 Hi, this is Gerald Friedman, Professor of Economics at the University of Massachusetts at Amherst. And I'm here today to talk about the housing bubble leading up to the crash of 2007, 2008. And, oh, it was glorious for a few years. I, of course, felt like an idiot. We had a house. We had just one house. I wasn't buying another house. Everybody else I knew was making all this money. Housing prices in the early years of the 21st century were rising 20, 25% a year. It's like you couldn't lose. If you were in Florida, Nevada, Arizona, Southern California, prices would just go through the roof. All you needed to do was put a little money down and you'd watch your money double, triple, quadruple in a year. I wasn't doing that. I thought I was an idiot. Passing up a chance after I had already passed up another chance. Because in the late 1990s, we had another bubble in internet stocks. And people like my next door neighbor retired on all the money he made from investing in the internet. There was a little warning there because after 2000, when the internet bubble popped, companies like AOL and Sun Microsystems lost 90, 95, 99% of their value. People like my neighbor suddenly went back to work. He got out of retirement and he started a business. He's happy. Things are fine for him. That's what's fine for a lot of other people. We have bubbles in financial markets. And bubbles are natural and unpredictable and nobody has been able to figure out when they're going to happen and when they're going to stop. When I say no one, I include one of the smartest people in the history of our race, of our species, Sir Isaac Newton, inventor of the calculus, inventor of gravity. Newton was a genius, right? Newton bought stock in what was called the South Sea Company, which was this company formed to trade between England and the South Pacific. In fact, they never traded anything. They never produced anything except a stock market bubble. That stock started going up. People decided that this was the thing that was going to keep going up, so they bought it. Anticipating it would go up. This is one of those minsky moments we talked about earlier. People got euphoric about it. Oh, and then they started getting like meme. Oh, my God. I didn't buy it. I should have bought it. Everybody else is getting rich. What's wrong with me? I should buy it. So they started buying it and the stock went up and up and up. Newton was smart enough to sell at the point where he had 20,000 pounds worth of stock. I mean, this at a time when per capita income in England was 10 pounds a year. So he had, what's that, 2,000 times per capita income. That's what the equivalent of $80 million he sold. All ready to retire and be a rich man. Very rich. And then it kept going up and kept going up. So what did Sir Isaac Newton, the smartest person in the world do? He bought into South Sea Corporation again. He took his money and he bought it, put it all into the company. And a few days later, it crashed. It lost almost all its value. And Sir Isaac Newton spent the rest of his life working. As the royal astronomer and the royal, the guy who turns base metals into gold. That was his other job. Well, anyway, bubbles are hard to predict. But they happen and they are self-reinforcing because people in the bubble just see that it's going up and they'll be able to make more money if they stay in or buy back in or go back in and stay in. And the more people buy into it, the more they drive up the prices. That's what happened to U.S. housing. And it was fed by the asymmetric information of people in the housing business because there are a lot of people in the housing business. There are hundreds of thousands of real estate agents in this country. Millions of real estate agents. There is something on the order of 9 million people involved in the real estate business in the United States in 2006. There are fewer nowadays. But about 9 million back then. Real estate agents, brokers, mortgage brokers, plus all the people in the banks who deal with mortgages. There are a lot of people. And a lot of them knew that what was going on was bogus, but they were getting money from it. The head of countrywide financial, the country's largest mortgage broker, he sent in an email to the top people in his company that the products were selling are poison. They've never seen such poisonous products, but he didn't stop selling them because they were getting rich selling them. And the products they were selling were carefully designed, here's asymmetric information, carefully designed to appear to be good investments, whereas really they were packaging lousy investments that they knew were, as he said, poisonous. Here's how it works. Your mortgage broker in Fresno or Nevada or someplace, you're paid by the number of mortgages you write. And once you write these mortgages, your company is going to sell them to somebody else. So what's your incentive like? Your incentive is to write lots of mortgages and conceal bad information about these mortgages. They started putting out what are called ninja loans, no interest, no job, no assets. Or another word for this, well, liars loans. People on Wall Street were talking about mortgage-backed securities backed by liars loans. You know that what's being written down on these papers is a lie. The person doesn't have that income. They don't have that assets. The house isn't worth that. And everybody's just writing this stuff down and giving mortgages and buying the property because they figure out what the hell, it doesn't matter that it's all bogus because the place is going to go up in value. So that will cancel out all our lies. As long as everything keeps going up 20, 25% a year, it doesn't matter that the person doesn't have the money to work the loan, to pay the loan. They'll just sell the property and pay it off with the proceeds. Everybody will walk away happy. That was part of what they were thinking. Another thing they were thinking was, I will be gone and you will be gone. I'm going to get paid for writing these mortgages, you'll get paid for marketing these mortgages, and when the mortgage fails in two years, five years, when the house goes into foreclosure, we'll be out of here and we'll have taken our money with us. Two ways to look at it. So, they write up these mortgages, banks issue the mortgages, give the people the money to buy the house. The bank owns the mortgage. The bank then packages the mortgage with a lot of other mortgages into a mortgage-backed security, an MBS. The MBS is sold on Wall Street to a group of people, each of whom in effect has a part of lots of different mortgages, and what they get in buying the mortgage-backed security is promised that they will be paid out of the payments made on the mortgage. So, they get the right to a certain stream of income coming from the people who have the houses and owe on the mortgages. Many of these mortgage-backed securities were then actually repackaged as collateralized loans where the mortgage-backed security was collateral for a loan and the loan was broken up into different tranches so that the first money paid on the loan would go into the first tranche. That was the highest security. If anything was paid on this thing, then you get that. Then there's the B grade, which is, well, once the first set of people are paid off, you get the next, and that would go down maybe to the tenth level. What would that be? The I grade, where if they pay everybody else, then you get it. That's the riskiest. And the idea is that this way we're breaking up the risk and people like more risk can get it that way and people with risk averse will be able to get what they want, so everybody will be fine. The problem is once things started to go bad, once the housing prices went down from that peak, just like with the internet, just like with the South Sea, just like with the Dutch tulips that we talked about last time, once the bubble burst, all these people who borrowed a lot of money to buy into this, they start thinking, all I want need to do, I have to get out of here, I have to get out of here, I have to get out of here, I have to sell, sell, sell. And then the price plummets. And the problem is when the prices of houses started to plummet, all the prices came down. It wasn't just the A grade securities or the B grade, the C grade. It wasn't the I grade. Everything came down. As somebody said at the time, what we hadn't realized is that when things go bad, all the correlations go towards one. So all of these securities got bad at the same time. Fresno's mortgage market collapsed, so did Nevada's, so did Arizona's and Florida's, even Amherst, Massachusetts took a hit. And when all these mortgages throughout the whole country started going bad, all these mortgage-backed securities that seemed to be well-diversified, et cetera, they all went bad. The banks realized that they were holding a whole lot of crap. And that's when the financial market went into major meltdown, which we will talk about later on. So thank you very much and have a nice day. Bye-bye.