Credit Crisis - Past, Present, and Future

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A look at the credit crisis, its causes, remedies, and implications for the future

A look at the credit crisis, its causes, remedies, and implications for the future

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  • @destevens56 please email me directly to discuss Jay@CenturyWealth.com
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  • interesting presentation, would you be willing to email me it to me so I can use with my econ class?

    thanks
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  • It's willful ignorance ofcourse ......... sad that it continues, and too bad that the CDS cat is still not out of the bag.
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  • 1. Is It Differentthis time?
    Credit Crisis: Past, Present, and Future
  • 2. Is It Different this Time?
    A look at the credit crisis, its causes, remedies, and implications for the future
    A Perfect Storm in the Making
    Crisis Unfolds
    Economy
    Markets
    Where do we go from here
    Questions
    Agenda
  • 3. YES
    &
    NO
    Is It Different this Time?
  • 4. There are some things that are always different and some things that are never different.
    “History never repeats itself, but it rhymes.”
    Mark Twain
    Is It Different this Time?
  • 5. A Perfect Storm in the Making
    Three Primary Causes
    Housing Bubble
    Credit Bubble
    Willful Ignorance
  • 6. A Perfect Storm in the Making
    HOUSING
  • 7. Perfect Storm: Housing
    Easy money
  • 8. Perfect Storm: Housing
    + Presidential / Legislative Support
    President Carter in 1977 signed the Community Reinvestment Act, which pushed Fannie and Freddie to aggressively lend to minority communities
    In 1994 President Clinton unveiled his National Homeownership Strategy; rewrites rules regarding Fannie Mae and Freddie Mac
    President 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
  • 9. Perfect Storm: Housing
    + Declining Underwriting Standards
    Source: LoanPerformance, Paulson presentation; USA Today via T2Partners Presentation
  • 10. Perfect Storm: Housing
    = Housing Bubble
    Source: Robert J. Shiller, Irrational Exuberance, 2nd. Edition, as updated by author: http://www.econ.yale.edu
  • 11. A Perfect Storm in the Making
    CREDIT
  • 12. Perfect Storm: Credit
    Appetite for Risk
    • Bond yields decline across the board
    • 13. Hedge fund inflows increase 54% in ’07
    • 14. Highly leveraged private equity buyouts peak in ’07
    • 15. REIT yields fell below 10 Yr Treasuries – Dec ‘06
    Source: Wells Fargo
  • 16. Perfect Storm: Credit
    Too Much Debt – Families and Financials
    Source: NY Times
  • 17. Perfect Storm: Credit
    Too Much Leverage - Banking
    In 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-1
    Source: http://andstillipersist.com
  • 18. Perfect Storm: Credit
    Explosion of Shadow Banking
    Source: www.eurekareport.com
  • 19. Perfect Storm: Credit
    Explosion of Securitization:
    Car Loans
    Residential Mortgages
    Credit Cards
    SBA Loans
    Student Loans
    HELOCs
    Equipment
    Commercial Mortgages
    Excluding Residential and
    Commercial Mortgages
    Source: SIMFA, New York Times, ABA
  • 20. Perfect Storm: Credit
    Explosion of Moral Hazard
    Everyone gets paid upfront
    Mortgage broker
    Underwriting bank
    Investment bank
    Servicer
    Rating agency
    No one shoulders any risk
    Or do they????
    Source: Ken Andrews
  • 21. Perfect Storm: Credit
    Explosion of Derivatives
    Warren Buffet’s famous “weapons of mass destruction”
    Massive issuance of CDS contracts, completely unregulated
    Used as insurance and risk mitigation
    No requirement of insurable interest – the equivalent of buying a life insurance policy on a stranger; illegal for a reason
    Plus, insurance is only as good as the company selling it – Lehman, AIG
    Source: New York Times
  • 22. A Perfect Storm in the Making
    OVERSIGHT
  • 23. Perfect Storm: Oversight
    Everyone dropped the ball:
    Gramm-Leach-Bliley Act (1999) repeals Glass Steagall and opens door for future shenanigans
    Fed and Treasury encouraged development of unregulated CDS markets
    Office of Federal Housing Enterprise Oversight (OFHEO) specifically tasked with regulating Fannie and Freddie – stifled by political lobbying
    Justice Department - unrestrained consolidation left the top 19 banks controlling 66% of bank assets
  • 24. Perfect Storm: Oversight
    More ball dropping:
    SEC got little right
    Corporate 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 markets
    Rating Agencies – completely disregarded the special role they play in capitalism; sold their soul
  • 25. A Perfect Storm in the Making
    Different
  • 26. A Perfect Storm in the Making
    Crisis Unfolds
    Economy
    Markets
    Where do we go from here
    Questions
    Agenda
  • 27. Calm Before Storm 2003 - 2006
    Upside:
    Solid (but not great) GDP growth
    Record profit margins – driven by outsourcing, leverage
    People felt safe/low risk premiums
    Record asset prices
    Downside:
    Everyone felt richer than they were
    Everyone lived beyond their means
    Everyone borrowed accordingly
    Real GDP Growth
    Source: New York Federal Reserve; JP Morgan
  • 28. Crisis Unfolds 2006 - 2008
    Cloudy Skies – late 2006
    Drizzle – 2007
    Dow Jones Industrials reach record high – 14,164 on October 9th, 2007; problem looks contained
    Steady Rain – Late 2007 – 2008
    Deluge – September 2008
  • 29. Deluge – September 2008
    Fannie and Freddie in conservatorship
    Lehman Brothers files for bankruptcy protection
    Reserve MM “breaks the buck”
    Federal Reserve lends $85 billion to AIG to avoid bankruptcy, and further ripple affects
    Treasury proposes and finally gets TARP
    But……credit markets seize anyway
    Warren Buffett calls the economy “a great athlete that’s had a cardiac arrest”
    President Bush: “This sucker could go down”
  • 30. Deluge – September 2008
    Flight to Quality
    Investors sell EVERYTHING – stocks bonds, money markets, etc., and
    Buy TREASURIES
    • Short-term Treasuries trade with a negative yield – Investors pay the U.S. Gov’t to hold their cash
    Source: Bespoke Investments
  • 31. Deluge – September 2008
    No Appetite for Risk
    Investors demand higher compensation to own risky assets
    In many cases, the highest ever
    Source: Wells Fargo
  • 32. Deluge – September 2008
    TED Spread: difference between the interest rates on interbank loans and T-bills; Indicator of perceived credit risk in the general economy
    Single best indicator of how close we came to the brink
    • Banks did not trust each other
    • 33. Virtually no market for any bonds other than US Treasuries
    • 34. Money market redemptions halted or delivered in kind
    • 35. No new credit…period
    • 36. Economy begins to grind to a halt
    Unprecedented
    TED Spread
    Uncomfortable
    Normal
    Normal
    Source: Bloomberg
  • 37. Nature of Credit Crisis
    Different
  • 38. The fire is going out. Which do you use first?
    Policy Response
  • 39. Policy Response
    • In steps the US Government as lender of last resort; unfreezing frozen markets
    FDIC expansion
    Money market protection
    Guarantees
    Capital infusions
    Asset purchases
    Commercial paper funding
    Enter the age of acronym: TARP, CPFF, MMIF, AMLF, TALF, PPIF, TLGP,CAP, TLG
    Be thankful the US Dollar is/was the flight to quality reserve currency
  • 40. Policy Response
    Source: Deutsche Bank
  • 41. Policy Response
    Source: News N Economics
  • 42. Nature of Response
    Different
  • 43. A Perfect Storm in the Making
    Crisis Unfolds
    Economy
    Markets
    Where do we go from here
    Questions
    Agenda
  • 44. Economy: Despite massive action…
    Global trade falls off a cliff
    Source: John Mauldin
  • 45. Economy
    Massive job losses – in both relative and absolute terms
    Source: Fortigent, Calculated Risk Blog
  • 46. Economy
    Sharp global contraction in GDP and Industrial Production (as of Q1 2009)
    Source: Wall Street Journal, NY Times, Bloomberg
  • 47. Economy
    Auto Sales…………………………enough said
    Source: Wall Street Journal
  • 48. Economy
    Bank failures – small in number
    Source: FDIC
  • 49. Economy
    Bank failures – but covering record deposits!!
    In billions
    Source: FDIC
  • 50. Economy
    Mortgage Delinquencies climb
    Source: Amherst Securities, LoanPerformance; National Delinquency Survey, Mortgage Bankers Association;
    FDIC Quarterly Banking Profile; T2 Partners
  • 51. Economy
    While home prices continue to fall
    Source: Standard & Poor’s, OFHEO Purchase-Only Index, NAR, T2 Partners
  • 52. What do Economists Say?
    Economy
    Who Cares!
  • 53. Economy
    What does the media Say?
  • 54. Economy
  • 55. Economy
  • 56. Economy
  • 57. Economy
  • 58. Economy
  • 59. Economy
  • 60. Economy
    1987
    1991
    1982
    1998
    1980
    2008
    1974
  • 61. How Bad Is It?
    This is not “Great Depression 2.0”
  • 62. 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 spending
    Correct monetary policy response – lower rates, increased money supply
    Backstop of FDIC – bank losses not flowing through to consumer
    Social shock absorbers – unemployment insurance, Soc. Sec., Medicare, Food stamps
    Coordinated global response
    Source: Slate
  • 63. How Bad Is It?
    But, This is the deepest and longest recession of the post WWII era
    Source: http://investorsconundrum.com
  • 64. How Bad Is It?
    There is no room for error:
    Banks – healthier but far from healthy
    State and local government deficits
    Stimulus – poorly conceived; little bang for lots of bucks
    Current federal deficit – 13%+ of GDP
    Continued home price decline / second wave of mortgage defaults / commercial property / Europe
    Unemployment – 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
  • 65. How Bad Is It?
    And…..great uncertainty in the short-term :
    De-leveraging
    Re-regulation
    De-globalization (protectionism)
    Increased taxes
    Political / legislative uncertainty
    Reduced corporate profits
  • 66. Economy
    Not
    Different
  • 67. What is Different This Time?
    Credit induced vs. Inventory or business cycle
    Systematic risk
    Global decline
    Deeper and longer than we’re used to
  • 68. On the Bright Side
    Snapback is historically proportional to decline
    Source: Bank Credit Analyst
  • 69. On the Bright Side
    Economic Indicators are getting better or have stopped getting worse:
    Consumer sentiment
    Initial unemployment claims
    Industrial production
    Retail sales
    Household savings
    Home affordability
    GDP -1.0% Q2 ‘09
  • 70. A Perfect Storm in the Making
    Crisis Unfolds
    Economy
    Markets
    Where do we go from here
    Questions
    Agenda
  • 71. Markets
    Steep declines driven by margin calls, redemptions, weak hands, flight to quality
    S&P 500
    price only
  • 72. Markets
    How bad was 2008?
    S&P 500: -37%
    Second worse year on record (-43% in 1931)
    Every asset class declines except high quality bonds
    International 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
  • 73. Markets
    Q1 ‘09
    Markets continued decline in January and February
    S&P 500 -56.7% peak to trough (price only)
    Markets looked broken, dysfunctional
    Diversification didn’t help as correlations go to 1.0
    But, with dislocation comes opportunity
  • 74. Markets
    Significant capitulation on March 9th
    Market is forward looking and sees brighter days ahead; continues to go up in the face of bad news
    Went from significantly undervalued to fairly valued
    S&P 500
    price only
    ~60% recovery!
  • 75. Markets
    US Equities not the only game in town
    YTD 2009
    High Yield bonds up 31.4% Vanguard VWEHX
    Convertible bonds up 34.9% Vanguard VCVSX
    Emerging Markets up 62.1% Vanguard VEIEX
    Small Cap Growth up 37.9%Vanguard VISGX
    Even Muni Bonds up 14.3% Vanguard VWLTX
    Meanwhile…….
    Long-term Treasuries - 9.1%Vanguard VUSTX
    All 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.
  • 76. Markets
    Can this last? Or is it a dead cat bounce?
    Source: Edward Jones
  • 77. Markets
    Historically Markets begin recovery about halfway through recessions even as bad news continues and unemployment rates increase
    Source: JP Morgan
  • 78. Markets
    Not
    Different
  • 79. Markets: Long Term
    Wasted 10 years…………roller coaster ride
    -1.46% annualized return (S&P 500, Vanguard VFINX, 1/98-12/08, inc. div)
  • 80. Markets: Long Term
    Again….US Equities not the only game in town
    10 years 1/98 – 12/08, annualized returns
    S&P 500 - 1.46% Vanguard VFINX
    US Small Cap Value +7.32% DFA DFSVX
    Emerging Markets +9.49% DFA DFEMX
    Intl. Small Cap Value +9.52% DFA DISVX
    Real Estate +7.55% DFA DFREX
    And don’t forget bonds
    Total 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.
  • 81. Markets: Long Term
    And.….Over 20 years……respectable
    Note: 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.
  • 82. A result we could have all lived with:
    Markets: Long Term
    ~8% annual growth
    Source: Yahoo, Century Wealth Management
  • 83. A Perfect Storm in the Making
    Crisis Unfolds
    Economy
    Markets
    Where do we go from here
    Questions
    Agenda
  • 84. Where Do We Go From Here
    Going forward…next 10 years should be better
    Source: DWS
  • 85. Where Do We Go From Here
    Why?...Reversion to the mean; driven by GDP
    Source: DFA, Federal Reserve; Hypothetical based on 15x P/E ratio
  • 86. Where Do We Go From Here
    Another reason to be cheerful……
    Stocks are cheap
    Price/ Peak Earnings
    Price/Normalized Earnings
    Price/Book
    Tobin’s Q Ratio
    Source: JP Morgan as of June 30, 2009
  • 87. Where Do We Go From Here
    And, when stocks are cheap….future returns are good
  • 88. Where Do We Go From Here
    Equity markets go up more than they go down
  • 89. Where Do We Go From Here
    Short term is meaningless
    Source: DFA
  • 90. Where Do We Go From Here
    Not much better
    Source: DFA
  • 91. Where Do We Go From Here
    A meaningful trend developing
    Source: DFA
  • 92. Where Do We Go From Here
    Only 2 negative ten year periods
    Source: DFA
  • 93. Where Do We Go From Here
    20 is the new 10
    Source: DFA
  • 94. Markets
    How should investors position their portfolios?
    Diversify globally – un-hedged international exposure
    Tactical vs. static allocation
    Be nimble; Buy what’s cheap, when it’s cheap
    Don’t forget bonds – high quality corporate vs. treasuries
    Use alternatives to diversify stock and bond exposure
    Market neutral strategies
    Arbitrage strategies
    Structured notes
    Inflation protection – down the road
    Tips
    Commodities
  • 95. Markets
    Not
    Different
  • 96. Biggest Long-term Challenges
    2nd Wave of defaults / FDIC / Comm. RE
    Source: FDIC, NY Times
  • 97. Biggest Long-term Challenges
    Double Dip Recession / Deflation
  • 98. Biggest Long-term Challenges
    Federal Debt/GDP
    Source: WSJ
  • 99. Biggest Long-term Challenges
    Entitlements
    Source: TCW
  • 100. Biggest Long-term Challenges
    Inflation / Value of $
    Source: WSJ
  • 101. Conclusion
    Yes, this recession is different from others
    But, each contraction poses unique problems
    No, this is not a repeat of the Great Depression
    Yes, we are entering into a new era of de-leveraging and slower growth
    The short term outlook is cautious
    While, long term, the investment opportunities are encouraging based on fundamentals and valuation
    If we successfully navigate long term issues
  • 102. Conclusion
    Different
    Different
    NotDifferent
    NotDifferent
    NotDifferent
    VeryDifferent
  • 108. Lessons Learned
  • 109. Disclaimer
    The 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.
  • 110. A Perfect Storm in the Making
    Crisis Unfolds
    Economy
    Markets
    Where do we go from here
    Questions
    Agenda
  • 111. Questions
    Century Wealth Management, llc
    5350 Poplar Ave., Suite 395
    Memphis, TN 38119
    P: 901.850.5532
    www.CenturyWealth.com
    email: Jay@CenturyWealth.com
    Presentation posted at:
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