Credit Crisis - Past, Present, and Future


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

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Credit Crisis - Past, Present, and Future

  1. Is It Differentthis time?<br />Credit Crisis: Past, Present, and Future<br />
  2. Is It Different this Time?<br />A look at the credit crisis, its causes, remedies, and implications for the future<br />A Perfect Storm in the Making<br />Crisis Unfolds<br />Economy<br />Markets<br />Where do we go from here<br />Questions<br />Agenda<br />
  3. YES<br />&<br />NO<br />Is It Different this Time?<br />
  4. There are some things that are always different and some things that are never different.<br />“History never repeats itself, but it rhymes.”<br />Mark Twain<br />Is It Different this Time?<br />
  5. A Perfect Storm in the Making<br />Three Primary Causes<br />Housing Bubble<br />Credit Bubble<br />Willful Ignorance<br />
  6. A Perfect Storm in the Making<br />HOUSING<br />
  7. Perfect Storm: Housing<br />Easy money<br />
  8. Perfect Storm: Housing<br />+ Presidential / Legislative Support<br />President Carter in 1977 signed the Community Reinvestment Act, which pushed Fannie and Freddie to aggressively lend to minority communities<br />In 1994 President Clinton unveiled his National Homeownership Strategy; rewrites rules regarding Fannie Mae and Freddie Mac<br />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.<br />Source: LoanPerformance, Paulson presentation; USA Today via T2Partners Presentation<br />
  9. Perfect Storm: Housing<br />+ Declining Underwriting Standards<br />Source: LoanPerformance, Paulson presentation; USA Today via T2Partners Presentation<br />
  10. Perfect Storm: Housing<br />= Housing Bubble<br />Source: Robert J. Shiller, Irrational Exuberance, 2nd. Edition, as updated by author:<br />
  11. A Perfect Storm in the Making<br />CREDIT<br />
  12. Perfect Storm: Credit<br />Appetite for Risk<br /><ul><li>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</li></ul>Source: Wells Fargo<br />
  16. Perfect Storm: Credit<br />Too Much Debt – Families and Financials<br />Source: NY Times<br />
  17. Perfect Storm: Credit<br />Too Much Leverage - Banking<br />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<br />Source:<br />
  18. Perfect Storm: Credit<br />Explosion of Shadow Banking<br />Source:<br />
  19. Perfect Storm: Credit<br />Explosion of Securitization:<br />Car Loans<br />Residential Mortgages<br />Credit Cards<br />SBA Loans<br />Student Loans<br />HELOCs<br />Equipment<br />Commercial Mortgages<br />Excluding Residential and <br />Commercial Mortgages<br />Source: SIMFA, New York Times, ABA<br />
  20. Perfect Storm: Credit<br />Explosion of Moral Hazard<br />Everyone gets paid upfront<br />Mortgage broker<br />Underwriting bank<br />Investment bank<br />Servicer<br />Rating agency<br />No one shoulders any risk<br />Or do they????<br />Source: Ken Andrews<br />
  21. Perfect Storm: Credit<br />Explosion of Derivatives<br />Warren Buffet’s famous “weapons of mass destruction”<br />Massive issuance of CDS contracts, completely unregulated<br />Used as insurance and risk mitigation<br />No requirement of insurable interest – the equivalent of buying a life insurance policy on a stranger; illegal for a reason<br />Plus, insurance is only as good as the company selling it – Lehman, AIG<br />Source: New York Times<br />
  22. A Perfect Storm in the Making<br />OVERSIGHT<br />
  23. Perfect Storm: Oversight<br />Everyone dropped the ball:<br />Gramm-Leach-Bliley Act (1999) repeals Glass Steagall and opens door for future shenanigans<br />Fed and Treasury encouraged development of unregulated CDS markets<br />Office of Federal Housing Enterprise Oversight (OFHEO) specifically tasked with regulating Fannie and Freddie – stifled by political lobbying<br />Justice Department - unrestrained consolidation left the top 19 banks controlling 66% of bank assets<br />
  24. Perfect Storm: Oversight<br />More ball dropping:<br />SEC got little right<br />Corporate Boards – encouraged risk taking; embraced short term funding of balance sheet (Robert Rubin, former Treasury Secretary, Chairman of CitiGroup)<br />Greenspan – a perennial advocate of deregulation, leverage, and free markets<br />Rating Agencies – completely disregarded the special role they play in capitalism; sold their soul <br />
  25. A Perfect Storm in the Making<br />Different<br />
  26. A Perfect Storm in the Making<br />Crisis Unfolds<br />Economy<br />Markets<br />Where do we go from here<br />Questions<br />Agenda<br />
  27. Calm Before Storm 2003 - 2006<br />Upside:<br />Solid (but not great) GDP growth<br />Record profit margins – driven by outsourcing, leverage<br />People felt safe/low risk premiums<br />Record asset prices<br />Downside:<br />Everyone felt richer than they were <br />Everyone lived beyond their means<br />Everyone borrowed accordingly<br />Real GDP Growth<br />Source: New York Federal Reserve; JP Morgan<br />
  28. Crisis Unfolds 2006 - 2008<br />Cloudy Skies – late 2006<br />Drizzle – 2007<br />Dow Jones Industrials reach record high – 14,164 on October 9th, 2007; problem looks contained<br />Steady Rain – Late 2007 – 2008<br />Deluge – September 2008<br />
  29. Deluge – September 2008<br />Fannie and Freddie in conservatorship<br />Lehman Brothers files for bankruptcy protection<br />Reserve MM “breaks the buck”<br />Federal Reserve lends $85 billion to AIG to avoid bankruptcy, and further ripple affects<br />Treasury proposes and finally gets TARP<br />But……credit markets seize anyway<br />Warren Buffett calls the economy “a great athlete that’s had a cardiac arrest”<br />President Bush: “This sucker could go down”<br />
  30. Deluge – September 2008<br />Flight to Quality<br />Investors sell EVERYTHING – stocks bonds, money markets, etc., and <br />Buy TREASURIES<br /><ul><li>Short-term Treasuries trade with a negative yield – Investors pay the U.S. Gov’t to hold their cash</li></ul>Source: Bespoke Investments<br />
  31. Deluge – September 2008<br />No Appetite for Risk <br />Investors demand higher compensation to own risky assets<br />In many cases, the highest ever<br />Source: Wells Fargo<br />
  32. Deluge – September 2008<br />TED Spread: difference between the interest rates on interbank loans and T-bills; Indicator of perceived credit risk in the general economy<br />Single best indicator of how close we came to the brink<br /><ul><li>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</li></ul>Unprecedented<br />TED Spread<br />Uncomfortable<br />Normal<br />Normal<br />Source: Bloomberg<br />
  37. Nature of Credit Crisis<br />Different<br />
  38. The fire is going out. Which do you use first?<br />Policy Response<br />
  39. Policy Response<br /><ul><li>In steps the US Government as lender of last resort; unfreezing frozen markets</li></ul>FDIC expansion<br />Money market protection<br />Guarantees<br />Capital infusions<br />Asset purchases<br />Commercial paper funding<br />Enter the age of acronym: TARP, CPFF, MMIF, AMLF, TALF, PPIF, TLGP,CAP, TLG<br />Be thankful the US Dollar is/was the flight to quality reserve currency<br />
  40. Policy Response<br />Source: Deutsche Bank<br />
  41. Policy Response<br />Source: News N Economics<br />
  42. Nature of Response<br />Different<br />
  43. A Perfect Storm in the Making<br />Crisis Unfolds<br />Economy<br />Markets<br />Where do we go from here<br />Questions<br />Agenda<br />
  44. Economy: Despite massive action…<br />Global trade falls off a cliff<br />Source: John Mauldin<br />
  45. Economy<br />Massive job losses – in both relative and absolute terms<br />Source: Fortigent, Calculated Risk Blog<br />
  46. Economy<br />Sharp global contraction in GDP and Industrial Production (as of Q1 2009)<br />Source: Wall Street Journal, NY Times, Bloomberg<br />
  47. Economy<br />Auto Sales…………………………enough said<br />Source: Wall Street Journal<br />
  48. Economy<br />Bank failures – small in number<br />Source: FDIC<br />
  49. Economy<br />Bank failures – but covering record deposits!!<br />In billions<br />Source: FDIC<br />
  50. Economy<br />Mortgage Delinquencies climb<br />Source: Amherst Securities, LoanPerformance; National Delinquency Survey, Mortgage Bankers Association;<br />FDIC Quarterly Banking Profile; T2 Partners<br />
  51. Economy<br />While home prices continue to fall<br />Source: Standard & Poor’s, OFHEO Purchase-Only Index, NAR, T2 Partners<br />
  52. What do Economists Say? <br />Economy<br />Who Cares!<br />
  53. Economy<br />What does the media Say? <br />
  54. Economy<br />
  55. Economy<br />
  56. Economy<br />
  57. Economy<br />
  58. Economy<br />
  59. Economy<br />
  60. Economy<br />1987<br />1991<br />1982<br />1998<br />1980<br />2008<br />1974<br />
  61. How Bad Is It?<br />This is not “Great Depression 2.0”<br />
  62. How Bad Is It?<br />This is not “Great Depression 2.0”<br />Government shows a willingness to do “whatever it takes” – Fed Funds Rate, balance sheet, deficit spending<br />Correct monetary policy response – lower rates, increased money supply<br />Backstop of FDIC – bank losses not flowing through to consumer<br />Social shock absorbers – unemployment insurance, Soc. Sec., Medicare, Food stamps<br />Coordinated global response<br />Source: Slate<br />
  63. How Bad Is It?<br />But, This is the deepest and longest recession of the post WWII era<br />Source:<br />
  64. How Bad Is It?<br />There is no room for error:<br />Banks – healthier but far from healthy<br />State and local government deficits<br />Stimulus – poorly conceived; little bang for lots of bucks<br />Current federal deficit – 13%+ of GDP<br />Continued home price decline / second wave of mortgage defaults / commercial property / Europe<br />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)<br />Possible vicious cycle – Paradox of Thrift – unemployment/defaults/banking losses/ tighter credit/unemployment…….<br />Source: BLE, JP Morgan, Pimco<br />
  65. How Bad Is It?<br />And…..great uncertainty in the short-term :<br />De-leveraging<br />Re-regulation<br />De-globalization (protectionism)<br />Increased taxes<br />Political / legislative uncertainty<br />Reduced corporate profits<br />
  66. Economy<br />Not<br />Different<br />
  67. What is Different This Time?<br />Credit induced vs. Inventory or business cycle<br />Systematic risk<br />Global decline<br />Deeper and longer than we’re used to<br />
  68. On the Bright Side<br />Snapback is historically proportional to decline<br />Source: Bank Credit Analyst<br />
  69. On the Bright Side<br />Economic Indicators are getting better or have stopped getting worse:<br />Consumer sentiment<br />Initial unemployment claims<br />Industrial production<br />Retail sales<br />Household savings<br />Home affordability<br />GDP -1.0% Q2 ‘09<br />
  70. A Perfect Storm in the Making<br />Crisis Unfolds<br />Economy<br />Markets<br />Where do we go from here<br />Questions<br />Agenda<br />
  71. Markets<br />Steep declines driven by margin calls, redemptions, weak hands, flight to quality<br />S&P 500 <br />price only<br />
  72. Markets<br />How bad was 2008? <br />S&P 500: -37% <br />Second worse year on record (-43% in 1931)<br />Every asset class declines except high quality bonds<br />International Equities (MSCI EAFA): -43.4%<br />Emerging Markets (MSCI EM): -54.3%<br />Commodities (Dow Jones AIG Index): -35.7%<br />Real Estate (NAREIT Equity Index): -37.7%<br />Source: Littman Gregory<br />
  73. Markets<br />Q1 ‘09<br />Markets continued decline in January and February<br />S&P 500 -56.7% peak to trough (price only)<br />Markets looked broken, dysfunctional<br />Diversification didn’t help as correlations go to 1.0<br />But, with dislocation comes opportunity<br />
  74. Markets<br />Significant capitulation on March 9th<br />Market is forward looking and sees brighter days ahead; continues to go up in the face of bad news<br />Went from significantly undervalued to fairly valued<br />S&P 500 <br />price only<br />~60% recovery!<br />
  75. Markets<br />US Equities not the only game in town<br />YTD 2009<br />High Yield bonds up 31.4% Vanguard VWEHX<br />Convertible bonds up 34.9% Vanguard VCVSX<br />Emerging Markets up 62.1% Vanguard VEIEX <br />Small Cap Growth up 37.9%Vanguard VISGX <br />Even Muni Bonds up 14.3% Vanguard VWLTX<br />Meanwhile…….<br />Long-term Treasuries - 9.1%Vanguard VUSTX<br />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.<br />
  76. Markets<br />Can this last? Or is it a dead cat bounce?<br />Source: Edward Jones<br />
  77. Markets<br />Historically Markets begin recovery about halfway through recessions even as bad news continues and unemployment rates increase<br />Source: JP Morgan<br />
  78. Markets<br />Not<br />Different<br />
  79. Markets: Long Term<br />Wasted 10 years…………roller coaster ride<br />-1.46% annualized return (S&P 500, Vanguard VFINX, 1/98-12/08, inc. div)<br />
  80. Markets: Long Term<br />Again….US Equities not the only game in town<br />10 years 1/98 – 12/08, annualized returns<br />S&P 500 - 1.46% Vanguard VFINX<br />US Small Cap Value +7.32% DFA DFSVX<br />Emerging Markets +9.49% DFA DFEMX<br />Intl. Small Cap Value +9.52% DFA DISVX<br />Real Estate +7.55% DFA DFREX<br />And don’t forget bonds<br />Total Bond Market Index +5.37% Vanguard VBMFX <br />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.<br />
  81. Markets: Long Term<br />And.….Over 20 years……respectable<br />Note: Average Investor compared to markets; Why? <br />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.<br />
  82. A result we could have all lived with:<br />Markets: Long Term<br />~8% annual growth<br />Source: Yahoo, Century Wealth Management<br />
  83. A Perfect Storm in the Making<br />Crisis Unfolds<br />Economy<br />Markets<br />Where do we go from here<br />Questions<br />Agenda<br />
  84. Where Do We Go From Here<br />Going forward…next 10 years should be better<br />Source: DWS<br />
  85. Where Do We Go From Here<br />Why?...Reversion to the mean; driven by GDP<br />Source: DFA, Federal Reserve; Hypothetical based on 15x P/E ratio<br />
  86. Where Do We Go From Here<br />Another reason to be cheerful……<br />Stocks are cheap<br />Price/ Peak Earnings<br />Price/Normalized Earnings<br />Price/Book<br />Tobin’s Q Ratio<br />Source: JP Morgan as of June 30, 2009<br />
  87. Where Do We Go From Here<br />And, when stocks are cheap….future returns are good<br />
  88. Where Do We Go From Here<br />Equity markets go up more than they go down<br />
  89. Where Do We Go From Here<br />Short term is meaningless<br />Source: DFA<br />
  90. Where Do We Go From Here<br />Not much better<br />Source: DFA<br />
  91. Where Do We Go From Here<br />A meaningful trend developing<br />Source: DFA<br />
  92. Where Do We Go From Here<br />Only 2 negative ten year periods<br />Source: DFA<br />
  93. Where Do We Go From Here<br />20 is the new 10<br />Source: DFA<br />
  94. Markets<br />How should investors position their portfolios?<br />Diversify globally – un-hedged international exposure<br />Tactical vs. static allocation<br />Be nimble; Buy what’s cheap, when it’s cheap<br />Don’t forget bonds – high quality corporate vs. treasuries<br />Use alternatives to diversify stock and bond exposure<br />Market neutral strategies<br />Arbitrage strategies<br />Structured notes<br />Inflation protection – down the road<br />Tips<br />Commodities<br />
  95. Markets<br />Not<br />Different<br />
  96. Biggest Long-term Challenges<br />2nd Wave of defaults / FDIC / Comm. RE<br />Source: FDIC, NY Times<br />
  97. Biggest Long-term Challenges<br />Double Dip Recession / Deflation <br />
  98. Biggest Long-term Challenges<br />Federal Debt/GDP<br />Source: WSJ<br />
  99. Biggest Long-term Challenges<br />Entitlements<br />Source: TCW<br />
  100. Biggest Long-term Challenges<br />Inflation / Value of $<br />Source: WSJ<br />
  101. Conclusion<br />Yes, this recession is different from others<br />But, each contraction poses unique problems<br />No, this is not a repeat of the Great Depression<br />Yes, we are entering into a new era of de-leveraging and slower growth<br />The short term outlook is cautious <br />While, long term, the investment opportunities are encouraging based on fundamentals and valuation<br />If we successfully navigate long term issues<br />
  102. Conclusion<br /><ul><li>Nature of Crisis
  103. Policy Response
  104. Economic Result
  105. Market Response
  106. Market Outlook
  107. Long-term Challenges</li></ul>Different<br /> Different<br /> NotDifferent <br /> NotDifferent <br /> NotDifferent <br /> VeryDifferent <br />
  108. Lessons Learned<br />
  109. Disclaimer<br />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.<br />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.<br />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.<br />All material is compiled from sources believed to be reliable, but accuracy cannot be guaranteed.<br />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.<br />
  110. A Perfect Storm in the Making<br />Crisis Unfolds<br />Economy<br />Markets<br />Where do we go from here<br />Questions<br />Agenda<br />
  111. Questions<br />Century Wealth Management, llc <br />5350 Poplar Ave., Suite 395 <br />Memphis, TN 38119<br />P: 901.850.5532 <br /><br />email:<br />Presentation posted at: <br /><br /><br />Email newsletter:<br />