Is It Differentthis time?Credit Crisis: Past, Present, and Future

Is It Different this Time?A look at the credit crisis, its causes, remedies, and implications for the futureA Perfect Storm in the MakingCrisis UnfoldsEconomyMarketsWhere do we go from hereQuestionsAgenda

YES&NOIs It Different this Time?

There are some things that are always different and some things that are never different.“History never repeats itself, but it rhymes.”Mark TwainIs It Different this Time?

A Perfect Storm in the MakingThree Primary CausesHousing BubbleCredit BubbleWillful Ignorance

A Perfect Storm in the MakingHOUSING

Perfect Storm: HousingEasy money

Perfect Storm: Housing+ Presidential / Legislative SupportPresident Carter in 1977 signed the Community Reinvestment Act, which pushed Fannie and Freddie to aggressively lend to minority communitiesIn 1994 President Clinton unveiled his National Homeownership Strategy; rewrites rules regarding Fannie Mae and Freddie MacPresident Bush set a goal to increase the number of minority homeowners by 5.5 million families by the end of the decade. Signed five legislative initiatives promoting this goal.Source: LoanPerformance, Paulson presentation; USA Today via T2Partners Presentation

Perfect Storm: Housing+ Declining Underwriting StandardsSource: LoanPerformance, Paulson presentation; USA Today via T2Partners Presentation

Perfect Storm: Housing= Housing BubbleSource: Robert J. Shiller, Irrational Exuberance, 2nd. Edition, as updated by author: http://www.econ.yale.edu

A Perfect Storm in the MakingCREDIT

Perfect Storm: CreditAppetite for RiskBond yields decline across the boardHedge fund inflows increase 54% in ’07Highly leveraged private equity buyouts peak in ’07REIT yields fell below 10 Yr Treasuries – Dec ‘06Source: Wells Fargo

Bond yields decline across the board

Hedge fund inflows increase 54% in ’07

Highly leveraged private equity buyouts peak in ’07

REIT yields fell below 10 Yr Treasuries – Dec ‘06

Perfect Storm: CreditToo Much Debt – Families and FinancialsSource: NY Times

Perfect Storm: CreditToo Much Leverage - BankingIn 2004 the SEC granted special permission to the five largest U.S. investment banks, allowing them to increase leverage ratios from 15-1 up to 40-to-1Source: http://andstillipersist.com

Perfect Storm: CreditExplosion of Shadow BankingSource: www.eurekareport.com

Perfect Storm: CreditExplosion of Securitization:Car LoansResidential MortgagesCredit CardsSBA LoansStudent LoansHELOCsEquipmentCommercial MortgagesExcluding Residential and Commercial MortgagesSource: SIMFA, New York Times, ABA

Perfect Storm: CreditExplosion of Moral HazardEveryone gets paid upfrontMortgage brokerUnderwriting bankInvestment bankServicerRating agencyNo one shoulders any riskOr do they????Source: Ken Andrews

Perfect Storm: CreditExplosion of DerivativesWarren Buffet’s famous “weapons of mass destruction”Massive issuance of CDS contracts, completely unregulatedUsed as insurance and risk mitigationNo requirement of insurable interest – the equivalent of buying a life insurance policy on a stranger; illegal for a reasonPlus, insurance is only as good as the company selling it – Lehman, AIGSource: New York Times

A Perfect Storm in the MakingOVERSIGHT

Perfect Storm: OversightEveryone dropped the ball:Gramm-Leach-Bliley Act (1999) repeals Glass Steagall and opens door for future shenanigansFed and Treasury encouraged development of unregulated CDS marketsOffice of Federal Housing Enterprise Oversight (OFHEO) specifically tasked with regulating Fannie and Freddie – stifled by political lobbyingJustice Department - unrestrained consolidation left the top 19 banks controlling 66% of bank assets

Perfect Storm: OversightMore ball dropping:SEC got little rightCorporate Boards – encouraged risk taking; embraced short term funding of balance sheet (Robert Rubin, former Treasury Secretary, Chairman of CitiGroup)Greenspan – a perennial advocate of deregulation, leverage, and free marketsRating Agencies – completely disregarded the special role they play in capitalism; sold their soul

A Perfect Storm in the MakingDifferent

A Perfect Storm in the MakingCrisis UnfoldsEconomyMarketsWhere do we go from hereQuestionsAgenda

Calm Before Storm 2003 - 2006Upside:Solid (but not great) GDP growthRecord profit margins – driven by outsourcing, leveragePeople felt safe/low risk premiumsRecord asset pricesDownside:Everyone felt richer than they were Everyone lived beyond their meansEveryone borrowed accordinglyReal GDP GrowthSource: New York Federal Reserve; JP Morgan

Crisis Unfolds 2006 - 2008Cloudy Skies – late 2006Drizzle – 2007Dow Jones Industrials reach record high – 14,164 on October 9th, 2007; problem looks containedSteady Rain – Late 2007 – 2008Deluge – September 2008

Deluge – September 2008Fannie and Freddie in conservatorshipLehman Brothers files for bankruptcy protectionReserve MM “breaks the buck”Federal Reserve lends $85 billion to AIG to avoid bankruptcy, and further ripple affectsTreasury proposes and finally gets TARPBut……credit markets seize anywayWarren Buffett calls the economy “a great athlete that’s had a cardiac arrest”President Bush: “This sucker could go down”

Deluge – September 2008Flight to QualityInvestors sell EVERYTHING – stocks bonds, money markets, etc., and Buy TREASURIESShort-term Treasuries trade with a negative yield – Investors pay the U.S. Gov’t to hold their cashSource: Bespoke Investments

Short-term Treasuries trade with a negative yield – Investors pay the U.S. Gov’t to hold their cash

Deluge – September 2008No Appetite for Risk Investors demand higher compensation to own risky assetsIn many cases, the highest everSource: Wells Fargo

Deluge – September 2008TED Spread: difference between the interest rates on interbank loans and T-bills; Indicator of perceived credit risk in the general economySingle best indicator of how close we came to the brinkBanks did not trust each otherVirtually no market for any bonds other than US TreasuriesMoney market redemptions halted or delivered in kindNo new credit…periodEconomy begins to grind to a haltUnprecedentedTED SpreadUncomfortableNormalNormalSource: Bloomberg

Banks did not trust each other

Virtually no market for any bonds other than US Treasuries

Money market redemptions halted or delivered in kind

No new credit…period

Economy begins to grind to a halt

Nature of Credit CrisisDifferent

The fire is going out. Which do you use first?Policy Response

Policy ResponseIn steps the US Government as lender of last resort; unfreezing frozen marketsFDIC expansionMoney market protectionGuaranteesCapital infusionsAsset purchasesCommercial paper fundingEnter the age of acronym: TARP, CPFF, MMIF, AMLF, TALF, PPIF, TLGP,CAP, TLGBe thankful the US Dollar is/was the flight to quality reserve currency

In steps the US Government as lender of last resort; unfreezing frozen markets

Policy ResponseSource: Deutsche Bank

Policy ResponseSource: News N Economics

Nature of ResponseDifferent

A Perfect Storm in the MakingCrisis UnfoldsEconomyMarketsWhere do we go from hereQuestionsAgenda

Economy: Despite massive action…Global trade falls off a cliffSource: John Mauldin

EconomyMassive job losses – in both relative and absolute termsSource: Fortigent, Calculated Risk Blog

EconomySharp global contraction in GDP and Industrial Production (as of Q1 2009)Source: Wall Street Journal, NY Times, Bloomberg

EconomyAuto Sales…………………………enough saidSource: Wall Street Journal

EconomyBank failures – small in numberSource: FDIC

EconomyBank failures – but covering record deposits!!In billionsSource: FDIC

EconomyMortgage Delinquencies climbSource: Amherst Securities, LoanPerformance; National Delinquency Survey, Mortgage Bankers Association;FDIC Quarterly Banking Profile; T2 Partners

EconomyWhile home prices continue to fallSource: Standard & Poor’s, OFHEO Purchase-Only Index, NAR, T2 Partners

What do Economists Say? EconomyWho Cares!

EconomyWhat does the media Say?

Economy

Economy

Economy

Economy

Economy

Economy

Economy1987199119821998198020081974

How Bad Is It?This is not “Great Depression 2.0”

How Bad Is It?This is not “Great Depression 2.0”Government shows a willingness to do “whatever it takes” – Fed Funds Rate, balance sheet, deficit spendingCorrect monetary policy response – lower rates, increased money supplyBackstop of FDIC – bank losses not flowing through to consumerSocial shock absorbers – unemployment insurance, Soc. Sec., Medicare, Food stampsCoordinated global responseSource: Slate

How Bad Is It?But, This is the deepest and longest recession of the post WWII eraSource: http://investorsconundrum.com

How Bad Is It?There is no room for error:Banks – healthier but far from healthyState and local government deficitsStimulus – poorly conceived; little bang for lots of bucksCurrent federal deficit – 13%+ of GDPContinued home price decline / second wave of mortgage defaults / commercial property / EuropeUnemployment – 9.7%! (12.2% in CA, 12.2% OR, 15.2% MI, 11.5% in SC, 13.2% in NV as of September‘09)Possible vicious cycle – Paradox of Thrift – unemployment/defaults/banking losses/ tighter credit/unemployment…….Source: BLE, JP Morgan, Pimco

How Bad Is It?And…..great uncertainty in the short-term :De-leveragingRe-regulationDe-globalization (protectionism)Increased taxesPolitical / legislative uncertaintyReduced corporate profits

EconomyNotDifferent

What is Different This Time?Credit induced vs. Inventory or business cycleSystematic riskGlobal declineDeeper and longer than we’re used to

On the Bright SideSnapback is historically proportional to declineSource: Bank Credit Analyst

On the Bright SideEconomic Indicators are getting better or have stopped getting worse:Consumer sentimentInitial unemployment claimsIndustrial productionRetail salesHousehold savingsHome affordabilityGDP -1.0% Q2 ‘09

A Perfect Storm in the MakingCrisis UnfoldsEconomyMarketsWhere do we go from hereQuestionsAgenda

MarketsSteep declines driven by margin calls, redemptions, weak hands, flight to qualityS&P 500 price only

MarketsHow bad was 2008? S&P 500: -37% Second worse year on record (-43% in 1931)Every asset class declines except high quality bondsInternational Equities (MSCI EAFA): -43.4%Emerging Markets (MSCI EM): -54.3%Commodities (Dow Jones AIG Index): -35.7%Real Estate (NAREIT Equity Index): -37.7%Source: Littman Gregory

MarketsQ1 ‘09Markets continued decline in January and FebruaryS&P 500 -56.7% peak to trough (price only)Markets looked broken, dysfunctionalDiversification didn’t help as correlations go to 1.0But, with dislocation comes opportunity

MarketsSignificant capitulation on March 9thMarket is forward looking and sees brighter days ahead; continues to go up in the face of bad newsWent from significantly undervalued to fairly valuedS&P 500 price only~60% recovery!

MarketsUS Equities not the only game in townYTD 2009High Yield bonds up 31.4% Vanguard VWEHXConvertible bonds up 34.9% Vanguard VCVSXEmerging Markets up 62.1% Vanguard VEIEX Small Cap Growth up 37.9%Vanguard VISGX Even Muni Bonds up 14.3% Vanguard VWLTXMeanwhile…….Long-term Treasuries - 9.1%Vanguard VUSTXAll numbers as of 9/21/09; Any past or expected return information (average annual returns, compound return, standard deviation, and yield) are provided for illustration only and are not a guarantee or prediction of future performance. They are not to be considered representative of securities recommended by us now or in the past.

MarketsCan this last? Or is it a dead cat bounce?Source: Edward Jones

MarketsHistorically Markets begin recovery about halfway through recessions even as bad news continues and unemployment rates increaseSource: JP Morgan

MarketsNotDifferent

Markets: Long TermWasted 10 years…………roller coaster ride-1.46% annualized return (S&P 500, Vanguard VFINX, 1/98-12/08, inc. div)

Markets: Long TermAgain….US Equities not the only game in town10 years 1/98 – 12/08, annualized returnsS&P 500 - 1.46% Vanguard VFINXUS Small Cap Value +7.32% DFA DFSVXEmerging Markets +9.49% DFA DFEMXIntl. Small Cap Value +9.52% DFA DISVXReal Estate +7.55% DFA DFREXAnd don’t forget bondsTotal Bond Market Index +5.37% Vanguard VBMFX All numbers as of 12/31/08; Any past or expected return information (average annual returns, compound return, standard deviation, and yield) are provided for illustration only and are not a guarantee or prediction of future performance. They are not to be considered representative of securities recommended by us now or in the past.

Markets: Long TermAnd.….Over 20 years……respectableNote: Average Investor compared to markets; Why? Source: JP Morgan; The indexes used: S&P 500 Index: Standard & Poor’s 500 Index, REITS: NAREIT Equity ReitsIndex, EAFE: MSCI EAFE, Oil: West Texas Intermediate Index, Bonds: Barclays Capital U.S. Aggregate Index, Homes: Median Sales Price of Existing Single-family homes, Gold: USD/troy oz. All returns are annualized (andtotal return where applicable), and represent the 20-year period ending 6/30/09. Average equity investor return is based on an analysis by Dalbar, Inc. which utilizes the net of aggregate mutual fund sales, redemptions and exchanges each month as a measure of investor behavior. *DALBAR returns are through 2007, next update due in 1Q09.

A result we could have all lived with:Markets: Long Term~8% annual growthSource: Yahoo, Century Wealth Management

A Perfect Storm in the MakingCrisis UnfoldsEconomyMarketsWhere do we go from hereQuestionsAgenda

Where Do We Go From HereGoing forward…next 10 years should be betterSource: DWS

Where Do We Go From HereWhy?...Reversion to the mean; driven by GDPSource: DFA, Federal Reserve; Hypothetical based on 15x P/E ratio

Where Do We Go From HereAnother reason to be cheerful……Stocks are cheapPrice/ Peak EarningsPrice/Normalized EarningsPrice/BookTobin’s Q RatioSource: JP Morgan as of June 30, 2009

Where Do We Go From HereAnd, when stocks are cheap….future returns are good

Where Do We Go From HereEquity markets go up more than they go down

Where Do We Go From HereShort term is meaninglessSource: DFA

Where Do We Go From HereNot much betterSource: DFA

Where Do We Go From HereA meaningful trend developingSource: DFA

Where Do We Go From HereOnly 2 negative ten year periodsSource: DFA

Where Do We Go From Here20 is the new 10Source: DFA

MarketsHow should investors position their portfolios?Diversify globally – un-hedged international exposureTactical vs. static allocationBe nimble; Buy what’s cheap, when it’s cheapDon’t forget bonds – high quality corporate vs. treasuriesUse alternatives to diversify stock and bond exposureMarket neutral strategiesArbitrage strategiesStructured notesInflation protection – down the roadTipsCommodities

MarketsNotDifferent

Biggest Long-term Challenges2nd Wave of defaults / FDIC / Comm. RESource: FDIC, NY Times

Biggest Long-term ChallengesDouble Dip Recession / Deflation

Biggest Long-term ChallengesFederal Debt/GDPSource: WSJ

Biggest Long-term ChallengesEntitlementsSource: TCW

Biggest Long-term ChallengesInflation / Value of $Source: WSJ

ConclusionYes, this recession is different from othersBut, each contraction poses unique problemsNo, this is not a repeat of the Great DepressionYes, we are entering into a new era of de-leveraging and slower growthThe short term outlook is cautious While, long term, the investment opportunities are encouraging based on fundamentals and valuationIf we successfully navigate long term issues

ConclusionNature of CrisisPolicy ResponseEconomic ResultMarket ResponseMarket OutlookLong-term ChallengesDifferent Different NotDifferent NotDifferent NotDifferent VeryDifferent

Nature of Crisis

Policy Response

Economic Result

Market Response

Market Outlook

Long-term Challenges

Lessons Learned

DisclaimerThe information contained in this document is for background purposes only, and does not purport to be full or complete. Any information contained herein is subject to revision, updating, completion, modification, and amendment.This document does not constitute an offer to sell or a solicitation of an offer to buy any securities, and may not be relied upon in connection with any offer or sale of securities. Past performance is not indicative of future performance.The views contained herein are solely of Jay Healy as of date of presentation, and not that of Century Wealth Management, and are subject to change without notice.All material is compiled from sources believed to be reliable, but accuracy cannot be guaranteed.This material may not be distributed to other than the intended recipients. Unauthorized reproduction or distribution of all or any of this material is strictly prohibited.

A Perfect Storm in the MakingCrisis UnfoldsEconomyMarketsWhere do we go from hereQuestionsAgenda

QuestionsCentury Wealth Management, llc 5350 Poplar Ave., Suite 395 Memphis, TN 38119P: 901.850.5532 www.CenturyWealth.comemail: Jay@CenturyWealth.comPresentation posted at: http://www.linkedin.com/in/jayhealyhttp://www.centurywealth.com/blog/Email newsletter: http://www.centurywealth.com/sign_up.html