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

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

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 ‘06Source: 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”

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

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 haltUnprecedented 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

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

103. Policy Response

104. Economic Result

105. Market Response

106. Market Outlook

107. Long-term ChallengesDifferent 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: http://www.linkedin.com/in/jayhealy http://www.centurywealth.com/blog/ Email newsletter: http://www.centurywealth.com/sign_up.html