: GSE: government-sponsored enterprise (including Fannie Mae
and Freddie Mac); ABS: asset-backed securities; MMF: money market fundsQ1 1980
31%69%
Q1 2008
64%36%
Nonbank Financials
Broker-Dealers
Banks 13 0 0.25 0.50 0.75 1.00 1.25 1.50 1.75 $2.00 trillion200820052000199519901985198019751970
The use of repo funding tripled
in the decade prior to 2008.ANTECEDENTS
The amount of
nancial assets nanced with short-term liabilities had also risen sharply, increasing the vulnerability of the nancial system to runs.Net repo funding to banks and broker-dealers
Source: Federal Reserve Board Financial Accounts of the United States 14 0 2 4 6 8 10 12 14%Wells Fargo
CitiGoldman SachsMorgan
Stanley
BearStearns
JPMorgan
ChaseMerrill
LynchLehman
Bank of America
0%Reliance on short-term funding*
10%20%30%40%50%60%
0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0% '08'07'06'05'04'03'02'01Largest U.S. bank
holding companiesAll U.S.
nancial institutionsTier 1 common equity
ANTECEDENTS
The regulatory capital regime for the U.S.
nancial system was inadequate.Tier 1 common equity as a percent of risk-weighted assets Tangible common equity to tangible assets ratio
Sources: Capital ratios: Federal Reserve Bank of New York's Research and StatisticsGroup; tangible common equity to tangible assets: company reports*Determined by share of !nancial assets pledged
Estimated
capital and funding ratios, Q4 2007Commercial bank
Investment bank
Some institutions more
dependent on short-term funding were more leveraged.The pre-crisis capital ratios
did not re ect the growing risks. 15The Arc of the Crisis
16 0 100200
300
400
500 basis points
200920082007
Bank CDS
spreadsSource: Bloomberg. Note: Credit default swap spreads are equal-weighted averages of JPMorgan Chase,
Citigroup, Wells Fargo, Bank of America, Morgan Stanley, and Goldman Sachs.ARC OF THE CRISIS
The nancial crisis unfolded in several phases.Bank credit default swap spreads and Libor-OIS
Libor-OIS
spreadIncreasing StressEarly
Escalation
Breaking the Panic
and Resolution 17200820072006
-50 -40 -30 -20 -10 0 +10%Detroit
San Francisco
Miami TampaLos Angeles
San Diego
Phoenix
Las Vegas
Change, July 2006-March 2008
-22.5% -22.6 -23.1 -23.4 -24.4 -25.6 -26.6 -27.7ARC OF THE CRISIS
Home prices peaked nationally in the summer of 2006, then fell rapidly - eight major cities had declined more than 20 percent by March 2008.U.S. peak:
July 2006
U.S. change by March 2008: -9.0%
Sources: S&P CoreLogic Case-Shiller Home Price Indexes for 20 individual cities and National Home Price Index via Federal Reserve Economic Data
18 basis points 0 50100
150
200
250
300
350
400
200920082007
Source: Bloomberg Note: GSE: government-sponsored enterpriseARC OF THE CRISIS
Stress in the
nancial system built up gradually over late 2007 and early 2008, as mortgage troubles and recession fears increased.Libor-OIS spread
Bank of England provides
emergency credit to NorthernRock, a troubled mortgage
lender, Sept. 14, 2007Banks and GSEs start reporting
billions in losses in November 2007, and warn of dividend cuts and a need for more capital; stocks fallBNP Paribas freezes
three funds onAug. 9, 2007, amid
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