Economic Turmoil and its Impact on People
Dr. Antonio Avalos
aavalos@csufresno.edu
(559) 278-8793
Department of Economics
California State University, Fresno
OSHER Lifelong Learning Institute
Jan 28, 2008
Presentation
1) Global perspective of the origin of the crisis
2) Connection to the US Economy
3) The increased complexity of the finance world
4) The current economic crisis
5) Impact on people
6) Attempts to ‘fix the economy’ (TARP & ARRP)
7) Economic Forecasts
8) Final notes about Fresno County
The world is getting richer…
World GDP (current trillion US$)
70.0
60.0
50.0
40.0
30.0
20.0
10.0
08
20
6
20
0
4
20
0
02
20
00
20
8
19
9
6
19
9
94
19
2
19
9
0
19
9
8
6
19
8
4
19
8
2
19
8
19
8
19
8
0
0.0
Source: World Development Indicators 2008, World Bank
•
•
World GDP has multiplied by 6 in the last 3 decades
After last recession (2001-2002), growth increased significantly
…and people worldwide is saving more.
World Gross Domestic Savings (current trillion US$)
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
High income
Middle income
20
08
06
20
04
20
02
20
00
20
98
19
96
19
94
19
92
19
90
19
88
19
86
19
84
19
82
19
19
80
0.0
Low income
Source: World Development Indicators 2008, World Bank
Result  A “huge global pool of money”
2000
36 trillion US$
2007
70 trillion US$
>
2007 World
GDP
SHARP INCREASE IN SAVINGS !!!
•
Insurance companies saving for a catastrophe, pension funds saving
for retirement, deposits in central banks around the world, etc.
Important Consequences:
•
•
Global army of nervous investment managers hungry for attractive
returns to make it bigger and not to loose a penny.
Traditionally, they invest in secure financial instruments such as Tbills…..HOWEVER
In the US Monetary policy was changing…
Recession
Periods
1
•
Federal Reserve started lowering Federal Funds Rate to reach 1%
making this usually attractive instrument incredible unattractive and
driving global investment managers to look for substitutes.
…and the global pool of money discovered
a new financial instrument:
 MORTGAGE LOANS in the American Housing Market
T-bills
Paying 1%
or
Mortgage loans
Paying 5%-9%
?
But there was a problem  mortgage loans were too big of a hassle
to global international investors:
 They did not want to get involved with actual people and their messy
lives (their health issues, divorces, and any other reason that could
stop payment).
SO  Geniuses at Wall Street came up with an scheme to give
global investors the high yield of mortgage loans but without
the hassle and risks.
Mortgage Backed Securities (MBSs)
Family
Broker
Small
Bank
Big Investment
Firm
(Wall Street)
Global Pool of
Money
 Wall Street financial companies bought thousands of mortgages.
 Thousands of mortgage monthly checks producing a huge stream of
income, presumably for the next 30 years!
 Companies sold shares of that monthly income to investors as MBSs.
 Global investors loved MBSs  Wall Street had troubles keeping
up producing enough of them to satisfy the increasing demand.
A very nasty consequence  Enormous pressure to reduce standards!
An imprudent partnership
 In the beginning, most MBSs were composed by secure, responsible,
made mortgages and MANY of them were sold.
 Until 2003, pretty much everybody that needed a mortgage had
gotten one, but the Global Pool of Money wanted more…
 “Race to the Bottom” competition that produced lending to people
that under normal conditions would not receive a loan!!!
Standard
Loans
Stated Income
Verified Assets
Stated Income
Stated Assets
NINJA
LOANS
No Income
No Assets
A New Era
 Banks did not need to hold loans for 30 years
 Banks did not have to wait to see if loan would be paid or not.
 Only hold loans for 30 days and sell them to big investment firms
(Goldman Sachs, Merrill Lynch, Bearn Stearns, JP Morgan, etc).
 Home prices were increasing very rapidly, which fueled the notion that
home prices in the US would never go down.
 IN FACT  Even if the worse happened (default on a mortgage), the
bank would end up with a house that was increasing in price!
HUGE competition to lend since juicy
commission depended on number of loans
BOTTOM LINE:
LINE If they were BAD loans, that was somebody else’s
problem!
Another factor  Triumph of data over
common sense
 Computer financial software analyzed huge amounts of data, and it
never produced a negative result or even a warning!!!
WHY?  They were using the WRONG data:
 These data were based on regular loans, not the newly created loans!
 Historical data on foreclosure rate indicated it was less than 4% (they
calculated 10% or 12% in a worse case scenario).
 Historical data was IRRELEVANT  as some loans have registered a
50% foreclosure rate.
INCREDIBLY  Even rating agencies (Fitch, Moody’s, Standard &
Poor’s, etc.) which were supposed to accurately assess risk and
creditworthiness of these loans, assigned AAA ratings to MBSs.
The straw that broke the camel’s back
Collateralized Debt Obligation (CDOs)  Pool of slices of MBSs,
some of which are riskier than others.
REMEMBER  MBSs are pools of thousands of mortgages
 Those CDOs that have higher risk are called “TOXIC WASTE”
AGAIN, in 2005 and 2006, global pool of money loved them!
Due to competition for funds by selling CDOs, a similar pressure to
lower the standards occurred.
INCONSISTENCY  Even though housing prices were going up
(2002-2006) in this speculative housing bubble, households were not
making more money!
The housing bubble pops!  Late 2006
 As people were given more and more homes they could not afford,
around Halloween 2006, realtors started noticing that some households
could not make even the first payment!
 2006: The average home cost 4 times the average family income
(historic number was between 2 and 3 times)
 THE REVERSAL OF THE TREND: as more people defaulted, more
houses became available in the market and the price of homes started
to decline.
 Early 2007: Wall Street started to stay away from risky loans but small
banks were already indebted (borrowing money to buy loans that now
they could not sell!)
So  Banks had no option but to default!
The Global “Credit Crisis”
 Nobody really knows how much of the global pool of money was lost.
 The global pool of money now wants SAFETY! (zero risk!)
 Once again, T-bills look attractive, despite their incredibly low return
THUS, borrowing money is very difficult or costly
 Freezing of credit is new in the world, we have never seen
anything like this before.
 Trust among banks and financial institutions has been severely
damaged.
Spreading to other markets
COMERCIAL PAPER MARKET  Similar to credit cards for people to
pay day to day expenses such as payment to suppliers, payroll, etc.
(most large companies operate in this market basically writing short
term IOUs).
 Treasury of a company calls Wall Street (Goldman Sachs, Merrill
Lynch, Bearn Stearns, JP Morgan, Lehman Brothers, etc.) to issue
commercial paper (sometimes every day) and without this the US
Economy could hardly operate on a regular basis.
HOWEVER, in SEP 2008 this market got frozen, which marked the
beginning of a series of attempts on behalf of policy makers to rescue it.
 And all this is closely related to the MONEY MARKET MUTUAL
FUNDS!
Money Market Mutual Funds
 Usually very secure markets although the return is not very high.
 Earning this return usually implies buying Commercial Paper.
SAFE  People lending money to companies with great reputation
that for years had been paying on time these returns.
Safe until one very important and old mutual fund BROKE THE BUCK!
(“Reserve Fund” lost money from its depositors!)
WHY? They were buying from a company called Lehman Brothers
This caused the typical bank run  Pension fund managers and
other investors started pulling their money out of the commercial paper
market.
 The mortgage crisis was spreading to other markets!!!!!!
The Largest “Mattress” of the World
 Lehman Brothers went bankrupt because of its own exposure to bad
home loans.
 Then AIG almost collapsed as well.
IN TWO WEEKS  Basically there was no money in the commercial
paper market, it dried up!
A huge trust problem started. Nobody knew who had losses and who did
not. THUS, most people went to the safest instruments of all: T-bills
CONSEQUENCE  Borrowing money would be almost impossible with
tremendously negative consequences for a market economy such as
the U.S. Economy.
 Every day there are reports of companies cancelling plans because
inability to borrow money.
The ‘breaks’ that slowed down the economy
Consumption
falls
Housing
Crisis
Investment
falls
Confidence
falls
All this happens as credit
markets gets frozen and
crisis spreads to all sectors
of the economy
Government tax
revenues fall at
all levels:
Federal, State
and Local
The Current Economic Crisis
U.S. Employment Monthly Change (Thousands): 1998-2008
Source: U.S. Bureau of Labor Statistics (BLS)
Nearly 2.6 million jobs were lost over 2008, the highest
yearly job-loss total since 1945.
The Current Economic Crisis
U.S. Unemployment Rate (%): 1970-2008
7.2%
Source: U.S. Bureau of Labor Statistics (BLS)
Not quite the 10.8% we reached in Dec 1982, but rising
very quickly!
Unemployment Rate (annual average), 1990-2007
18.0%
16.0%
14.0%
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
1990
Down
ward
13.2%
trend
9.1%
1992
1994
1996
1998
2000
Fresno County
2002
2004
2006
2008
California
Source: California Employment Department, 2008
For the last 20 years, the unemployment rate in Fresno County has exceeded
the one for California by an annual average of 5.6 percentage points.
HOWEVER  This differential has tended to get smaller.
Impact of People
DIRECT:
 Losing jobs and losing homes (loss of wealth)
 Loosing health insurance
 Difficulties to afford child care and education (school)
 Lost of savings, mainly through pension funds
 Shifting behavior toward lower quality goods and services
 Emotional distress and tension between and among families
INDIRECTLY:
INDIRECTLY
 Loss of unemployment insurance
 Inability to borrow money (school loans, car loans, etc.)
 Reduction or even loss of important government services at federal, state
and local levels (health, education, security, etc.)
 Increase in crime rates
 Size and variety of goods and services available is being reduced
First attempt to solve the crisis: The TARP
TARP = Troubled Asset Relief Program ($700 billion)
 Originally, it allowed the US Department of the Treasury to purchase or
insure (TOXIC) "troubled” assets from banks and other financial
institutions.
 IMPORTANT GOAL: to encourage banks to resume lending at levels
seen before the crisis, both to each other and to consumers and
businesses (this goal has not been met).
 Revision to the plan: Treasury bought preferred stock and warrants in
the nine largest American Banks, and is buying preferred stock and
warrants from hundreds of smaller banks. The first $350 billion TARP
money was primarily used to buy preferred stock, which is similar to
debt in that it gets paid before common equity shareholders.
 Just recently, former President Bush extended the use of TARP funds
to support the auto industry.
Why the TARP is not working?
 Hundreds of billions of dollars have been injected into the marketplace
with no demonstrable effects on lending.
WHY?
 American taxpayers are the major provider of finance to the banks, yet
they have no voice in how the banks are run.
 It is almost impossible to value ‘toxic assets’ since they are not being
traded right now (government had to ‘make up’ a price).
 Banks are heavily leveraged, in some cases 25 or even 30 times their
equity (at 25 to 1 leverage, a 4% fall in the price of assets wipes out
a bank’s net worth!)
 Many millions poured into banks, is being poured out to their executives
in the form of bonuses and to their shareholders in the from of dividends
(but no lending!)
The Case for Bigger Government
 For the last 30 years, US economy relied on the magic of free markets:
today major sectors are deeply in trouble: health care, energy,
transportation, finance, etc. Social and environmental needs are vast.
 Furthermore, the US is not better off than other rich nations in the world:
child-poverty and infant-mortality rates are higher, life expectancy is
lower, teenagers rank among the lowest on tests of math and science.
 Most analysts agree that we need a more active role of the government:
We need more government and we need deficit spending
to help revive the economy from a recession.
BUT ONLY if the price is right and the strategies are convincing.
Government intervention should deal with the present crisis but at the
same time should be sensible of the future.
The second attempt: The AARP
AARP = American Recovery and Reinvestment Plan ($825 billion)
 Doubling the production of alternative energy in the next three years.
 Modernizing more than 75% of federal buildings and improve the
energy efficiency of two million American homes.
 Making the immediate investments necessary to ensure that within five
years, all of America’s medical records are computerized.
 Equipping tens of thousands of schools, community colleges, and
public universities with 21st century classrooms, labs, and libraries.
 Expanding broadband across America, so that a small business in a
rural town can connect and compete with their counterparts anywhere
in the world.
 Investing in the science, research, and technology that will lead to new
medical breakthroughs, new discoveries, and entire new industries.
Obama’s additional plans
 Responsibly end the war in Iraq and dedicate more resources to the
fight against the Taliban and al Qaeda in Afghanistan.
 Eliminate Our Current Imports from the Middle East and Venezuela
within 10 Years.
 Create Millions of New Green Jobs by investing $150 billion over the
next ten years to catalyze private efforts to build a clean energy future.
 Make the Tax System More Fair and Efficient.
 Affordable, accessible health care for all Americans.
 Expand the Earned Income Tax Credit.
 Raise the Minimum Wage to $9.50 an Hour by 2011.
 Provide Tax Relief (plan will eliminate taxes for seniors making
under $50,000 per year).
 Commitment to ensuring Social Security is solvent and viable for the
American people.
Simultaneously  Restore Fiscal Discipline to Washington
US Economic Forecasts
SOURCE
2008
2009
The Conference Board
RGDP
UR
IIIQ*
-0.5%
6.0%
UCLA Anderson
RGDP
UR
-0.5%
6.0%
-4.1%
6.5%
-3.4%
7.6%
-0.8%
8.2%
RGDP
UR
-0.5%
6.0%
-5.0%
-3.0%
-1.0%
RGDP
UR
-0.5%
6.0%
-2.9%
6.6%
Goldman Sachs
Survey of Professional Forecasters
IVQ
-5.9%
6.9%
IQ
-3.4%
7.5%
IIQ
-1.5%
8.2%
IIIQ
2.4%
8.6%
IVQ
2.5%
8.9%
8.4%
8.5%
9.0%
-1.1%
7.0%
0.8%
7.4%
0.9%
7.6%
2.3%
7.7%
RGDP = Real Gross Domestic Product
UR = Unemployment Rate
* = Actual official numbers
Recovery period
As far as financial markets…
 The crisis showed the flaws in financial markets, they were
plagued by:
 Poor regulation
 Dangerous incentives
 Reckless use of mathematical models using the wrong data
What can we expect in the near future?
 Smaller markets and smaller financial institutions
 More (or at least) better regulation
 More conservative
Rapid Population Growth in Fresno County
2000
2010
2020
2030
2040
2050
Fresno County
Population
Growth Rate
804,508
983,478
22.2%
1,201,792
22.2%
1,429,228
18.9%
1,670,542
16.9%
1,928,411
15.4%
California
Population
Growth Rate
34,105,437
39,135,676
14.7%
44,135,923
12.8%
49,240,891
11.6%
54,266,115
10.2%
59,507,876
9.7%
Source: State of California, Department of Finance, Population Projections for California and Its
Counties 2000-2050, Sacramento, California, July 2007.
•
•
By 2050, total population in Fresno County will be 2.4 times higher.
By 2050, total population in California will only be 1.7 times higher.
•
Despite the projected declining rates of growth, Fresno County will
continue to grow faster than California.
Hispanics Growing the Fastest: Fresno County
100%
90%
5.1%
8.2%
4.8%
9.4%
5.0%
8.9%
4.6%
4.6%
4.6%
11.1%
11.7%
12.2%
24.5%
21.2%
18.7%
10%
28.5%
20%
33.7%
30%
40.4%
40%
2
2010
3
2020
4
2030
2040
5
2050
6
0%
1
2000
62.4%
60.4%
57.7%
50%
55.6%
60%
50.1%
70%
44.0%
80%
White
Hispanic
Asian
Black
Other
Source: State of California, Department of Finance, Population Projections for California and Its Counties
2000-2050, Sacramento, California, July 2007.
2050: Hispanic population will be 3.4 times higher than in 2000  1,202,527
2050: White population will only be 1.1 times higher than in 2000  361,135
Larger Numbers of Working Age People: Fresno County
1,200,000
1,054,108
936,484
1,000,000
799,043
800,000
689,426
20-64
65+
574,467
600,000
440,153
400,000
200,000
136,226
79,282
193,075
243,540
317,524
92,657
0
2000
2010
2020
2030
2040
2050
Source: State of California, Department of Finance, Population Projections for California and Its Counties
2000-2050, Sacramento, California, July 2007.
•
•
Working age population in Fresno County will double by 2040
Retirement age population in Fresno County will triple by 2040
Fresno County Declining Worker/Elder Ratio
Worker / Elder Ratio
7
6
5
4
3
2
1
0
2000
2010
2020
Fresno County
2030
2040
2050
California
Source: State of California, Department of Finance, Population Projections for California and Its Counties
2000-2050, Sacramento, California, July 2007.
•
In Fresno County:
– 2000  Approximately 5.5 working people for every retired person.
– 2040  Approximately 3.8 working people for every retired person.
Income Distribution by Quintiles: Fresno, MSA: 2006
Low Middle
3%
Poorest
1%
Middle
5%
Upper
Middle
9%
Richest
82%
Source: U.S. Census Bureau,
American Community Survey (ACS)
 In 2006, while the richest 20% of families earned 82% of the total household
income in Fresno, the poorest 20% of families earned only 1%.
10 Fastest Growing Occupations (2004-2016)
Fresno County
Occupational Title
Network Systems and Data Communications Analysts
Computer Software Engineers, Applications
Pharmacy Technicians
Home Health Aides
Medical Assistants
Substance Abuse and Behavioral Disorder Counselors
Employment, Recruitment, and Placement Specialists
Bartenders
Computer Systems Analysts
Pharmacists
Respiratory Therapists
Annual Average
Employment
2006
2016
280
420
430
600
550
750
1,570
2,140
1,720
2,250
230
300
370
470
460
580
370
460
500
620
340
420
Percent
Change
50.0%
39.5%
36.4%
36.3%
30.8%
30.4%
27.0%
26.1%
24.3%
24.0%
23.5%
Median Hourly
Wage
$31.36
$38.72
$16.62
$8.89
$12.81
$15.94
$26.43
$8.66
$36.06
$58.08
$30.08
Source: California Employment Department, 2008
 Average hourly wage of 10 fastest growing occupations ($28.37) is higher
than average hourly wage for all occupations ($21.08).
 9,010 new jobs in these occupations will represent more than 27% of the total
new jobs in 2016.
Business Situation (Entrepreneurship), Selected Years
Number of Establishments by Employment-size Class
County/1997
Fresno
Riverside
San Bernardino
Washoe
Maricopa
County/2004
Fresno
Riverside
San Bernardino
Washoe
Maricopa
County/2006
Fresno
Riverside
San Bernardino
Washoe
Maricopa
1-4
8,017
13,105
13,064
5,748
35,741
1-4
7,937
16,338
14,905
6,378
42,460
1-4
8,139
18,286
16,143
6,623
47,290
5-9
10-19
3,070
4,792
5,159
2,002
12,719
5-9
2,056
3,006
3,427
1,297
8,821
10-19
3,019
5,824
5,776
2,124
13,893
5-9
2,314
4,001
4,209
1,622
10,192
10-19
3,132
6,234
6,056
2,226
14,938
2,366
4,365
4,409
1,699
11,076
20-49 50-99 100-249 250-499 500-999 1000+ TOTAL
1,409 416
2,142 726
2,656 875
869 274
6,324 2,214
197
368
445
149
1,298
44
75
115
39
341
20
29
34
11
110
5
9
16
16
79
15,234
24,252
25,791
10,405
67,647
20-49 50-99 100-249 250-499 500-999 1000+ TOTAL
1,648 530
3,011 1,058
3,282 1,099
1,060 350
7,599 2,846
231
564
635
196
1,654
54
123
165
39
445
20
50
46
16
170
9
24
27
14
86
15,762
30,993
30,144
11,799
79,345
20-49 50-99 100-249 250-499 500-999 1000+ TOTAL
1,786 564
3,262 1,159
3,604 1,160
1,189 373
8,433 3,276
281
682
720
234
1,923
59
153
188
54
585
23
61
47
19
183
11
30
29
14
86
16,361
34,232
32,356
12,431
87,790
Source: County Business Patterns, U.S. Census Bureau, 2008
 Signs of Improvement  In only 2 years (2004-2006) the total number of
Establishments grew 3.8% compared to 3.5% in the previous 7 years.
 Number of small businesses is also growing, rather than declining.
Thanks very much!
Dr. Antonio Avalos
aavalos@csufresno.edu
(559) 278-8793