The Financial Crisis of 2007:

A Multidisciplinary Approach Toward Its Understanding

By Carlos Valera

April 16, 2009

Defining the Financial Crisis of 2007

Collapse of Financial Markets and Banking System

Massive Rise in Defaults in Home Mortgages

Underwriting of Debt, Decapitalization of Banks

Credit Crunch

Lower Gross Domestic Product for 2008 (1.1% growth)

Less Investment/Production

Layoffs Less Available Income/Credit for Expenses

Businesses

Lower Consumption, Bigger Cash Savings

HouseholdsBusinesses HouseholdsBusinesses Households

caused by

Research Question

Can economic rationale alone explain the hype built around the Housing Market,

which led to the Financial Crisis of 2007?

Main Thesis

Conditioned by

Exacerbated by

Misleading economic information

on housing and financial markets

Greater socio-political

goal of Homeownership

Distorted speculative consumer and

investor behavior

Low Federal Funds Interest Rates

Multidisciplinary Approach

American Dream Concept

Boost Homeownership rates, especially among Minorities

Legislation

Lenient Lending Standards

Increased Demand for Housing

Rising expectations of House Prices

Creation of Profitable Financial Instruments

Excessive and Continuous Mortgage Borrowing

Boosted by Low Interest Rates

Sociological

Political

Psychological

Economic

Multidisciplinary Approach

Sociological Perspective

Life, Liberty, and The Pursuit of…

“[The American Dream is] that dream of a land in which life should be better and

richer and fuller for every man, with opportunity for each according to his

ability or achievement…It is not a dream of motor cars and high wages merely, but a dream of a social order in which each man and each woman shall be

able to attain to the fullest stature of which they are innately capable, and be recognized by others for what they

are, regardless of the fortuitous circumstances of birth or position.”

James Truslow Adams, “The Epic of America”

Political Perspective

Why is Homeownership

important?

Homeownership as a Public Policy Goal

“…I believe when somebody owns their own home, they're

realizing the American Dream…The problem is we have what we

call a homeownership gap in America. Three-quarters of

Anglos own their homes, and yet less than 50 percent of

African Americans and Hispanics own homes…So I've set this goal for the country. We

want 5.5 million more homeowners by 2010 – (sic)

million more minority homeowners by 2010. Five-and-a-half million families by 2010 will own a home. That is our goal. It is

a realistic goal.”

President George W. Bush at Department of Housing and Urban Development, Washington, D.C.

June 18, 2002

Legislation

• Community Reinvestment Act (1977, last modified 1995)

• Home Mortgage Disclosure Act (1975)

Lenient Lending Standards

“If you had a pulse, we gave you a loan”

Source: Richard Greenberg, Chris Hansen. Dateline NBC. March 22, 2009

Homeownership rates per State

Psychological Perspective

Speculation on Housing Prices

Economic Perspective

Profitable Financial Instruments: Mortgage-Backed Securities

MortgageB

MortgageA

MortgageC

Mortgage Pool

Mortgage-BackedSecurity

Mortgage-BackedSecurity

Mortgage-BackedSecurity

Asymmetrical, More Risk Symmetrical, Less Risk

Low Interest Rates: A “Liquidity Party”?

Conclusions

What went wrong?American Dream Concept

Boost Homeownership rates, especially among Minorities

Legislation

Lenient Lending Standards

Increased Demand for Housing

Rising expectations of House Prices

Creation of Profitable Financial Instruments

Excessive and Continuous Mortgage Borrowing

Boosted by Low Interest Rates

Sociological

Political

Psychological

Economic

Policy Implication

Challenge: Tradeoff between homeownership for all and return to

stricter lending standards

Acknowledgements

Dr. Stephen Quinn, Associate Professor of Economics, TCU Economics Department

In Loving Memory of Nora Miriana Rios Suarez (1926 – 2009)

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