Explaining the Financial Crisis


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For a class assignment on the 2007-08 economic crisis. We focused on the idea of a "Shifting Economic Position" as the major reason for the crisis (as per assignment) - Leave a comment if you download, please!

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  • Explaining the Financial Crisis

    1. 1. Armando Suarez, ArsenyLebedev, Joe Gunshor, Rebecca Ryba, Jacob Turner, Joe Amelio, Nicole Rizzuto
    2. 2. Contents <ul><li>Overview </li></ul><ul><li>Prelude to Shift </li></ul><ul><li>Cause of Crisis </li></ul><ul><li>History of the Past </li></ul><ul><li>Investment Strategies </li></ul><ul><li>Remedy to Crisis </li></ul><ul><li>When will the Crisis End? </li></ul>
    3. 3.
    4. 4. Nutshell
    5. 5. Banks Washington Mutual Barclays Capital Citigroup Lehman Brothers Merrill Lynch UBS
    6. 6. Businesses -30% Dow YTD <ul><li>Money is tight </li></ul><ul><li>Lowered consumer spending </li></ul>
    7. 7. Households ~14 Million People <ul><li>Difficulty to get loans </li></ul><ul><li>Sub-prime mortgage problems </li></ul>
    8. 8.
    9. 9. 2006-2007
    10. 10. 2008
    11. 11. What’s Wrong? <ul><li>The lack of organic demand is an important issue to look at. </li></ul><ul><li>everybody that wanted to buy a house did over the past 4 years. </li></ul><ul><li>The only real demand right now for the housing market are investors. </li></ul>
    12. 12.
    13. 13. Trade Account <ul><li>An indicator of a country’s financial position vs the rest of the world. US historically always in the black </li></ul><ul><ul><li>During the 70’s oil crisis deficit never exceeded $15 Bn </li></ul></ul><ul><ul><li>Tilted into free fall in ’99. </li></ul></ul><ul><ul><li>2006 deficit = $750 Bn </li></ul></ul><ul><ul><li>Total current account deficit ~ $800 Bn </li></ul></ul>
    14. 14. The Deficit <ul><li>Being financed by foreigners </li></ul><ul><ul><li>In 2006, US deficit consumed about 70% of the rest of the world’s surpluses. </li></ul></ul><ul><ul><li>Comes from private investors from Russia, China, and the Gulf countries. </li></ul></ul>
    15. 15. Central Banks <ul><li>Increasing amount coming from official sources, mostly central banks. </li></ul><ul><ul><li>2001, $35 Bn from official sources </li></ul></ul><ul><ul><li>2006, $440 Bn from official sources </li></ul></ul><ul><li>Investments for policy reasons, not due to returns </li></ul><ul><li>What if policy is reversed? What will they do with the money? </li></ul>
    16. 16. Central Banks and Government-Controlled Bodies <ul><li>Hold large concentrations of cashlike dollar assets </li></ul><ul><ul><li>China, $1.2 Tn </li></ul></ul><ul><ul><li>Rest of non-Chinese Asia, $1.2 Tn </li></ul></ul><ul><ul><li>OPEC Nations, $600 Bn </li></ul></ul><ul><ul><li>Russia, $400 Bn </li></ul></ul><ul><ul><li>2006 Total foreign held dollar reserves, $5 Tn </li></ul></ul>
    17. 17. US as Center of Trade and Investment Flows <ul><li>Emerging countries had no choice but to adopt an export-led growth strategy </li></ul><ul><ul><li>Lack basic banking and credit for internal consumption-led boom </li></ul></ul><ul><li>Dollar investments would benefit from most liquid security and trading markets. </li></ul><ul><li>Belief that China, India, oil exporters would have to absorb dollars. </li></ul>
    18. 18. Not today… <ul><li>America had all the world’s money, so countries would sign up in order to borrow </li></ul><ul><li>Today, America is still the center, but it is the world’s biggest borrower, while other countries have all the money. </li></ul>
    19. 19. Dollars not so attractive <ul><li>Holding dollars is increasingly against other countries interests. </li></ul><ul><ul><li>Countries may price their trades in dollars and invest surpluses in dollar-denominated assets </li></ul></ul><ul><ul><li>BUT, primary trade flows may not be with US </li></ul></ul>
    20. 20. Asia <ul><li>Asian countries are dollar-based </li></ul><ul><li>Since their economies are tied to China, and China’s trade is primarily with US, they must stay that way </li></ul>
    21. 21. Wrong. <ul><li>China is diversifying customer base </li></ul><ul><ul><li>50% of exports go to other Asian countries, MidEast, and LatAm NOT US, Europe, Japan </li></ul></ul><ul><ul><li>US share of Chinese exports is about 20% </li></ul></ul><ul><li>Since most Asian countries are becoming large importers of oil and gas, why maintain the dollar peg? </li></ul>
    22. 22. Gradual move away from the Dollar <ul><li>Most surplus countries are now diversifying their currency holdings and moving away from the dollar </li></ul><ul><ul><li>Pegging against a basket of reserve currencies </li></ul></ul><ul><li>US must keep interests rates higher than wanted to prevent a total currency rout </li></ul><ul><li>Countries do not want to be at Western mercy </li></ul>
    23. 23. The shift <ul><li>America used to buy foreign cheap, when its currency stood alone at the center, now foreigners are not willing to finance our deficits for free. </li></ul><ul><li>The “lords of the manor” are now Arab, Russian, and Chinese, while the peasant maidens are American. </li></ul>
    24. 24.
    25. 25.
    26. 26. The Great Depression <ul><li>Causes </li></ul><ul><ul><li>Rise in interest rates </li></ul></ul><ul><ul><li>Credit Crunch massive de-leveraging, Crash of 1929 </li></ul></ul><ul><ul><li>Central Bank Reduction in money supply, bank failures </li></ul></ul><ul><ul><li>Asset Class Deflation </li></ul></ul><ul><ul><li>Restricted World Trade </li></ul></ul><ul><ul><li>Tax Increases </li></ul></ul><ul><ul><li>P/E Ratio 1929: 28 P/E Ratio 1941: 12 </li></ul></ul><ul><ul><li>Avg. Dow Return 1.69% </li></ul></ul>
    27. 27. 1968-1982 <ul><li>Causes </li></ul><ul><ul><li>High Inflation </li></ul></ul><ul><ul><li>High Unemployment </li></ul></ul><ul><ul><li>Oil Shocks </li></ul></ul><ul><ul><li>End of Bretton Woods </li></ul></ul><ul><ul><li>Avg. Dow Return 1.59% </li></ul></ul><ul><ul><li>P/E Ratio 1966: 21 P/E Ratio 1982: 9 </li></ul></ul>
    28. 28.
    29. 29. Black Monday <ul><li>Causes </li></ul><ul><ul><li>Program trading </li></ul></ul><ul><ul><li>Market Valuation </li></ul></ul><ul><ul><li>Illiquidity </li></ul></ul><ul><ul><li>Market psychology </li></ul></ul><ul><ul><li>Dow Down ~23% for the year </li></ul></ul>
    30. 30. 2001 Recession <ul><li>Production Slowdown (tech sector) </li></ul><ul><li>High Unemployment </li></ul><ul><li>September 11 th attacks </li></ul><ul><li>Consumer Credit Intact </li></ul>
    31. 31.
    32. 32. Home Prices
    33. 33. LIBOR Spreads
    34. 34. Market Volatility
    35. 35. Dollar Strengthening?
    36. 36. Future Prospects <ul><li>Under Capitalized banking system </li></ul><ul><li>Unregulated Opaque markets (CDS, Overnight Repo) </li></ul><ul><li>Deflation in Housing Market </li></ul><ul><li>Loss of Confidence in Economy </li></ul><ul><li>Rising Unemployment </li></ul><ul><li>Moderate Inflation </li></ul><ul><li>Auto makers failure eminent </li></ul><ul><li>Over levered Consumer </li></ul>
    37. 37.
    38. 38. Is the Economic Shift Cyclical? <ul><li>Cyclical </li></ul><ul><li>Normal Pattern </li></ul><ul><ul><li>Following Past 6 Recessions </li></ul></ul><ul><li>Atypical </li></ul><ul><li>Black hole </li></ul><ul><ul><li>More Contraction less Expansion </li></ul></ul>In order to figure out how to tackle a solution, we need understand what type of predicament we are in.
    39. 39. Worsened Cyclical Economic Shift Deep Recession 2008 <ul><li>Defined By: </li></ul><ul><li>Below average Economic Growth </li></ul><ul><li>Lower Incomes </li></ul><ul><li>High Unemployment Rates </li></ul><ul><li>Decreased Consumer Spending </li></ul>
    40. 40. An Atypical Cycle An Atypical Cycle Each of the past six recessions has been accompanied by a bear market, with the Standard & Poor's 500-stock index losing, on average, 31%. By that measure, the stock market's current decline -- with the S&P 500 down 43% from its peak -- is already worse than usual. Bigger the Bubble  Bigger Burst
    41. 41. Problem Areas 3 1 2
    42. 42. Resuming Our Economic Position <ul><li>Restoring Investor Confidence </li></ul>Home Prices Unfreeze Credit Markets Decrease Unemployment Restore Consumer Buying
    43. 43. Fixing Unemployment <ul><li>Problem: Job market is deteriorating and that it is taking the unemployed longer to find work </li></ul><ul><ul><li>Sub Problem A : Companies are less efficient due to workforce cuts </li></ul></ul><ul><ul><li>Sub Problem B : Family Incomes Down, less consumer buying power </li></ul></ul><ul><ul><li>Sub Problem C : Unemployed become liability of Government </li></ul></ul><ul><li>Solution: </li></ul><ul><li>Fiscal Policy : Expand Government Spending to create projects that hire unemployed i.e. highway project , however increases government deficit </li></ul><ul><li>Monetary Policy: </li></ul><ul><ul><li>Option 1: Use its own reserve money to buy government bonds - Buying bonds translates to income for the U.S. government, will allow the Government to sufficiently expand monetary policy </li></ul></ul><ul><ul><li>Option 2: lower interest increase consumer spending and investment  aggregate demand will rise, there will be an increase in economic growth and therefore firms will demand more workers (this has not been working due to poor investor confidence) </li></ul></ul><ul><li>Tax Policy : Give Business tax breaks if hire onshore instead offshore </li></ul><ul><li>Recession Proof Jobs </li></ul><ul><li>Research in Energy Alternatives </li></ul><ul><li>International Business in growing markets </li></ul><ul><li>Environmental Sector, targeting Global Warming </li></ul><ul><li>Education, people go back to school during recession </li></ul>
    44. 44. Fixing Home Market These include an infusion of capital that would allow banks to step up their lending activity, Ms. Wachter, the University of Pennsylvania economist, said, and a restructuring of troubled mortgages in order to reduce the number of foreclosed homes flooding the market. If banks expect home prices to continue to tumble, they will be reluctant to lend, even if they have the capital to do so, and the number of people willing to buy a home will remain low. Problem : Stop Downward spiral of home prices Solution : Reduce Growing Inventory, Government help restructure loans to prevent defaults Problem : Keeps banks doors open to new investors Solution : Bail out will take bad loans off books, which will hopefully unfreeze credit markets due to reduce liabilities of banks
    45. 45. Increase GDP <ul><li>Problem 1 : Higher than expected GDP but due to exports , indicate falling national consumption </li></ul><ul><li>Problem 2: Will no longer be able to depend on strong exports with falling global consumption </li></ul><ul><li>Solution: </li></ul><ul><ul><li>we must increase spending power of consumer (70% of GDP) </li></ul></ul><ul><ul><li>New Jobs need to be created </li></ul></ul><ul><ul><li>Companies need to produce for future demand </li></ul></ul>
    46. 46. Thaw the Credit Markets <ul><li>Problem: Consumers, Businesses, and Corporations do not have access to capital because banks are hoarding cash </li></ul>Solution: Bail Out: TARP Treasury taking Equity stakes down Graph indicates banks and other financial institutions reluctance to lend as compared to previous years, due to fear of defaults and illiquidity WSJ
    47. 47. Confident Leadership <ul><li>The Government and Media is Contributing to the Panic </li></ul><ul><li>The Fed, the Treasury and the SEC appear to be in a state of panic. </li></ul><ul><li>A crisis mentality led them to jettison their lifelong commitments to the capital markets in favor of a series of short-term regulatory quick fixes. </li></ul><ul><li>ignored the most primary responsibility of central bankers to promote stability and to maintain confidence </li></ul><ul><li>central bankers appear to have suddenly lost confidence both in their own abilities and in the standard tools of fiscal and monetary policy. </li></ul>
    48. 48. Despite Economic Downturn The Equity Market Moves Upward Hope for the Future
    49. 49. <ul><li>Expert Opinions </li></ul>
    50. 50. <ul><li>“ For the first time since the crisis intensified at the end of the summer, credit markets thawed slightly after the threats to the financial system were tamped down by the U.S. government's move to take stakes in major banks. But lending remained tight in nearly all markets and may not ease significantly for weeks, market participants said. </li></ul><ul><li>Referring to the possible fallout in the broader economy from the credit crisis, he added: &quot;We don't yet know what that is, because this situation is so unprecedented. Every road sign has been obliterated.&quot; </li></ul><ul><ul><ul><ul><ul><li>Kent Engelke, managing director at the brokerage Capitol Securities Management, </li></ul></ul></ul></ul></ul>Source: WSJ
    51. 51. <ul><li>Bernanke states that the credit crisis is on its way to being fixed, but has a long way to go. </li></ul><ul><ul><li>TARP, to create a set of mechanisms that would create market-based price discovery by buying assets from institutions. </li></ul></ul><ul><ul><ul><ul><ul><li>Bernanke </li></ul></ul></ul></ul></ul><ul><li>The crisis moment may be past for the Big Four. They are due the biggest capital injections in the Treasury bailout plan, getting $100 billion of the $250 billion, including Merrill Lynch, which will soon belong to Bank of America. </li></ul><ul><ul><li>BIG FOUR  J.P. Morgan Chase, Wells Fargo, Citigroup, Bank of America </li></ul></ul><ul><li>It would be foolish to bet against the Treasury's backstop, and these banks will make money again. It just isn't clear they will make it quickly enough to give investors reasons to rush back into them. </li></ul>Source: WSJ