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Consumer Confidence

The rapid reduction of consumer spending on durables (such as houses, cars, etc) has caused production to fall. Orders for durable goods decreased by 4. 5% from August to September of 2008 to a seasonally adjusted $208. 50 billion, according to the Commerce Department. New-home sales dived 11. 5% to 460,000, the lowest mark in 17 years, Commerce said in a separate report. The Labor Department said new claims for jobless benefits jumped by 32,000 on a seasonally adjusted basis to 493,000 in the week

ended Sept. 20. Gallup polls’ summary economic indicators show a deterioration of public confidence in the economy since the news that Lehman Brothers, succumbing to the financial pressure of the nation’s mortgage industry crisis, went bankrupt. (Consumer Confidence, 2008) That deterioration seemed to accelerate in the following weeks, after a several days of news discussion about the failure of insurance giant AIG, and other institutions. (Consumer Confidence, 2008)

The percentage of Americans calling current economic conditions “poor” is now 45%, the worst this rating has been since early August — although still below the record high for the year of 52% in July. (Consumer Confidence, 2008) This is up from 40% just prior to the news of

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Lehman Brothers’ demise. Earlier this month, only 38% of Americans called the economy poor, which was the lowest rating on this measure seen since March. (Consumer Confidence, 2008) Many individuals in the media have called for panic in the face of the crisis.

(Pitzke, 2008) Millions of home owners have defaulted on their mortgages due to lending practices that fudged qualification guidelines, and imposed prohibitive “balloon-style” interest rates (ARM’s) which were impossible for buyers to keep up with. Over the 2003-2006 time period unusually low interest rates and buyers expectations of double-digit home-price increases facilitated a record $3. 2 trillion in home mortgages being written by U. S. lenders, with about 20% of this amount considered sub-prime.

(The US Mortgage Crisis, 2008) The sub-prime mortgage sector serves borrowers with poor credit histories at higher interest rates. The fast pace of mortgage originations was greater than long-term mortgage demand levels. (The US Mortgage Crisis, 2008) As a result there will be much lower housing demand in the coming few years. One of the major developments leading to the large increase in sub-prime lending over the last few years was the adoption of new credit scoring techniques. (The US Mortgage Crisis, 2008) This allowed lenders to sort applicants by creditworthiness and set risk-based loan interest rates.

A large percentage of these loans were originated by mortgage brokers who then sold the loans to Wall Street investment banks. (The US Mortgage Crisis, 2008) The investment banks, in turn, packaged the loans into collateralized debt obligations and sold these to investors around the world. As with any new credit product, investors had difficulty evaluating the sub-prime debt default risk. (The US Mortgage Crisis, 2008) Historical data suggested that if the unemployment rate remained low, so too would default risk.

(The US Mortgage Crisis, 2008) That quantitative model ignored two factors keeping defaults low over the 2002-2005 periods. Rising home prices allowed sub prime borrowers the opportunity to refinance the loan or sell the property whenever they where unable to make their monthly payments. (The US Mortgage Crisis, 2008) Second, falling interest rates from 2001 to 2004 reduced ARM indexes which limited the teaser interest rate (the “low introductory rate” offered in the short term) increases.

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