Subprime Mortgage Crisis and Oil Price Shock

Cracks in the Façade: The 2007 Subprime Mortgage Crisis

• Subprime mortgages were a rapidly growing segment of the US mortgage market, given to borrowers with poor credit history.
• Loose lending standards, adjustable-rate mortgages with low introductory rates (teaser rates), and little documentation requirements fueled this growth.
• Subprime borrowers defaulted on their mortgages as housing prices slowed and interest rates reset higher.
• This led to concerns about a broader credit crunch impacting the US economy.
• Potential consequences included unsold homes, falling house prices, reduced consumer spending, and recession.
• The subprime crisis highlighted regulatory failure and the need for consumer protection measures, while balancing the need to avoid overly restrictive regulations.

The Looming Debt Crisis from Rising Oil Prices (1974)

• OPEC nations' oil price quadrupling significantly shifted income towards them.
• A massive trade surplus for OPEC and a growing debt burden for oil-importing nations resulted.
• Chairman Burns warned that this debt accumulation could lead to potential economic and political collapse of weaker nations, beggar-thy-neighbor trade policies, and excessive reliance on short-term financing.
• "Recycling" the debt was unsustainable; reducing oil prices was argued as the fundamental solution, achievable via increased supply (new discoveries/alternative energy) and decreased demand (conservation).
• The US, as the largest oil consumer, was urged to lead this effort through energy development and conservation policies.

A "Crisis of Confidence" and the Energy Problem (1979)

• President Carter addressed a "crisis of confidence" affecting the American spirit.
• Growing pessimism about the future, declining voter participation, falling productivity, and increased disrespect for institutions were highlighted symptoms.
• He attributed these to economic challenges (including inflation and foreign oil dependence), social and political upheavals (Vietnam War and Watergate).
• Carter advocated for a renewal of American values and a common purpose.
• He outlined ambitious energy policies focused on reducing foreign oil dependence, promoting conservation, and developing alternative energy sources.

The Financial Services Modernization Act of 1999: A Warning

• Senator Dorgan criticised the proposed act, arguing it would increase financial risks by separating commercial banking from riskier investment activities.
• He cited the historical precedent of the Glass-Steagall Act.
• Dorgan highlighted concerns about unregulated hedge funds, excessive speculation, and "too big to fail" doctrine leading to moral hazard in derivatives trading.
• He advocated for aggressive antitrust enforcement, tighter controls on risky activities, and remembering historical lessons.

The Global Housing Bubble and the Limits of Monetary Policy

• Alan Greenspan argued the global housing bubble was primarily caused by global forces (like excess savings in developing countries and declining global interest rates).
• He criticised the "Taylor Rule" as a reliable monetary policy guide.
• He defended the Fed's performance during his tenure, citing Milton Friedman's positive assessment.
• Greenspan proposed higher capital requirements, fraud prosecution, and encouraging responsible risk management as the appropriate policy responses.

Nixon's New Economic Policy (1971)

• President Nixon announced a new economic policy to address unemployment, inflation, and international speculation against the dollar.
• The policy included fiscal measures.

Reagan's Tax Cut Plan (1981)

• President Reagan advocated for tax reduction legislation as a key component of his economic recovery plan.
• He contrasted his plan (25% tax reduction over 3 years) with a competing proposal (15% tax cut over 2 years), criticizing the latter for increasing taxes due to bracket creep.
• Reagan argued his plan offered greater certainty for planning, targeted middle-income earners, and provided lasting tax relief.

The Global Property Bubble: A House of Cards?

• The article analysed the global property boom as a potential bubble, citing symptoms like unprecedented house price rise, low interest rates, and investor enthusiasm.
• The article warned that a housing bubble's burst could be more damaging than a stock market crash due to larger wealth effects, higher household debt, and greater impact on banks.
• The analysis predicted significant price declines in several countries, including the US, Australia, and European nations.

The Importance of Social Statistics and Expert Interpretation

• Milton Friedman emphasized the importance of social statistics for understanding societal trends.
• Experts, not the general public, should have deep understanding of social statistics.
• Statistics should be interpreted within a theoretical framework to avoid misinterpretations.

Explore the causes and consequences of the 2007 subprime mortgage crisis and the 1974 oil price surge. This quiz delves into how regulatory failures and economic shifts affected borrowers and the broader US economy. Test your knowledge on these pivotal financial events.