Merrill Lynch Demystifying The Market

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Merrill Lynch Demystifying The Market

  1. 1. De-mystifiying the market By Sarah Butcher – Editor eFinancialCareers.com
  2. 2. Agenda <ul><li>Part 1 – The current market place and how did we get here. </li></ul><ul><li>Part 2 – Government rescue. </li></ul><ul><li>Part 3 – Where are we going and the implications for the future. </li></ul><ul><li>Part 4 – Questions and Answers </li></ul>
  3. 3. Taking stock: where we are now <ul><li>Writedowns: </li></ul><ul><li>- $50 trillion of financial assets (stocks, bonds and currencies) written down in 2008 according to the Asian Development Bank. Equivalent to one year’s global GDP </li></ul><ul><li>- 40-45% of the world’s wealth destroyed says Stephen Schwarzman, chairman and chief executive of Blackstone Group </li></ul>
  4. 4. Taking stock: where we are now <ul><li>Financials have taken a (big) hit </li></ul>Source: StockCharts.com
  5. 5. Taking stock: where we are now <ul><li>Financials have taken a (big) hit </li></ul><ul><li>Citigroup shares fell to $1, down from highs of $55 in 2007 </li></ul><ul><li>Further writedowns from Eastern Europe, credit cards, corporate and consumer debt are very possible </li></ul><ul><li>277,400 finance industry jobs lost worldwide (Bloomberg) </li></ul>
  6. 6. Taking stock: where we are now <ul><li>Ready to default? </li></ul>Source: Wall St. Journal
  7. 7. Taking stock: where we are now <ul><li>Volatile equity markets </li></ul><ul><li>- FTSE at 6 year low in late February </li></ul><ul><li>S&P 500 at 12 year low in late February </li></ul><ul><li>20% recovery in S&P by late March 2009, 7% recovery on Monday March 23 rd after the Geithner plan was announced </li></ul><ul><li>From March 9 to March 20 2009, the KBW bank index rose by 33 percent, while the overall Dow Industrials rose by only 11 percent. </li></ul><ul><li>Citibank quadrupled in value from early March to mid-April. </li></ul><ul><li>Bear market rally? </li></ul><ul><li>Star fund managers call the bottom of the market – March 15 th Anthony Bolton said we may be near the bottom, and entering a new bull market. </li></ul>
  8. 8. Taking stock: where we are now <ul><li>Volatile equity markets </li></ul>Source: MoneyWeek
  9. 9. Taking stock: where we are now Source: Clusterstock
  10. 10. Taking stock: where we are now <ul><li>Manufacturing trauma </li></ul><ul><li>Number of cars assembled in the US down 60% in Jan 09 </li></ul><ul><li>Chinese exports down 17% in Jan 09 </li></ul><ul><li>Japanese exports down 46% in Jan 09 </li></ul>
  11. 11. Taking stock: Where we’ve come from <ul><li>2007-8 </li></ul>
  12. 12. Taking stock: Where we’ve come from <ul><li>2007: Rumblings </li></ul><ul><li>February: HSBC fires chiefs of US division (Household International) </li></ul><ul><li>May: UBS closes Dillon Reed Capital Management </li></ul><ul><li>June: Bear Stearns bails out its hedge funds for the first time </li></ul><ul><li>August: 3 BNP Paribas funds, once worth €1.6bn, suspended </li></ul><ul><li>August: Stock markets tumble, central banks intervene </li></ul><ul><li>September: Northern Rock </li></ul><ul><li>October: $8.4bn loss at ML, Stan O’Neal ousted </li></ul>
  13. 13. Taking stock: Where we’ve come from <ul><li>2008: Disintegration </li></ul><ul><li>FTSE down 31% </li></ul><ul><li>Bye bye Bear Stearns </li></ul><ul><li>So long Lehman </li></ul><ul><li>BofA and Merrill get together </li></ul><ul><li>Goldman and Morgan Stanley become bank holding companies </li></ul><ul><li>Perilously close to meltdown: Crisis in the money markets. September $550bn withdrawn in a few hours on Sept 18 th after money market fund the Reserve Fund caught holding Lehman debt. US gov introduced $3.4 trillion money market guarantee programme. </li></ul>
  14. 14. Taking stock: Where we’ve come from <ul><li>2008: Disintegration </li></ul><ul><li>LIBOR (London interbank offer rate) post Lehman </li></ul>Source: John Taylor, Stanford University, via FTAlphaville
  15. 15. Taking stock: Where we’ve come from <ul><li>2008: Disintegration </li></ul>Source: FTAlphaville
  16. 16. Taking stock: Where we’ve come from <ul><li>2008: Crisis timeline </li></ul>Source: Pragmatic Capitalist
  17. 17. How did it come to this?
  18. 18. How did it come to this? <ul><li>The ‘Great Moderation’ </li></ul>Source: Dallas Fed
  19. 19. How did it come to this? <ul><li>Leverage, leverage, leverage </li></ul>Source: Market Oracle
  20. 20. How did it come to this? <ul><li>Money from overseas </li></ul>Source: BusinessWeek
  21. 21. How did it come to this? <ul><li>New funding model </li></ul><ul><li>“ In the UK, regulators and shareholders acquiesced while six major banks increased their aggregate reliance on wholesale, unsecured funding from £38bn in 2003 to £498bn in 2008 in order to finance increasingly speculative lending.” </li></ul><ul><li>Guy Hands, CEO Terra Firma Capital Partners </li></ul>
  22. 22. How did it come to this? <ul><li>Securitization </li></ul>Source: Economistsview
  23. 23. How did it come to this? <ul><li>Securitization </li></ul><ul><li>Think David Bowie’s back catalogue </li></ul><ul><li>Pools of mortgaged backed securities collected and re-securitized </li></ul><ul><li>SIV= Structured investment vehicle – issues short and medium term debt payable in 2-270 days </li></ul><ul><li>CDO= Collateralised debt obligation – longer term debt </li></ul>
  24. 24. How did it come to this? <ul><li>CDOs </li></ul>Source: Reserve Bank of Australia
  25. 25. How did it come to this? <ul><li>CDOs </li></ul>Source: SIFMA (via SuddenDebt)
  26. 26. How did it come to this? <ul><li>Sub prime loans </li></ul>Source: Carpe Diem
  27. 27. How did it come to this? <ul><li>Underestimation of risk </li></ul><ul><li>Complicity of ratings agencies – </li></ul><ul><li>“ It could be structured by cows and we would rate it.” </li></ul><ul><li>Retrospective risk models </li></ul><ul><li>Low interest rates encourage investors to look for high returns </li></ul>
  28. 28. How did it come to this? <ul><li>Writedowns </li></ul><ul><li>$450bn of CDOs of ABS issued from late 2005 to mid 2007 </li></ul><ul><li>Around $305bn of these CDOs are now in a formal state of default </li></ul><ul><li>Mark to market accounting obliged banks to price assets according to current market value. </li></ul><ul><li>European banks: $316bn of writedowns to Feb 09 (Bloomberg) </li></ul><ul><li>Global banking writedowns: $1 trillion to Feb 09 (Roubini). Predicts $1.8 trillion. </li></ul><ul><li>Most securities now written down. Writedowns on loans still to come </li></ul>
  29. 29. How did it come to this? <ul><li>Negative feedback loop </li></ul>Source: BBC
  30. 30. Governments to the rescue
  31. 31. Governments to the rescue <ul><li>US banking rescue lot bigger than the Marshall plan </li></ul>Source: Alea (Total value of the rescue in March 2009 = $11.6 trillion)
  32. 32. Governments to the rescue <ul><li>Rescues by genre </li></ul><ul><li>Capital injections (buying preferred equity/ordinary stock) </li></ul><ul><li>Unfreezing credit markets (Eg. Central banks swap cash/government bonds for asset backed securities). </li></ul><ul><li>Attempts to buy up banks’ toxic assets – Eg. Original TARP and Geithner plan </li></ul><ul><li>Guarantees/insurance programmes – Eg. above a pre-determined level, governments insure banks against losses on their toxic assets. </li></ul><ul><li>Loans to get markets moving again – Eg. US government lending up to $200bn to holders of asset backed securities under TALF. </li></ul>
  33. 33. Governments to the rescue <ul><li>So, who’s been bailed out? </li></ul><ul><li>Fannie and Freddie, UBS, Commerzbank, Bank of America, Citigroup, RBS, AIG, Bradford & Bingley, Lloyds Banking Group, Northern Rock, Fortis, Dexia, SocGen, BNP Paribas, Credit Agricole, Bank of Ireland, Allied Irish, Goldman Sachs, Morgan Stanley, JPMorgan Chase, State Street, Northern Trust, Unicredit, Gulf Bank… </li></ul>
  34. 34. <ul><li>What? </li></ul><ul><li>Very big insurance company. Insures 90% of Fortune 500. </li></ul><ul><li>Operating in 140 countries globally </li></ul><ul><li>Offered both standard insurance (eg. car insurance) and insurance against financial products defaulting. $1.6 trillion in ‘notional derivatives exposures.’ </li></ul>
  35. 35. <ul><li>Why bailed out? </li></ul><ul><li>Systemic risk from loss of AAA rating. ‘Confidential report said’ – </li></ul><ul><li>‘ The failure of AIG would cause turmoil in the US economy and global markets and have multiple and potentially catastrophic unforseen consequences.’ </li></ul><ul><li>- Eg. Plummeting dollar. ‘Enormous downward pressure’ on securities valuations as products dumped. </li></ul>
  36. 36. <ul><li>How bailed out? </li></ul><ul><li>On 16th September 2008, the day after Lehman went under, the US government lent AIG an initial $85bn to save it from collapse. </li></ul><ul><li>It received a 79% stake in the company in return. </li></ul>
  37. 37. <ul><li>Was the bailout successful? </li></ul><ul><li>- Yes: meltdown averted. </li></ul><ul><li>No: AIG has needed multiple bailouts. </li></ul><ul><li>US government injected more money in November 2008 and March 2009 . </li></ul><ul><li>The US government has $160bn pledged so far. In 4Q08 AIG lost $465,421 every single minute. </li></ul>
  38. 38. <ul><li>What? </li></ul><ul><li>The biggest bank in the world until 2008. </li></ul><ul><li>Operating in over 100 countries globally. </li></ul><ul><li>325,000 employees worldwide in 2007 </li></ul>
  39. 39. <ul><li>Why bailed out? </li></ul><ul><li>- Big exposure to toxic assets, comparatively small capital base. </li></ul><ul><li>$60bn of market to market losses on asset writedowns by early 2009. </li></ul><ul><li>$300bn plus in additional toxic debt. </li></ul><ul><li>Share price fell below $1 in March 2009 (after bailout). </li></ul>
  40. 40. <ul><li>How bailed out? </li></ul><ul><li>Bailout No. 1: October 2008, US gov invests $25bn in preferred shares (without voting rights). </li></ul><ul><li>Bailout No. 2: November 2008, US gov invests another $20bn investment in preferred shares; guarantees to cover most of the losses on $300bn toxic debt. </li></ul><ul><li>Bailout No 3: No more cash, conversion of gov’s preferred stock into into ordinary stock. 36% voting stake as a result. </li></ul>
  41. 41. <ul><li>Was the bailout successful? </li></ul><ul><li>Yes: meltdown averted </li></ul><ul><li>No: Citigroup’s stock fell 60% immediately after third bailout, but rose on reassuring words from the CEO. </li></ul><ul><li>Concerns of further big writedowns to come. Eg. On credit card debt. </li></ul>
  42. 42. <ul><li>What? </li></ul><ul><li>One of the UK’s largest mortgage lenders. </li></ul><ul><li>Former building society, formed 1965, floated on the stock exchange 1997 and changed its business model </li></ul>
  43. 43. <ul><li>Why bailed out? </li></ul><ul><li>Over-reliance on funding in wholesale markets </li></ul><ul><li>Wholesale funding dried up in August 2007. </li></ul><ul><li>12/9/07 it emerged that Northern Rock needed an emergency loan from Bank of England. </li></ul><ul><li>Run on the bank. </li></ul>
  44. 44. <ul><li>How bailed out? </li></ul><ul><li>UK gov tried, failed, to find a buyer. </li></ul><ul><li>Feb 2008, UK gov lent Northern Rock £26.9bn: nationalization. </li></ul><ul><li>Little compensation offered to Northern Rock shareholders. </li></ul>
  45. 45. <ul><li>Was the bailout successful? </li></ul><ul><li>Yes: meltdown averted. </li></ul><ul><li>£18bn of government loan repaid in February 2009. </li></ul><ul><li>Northern Rock could form core of a good bank. </li></ul><ul><li>But bad debts on Northern Rock’s mortgages are rising. </li></ul>
  46. 46. <ul><li>What? </li></ul><ul><li>Very large and venerable Scottish bank. </li></ul><ul><li>Founded founded in 1727 by a Royal Charter of King George I. </li></ul>
  47. 47. <ul><li>Why bailed out? </li></ul><ul><li>Too many debts, too little capital. </li></ul><ul><li>Expensive ABN AMRO acquisition: £10bn at the top of the market. </li></ul><ul><li>RBS stock fell 40% in October 2008. </li></ul><ul><li>RBS stock fell 70% in February 2009 before reported biggest loss in UK corporate history: £24.1bn. </li></ul>
  48. 48. <ul><li>How bailed out? </li></ul><ul><li>Bailout No. 1: £20bn from UK gov in October 2008. </li></ul><ul><ul><ul><ul><li>60% stake in preference shares. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Converted to ordinary shares Jan 09; RBS agrees to increase lending. </li></ul></ul></ul></ul><ul><li>Bailout No. 2: £19bn from UK government in Feb 2009. </li></ul><ul><ul><ul><ul><li>75% stake in preference shares. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Gov guarantee against losses on £325bn of toxic assets. </li></ul></ul></ul></ul>
  49. 49. <ul><li>Was the bailout successful? </li></ul><ul><li>Yes: no meltdown. </li></ul><ul><li>RBS could be start of a bad bank. ‘Non-core’ RBS to include £300bn of unwanted operations and toxic assets. </li></ul>
  50. 50. What now? <ul><li>Good bank/bad bank? </li></ul>
  51. 51. What about quantitative easing? <ul><li>Creating money in the hope banks start lending again. </li></ul><ul><li>Bank of England: buying up to £100bn in short and medium term government bonds; up to £50bn in high grade corporate debt. </li></ul><ul><li>Federal Reserve : buying up to $300 billion of longer-dated Treasuries over the next six months and buy another $850 billion of mortgage securities. </li></ul><ul><li>Banks could either hoard the extra money or there could be… </li></ul>
  52. 52. <ul><li>- Zimbabwe introduced a 100 trillion note worth US$300 </li></ul>Hyperinflation
  53. 53. What does this mean for you?
  54. 54. What does this mean for you? <ul><li>Fewer jobs </li></ul><ul><li>Lower pay </li></ul><ul><li>More uncertainty </li></ul><ul><li>Danger of redundancy </li></ul><ul><li>New institutions? </li></ul>
  55. 55. What does this mean for you? <ul><li>The havens: </li></ul><ul><li>FX trading </li></ul><ul><li>Sales and trading, simple products </li></ul><ul><li>Risk </li></ul><ul><li>Compliance (and working for the regulator) </li></ul><ul><li>Old-fashioned relationship banking </li></ul><ul><li>Private banking (at least until recently) </li></ul><ul><li>Fund management </li></ul>

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