Economics 434 Theory of Financial Markets

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Economics 434Theory of Financial Markets
Professor Edwin T Burton Economics
Department The University of Virginia
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The Housing Bubble.what caused it

• Tax Advantages to housing
• Tax deductability of mortgage interest payments
• Tax free sales of gains up to 250,000 (
  500,000 for joint filers)
• Lower than market mortgage rates due to the
  existence of FNM and FRE

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Short sellingwhat is it?

• Sell stock that you do not own
• Thats okay as long as you have stock to deliver
  to buyer (two days later on settlement date)
• How do you get the stock
• You borrow the stock (temporarily) from
  institutions like endowments and pension funds
• The uptick rule suspended in 2007

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The Fire Rages On

• March 16 Bear Stearns sold to JPM
• Sept 7 FNM and FRE taken over by US Govt
• Sept 15 Lehman files for bankruptcy
• Sept 16 FRS makes 85 billion bridge loan to
  AIG
• Sept 17 MS and GS drop precipitously

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Are speculators the problem?

• What is a short sale?
• The uptick rule
• Providing stock for delivery now required at
  settlement date
• New disclosure rules for funds greater than 100
  Million

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Dow Jones Industrial Average
11,400
10,600
Sept 15
Sept 17
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Lehman Brothers
20
10 cents
Sept 8
Sept 15
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AIG
23
2
Sept 8
Sept 15
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Goldman Sachs
155 ( 60 Billion)
97 ( 39 Billion)
Sept 15
Sept 17
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Morgan Stanley
38 ( 42 billion)
16 ( 18 Billion)
Sept 15
Sept 17
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We are where we arewhat should we do?

• What happens if we do nothing at all (this, of
  course, is the great unknown)
• Proposals
• Continue ad hoc case by case policy
• Draw a policy line in the sand
• Buy distressed assets and sell them (RTC style)

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What should we have done?

• Should we have let BS go
• FNM and FRE
• Lehman
• AIG
• WM, MS, GS?

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The End