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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Henry Waxman Grills Richard Fuld (CEO of Lehman
Brothers)
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Market Reaction to Paulson Plan Vote
Fridays Close 10,340
10,600 10,700
Mondays Close 9,955
Monday 2PM 9,540
Mon, Sept 29 --------------- Friday 2 PM, Oct 3
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Crisis Intensifies Globally

• Monday morning (before 930 AM in NYC
• European and Asian stocks drop 5
• Russia, Brazil down 20
• Europe banks stumble
• Deposit guarantees sweep across Europe
• Generally, problems are much larger in European
  banking than in US banking
• No serious banking problems in Asia, except in
  China
• US Problems
• Commercial Paper Market (new facility
  backstop announced by FRS and Treasury this
  morning)
• State and local borrowing (the municipal bond
  market)
• Jim Cramer issues a sell call _at_ 9555.50

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Meanwhileback to mortgages
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Constant Mortgage Payments Over Time
1,199.10
Principal payment
Interest expense
time
360 Months of Payments
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Things to Note

• Interest expense is deductible for tax purposes.
  This means the government is providing at 35 to
  40 percent subsidy to the interest expense part
  of the mortgage payment
• Early payments most valuable
• Provides incentive to refinance, even if rates
  have not changed or even if they have gone up
• What if you decide to sell your home? Then you
  would prepay your mortgage.
• GNMA mortgages let you do this without any
  penalty
• If this was a commercial loan (think office
  building), the penalty would be equal to whatever
  the prepayment costs the lender

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The End