This document discusses a global market crisis occurring in 2008. It begins by outlining topics to be covered, including what is happening in the housing market, if this has occurred before, who is to blame, and what can be done. It then goes into detail about the changes that occurred in the housing market, such as increased leverage and riskier loans, and how this led to a collapse similar to the Great Depression when home values declined. While no single party is entirely to blame, changes are needed to restore confidence and prepare for an economic downturn.

1. A Global Market Crisis
Tim Kelly, Partner
Adams Street Partners, LLC
AP Economics
Conant High School
Oct 2, 2008

2. Discussion Topics
• What’s happening in the market?
• Has it ever happened before?
• Who’s to blame?
• What to do?
• Future?

3. What is happening in the market?
$100,000 cash
$400,000 loan/mortgage
$500,000
Want to buy

4. What is happening in the market?
$700,000
$400,000 loan/mortgage
+ $100,000 cash+ $200,000 gain
$300,000
$400,000 loan/mortgage now
worth $300,000
+$100,000 cash is now $0
Bank losing and Owners Lost
$500,000
$400,000 loan/mortgage
+$100,000 cash = Neutral

5. What is happening in the market?
Scenario I - Gains
$700,000
$400,000 loan/mortgage
+ $100,000 cash+ $200,000 gain
• Consumer Confidence/Discretionary
Spending/Consumption – all UP: Owners go on vacation,
buy new car, charge more on credit cards, buy new house
• Economy: Booming! Consumption up, savings up,
employment up, dollar strong (importing), inflation no
problem since GDP growing nicely, all is good
Marketplace is awash with lots of money (liquidity)

6. What is happening in the market?
Future starts to look not as good so
people slow down spending
Income “Smoothing”
Begins
• Hold off on that new frig
• Delay BIG trip for smaller one
• Inflation creeps up
• GDP slows
• Layoffs begin
• Consumption falls
• Savings decline
• Lending declines
• Sales/Profits fall – stocks fall
Time 0 Time 1
Normal Cycle

7. What is happening in the market?
Market in the dull drums; output (GDP) falls until
some stimulus causes spending again
GDP slows… falls… recession
• Two+ quarters of –GDP = recession
• Unemployment rises, consumptions falls
• Confidence wanes, tax pools fall
• Watch for negative externalities to amplify! Time 3
Time 2
Normal Cycle

8. What is happening in the market?
Scenario II – Losses Today
$400,000 loan/mortgage now
worth $300,000
+$100,000 cash is now $0
Bank losing and Owners Lost
$700,000
$500,000
$300,000
Paper gains converted to cash through equity loans:
perception of gain became reality of loss

9. What is happening in the market?
What’s changed? The old system
Bailey Bank
$1.2 million in capital
4% aver cost
500 customers
$1,000 ea in savings=
$500k total deposits
Savings rate: 5%
Fed Reserve
Fed Funds
FOMC
$500k loans
3% interest
Wall Street
$200k equity
% of profits
$400k loan, 8%
3 x Borrowers
$100K
Cost 4% (aver of 5% and 3%)
Loan 8%
Profit 4% = “profit spread”

10. But this model presents a real risk (absent
the Fed Reserve and FDIC but pretend
those don’t exist)… if confidence is shaken
about the health of the bank in any way,
depositors could fear losing their savings
and “run” to the bank to withdraw their
deposits… watch what this looks like:
What is happening in the market?
What’s changed? The old system
http://www.youtube.com/watch?v=MJJN9qwhkkE

11. What is happening in the market?
What’s changed – The new system
$100k loan, 8% i, fees
Borrowers
Bailey Bank
$300k in capital
4% aver cost
100 customers
$10,000 ea in savings
Savings rate: 5%
Capital base: $100k
Fed Reserve
$100k loans
3% interest
Wall Street
$100k equity
% of profits
Fannie Mae
Freddie Mac
3 - $100k loans
Buys all 3 for 100% face
Pays Bailey Bank 1% of i

12. Profitability from Scaling Assets
Bailey Bank
$300k in capital
4% profit spread
+ Fees
$12k yr + fees = annual profit
More loans as 3 outstanding
are repaid or more savings
come in
3- $100k loans = $300k x 4% =
$12k + (3 x fees)
Bailey Bank
Unlimited capital from Fannie
and Freddie
1% profit spread
+ Fees
(# Loans issued x 1%) + fees
= annual profit
More loans as fast as
marketing team can find
home buyers
12- $100k loans = $1.2M x 1%
= $12k + (12 x fees)

13. What is happening in the market?
Bailey Bank
$300k in capital
Fannie Mae
Freddie Mac
3 - $100k loans
Buys all 3 for 100% face
Pays Bailey Bank 1% of i
Fannie Mae
Freddie Mac
Fannie Mae
Freddie Mac
Fannie Mae
Freddie Mac Fannie Mae
Freddie Mac
Fannie Mae
Freddie Mac
Fannie Mae
Freddie Mac
Domino risk is born

14. What is happening in the market?
Housing Market Basics – new
system
Bailey Bank
$300k in capital
Fannie Mae
Freddie Mac
Wall Street
Gets interested!

15. What is happening in the market?
Housing Market Basics – new
system
Fannie Mae
Freddie Mac
Fannie Mae
Freddie Mac
Fannie Mae
Freddie Mac
Fannie Mae
Freddie Mac
Fannie Mae
Freddie Mac
$400k loans
7% interest (1% paid)
5.5%
Savings Accts 5%
T-bills 3%
Fannie Mae
Freddie Mac
7.0%

16. What is happening in the market?
Fannie Mae
Freddie Mac
$500k rises to $700k on paper
Let’s Recap

17. What is happening in the market?
Recap
Fannie Mae
Freddie Mac
Bigger home
Bigger mortgage
Fancy car
Big loan
Vacations
Jewelry
Credit card debt

18. The system was starting to show
signs of cracks

19. What is happening in the market?
Fannie Mae
Freddie Mac
$400k at 8% strong credit
$400k at 8% bad credit
$400k at 8% bad credit
$400k at 8% good credit
$400k at 8% bad credit
Credit Quality was falling

20. What is happening in the market?
Recap
Fannie Mae
Freddie Mac
Bigger home
Bigger mortgage
Fancy car
Big loan
Vacations
Jewelry
Credit card debt

21. What is happening in the market?
Recap
Fannie Mae
Freddie Mac
Bigger home
Bigger mortgage
Fancy car
Big loan
Vacations
Jewelry
Credit card debt

22. What is happening in the market?
Leverage amplifies risk
Standard mortgage
leverage
$20k equity for every $100k borrowed
Or 20% equity (4:1 leverage)
And, loan never more than 80% of
house value
Why?
$400k loan and $100 equity = $100k
cushion to bank
Recent mortgage leverage
$0-5k equity for every $100k borrowed
Or 0 to 5% equity (19:1 leverage)
And, loans often more than 95-110% of
house value
Why?
FEES and Willing Investors!

23. Has this happened before?
• Yes, Great Depression
– Stock values versus house prices collapsed
– Speculation and exuberance on Wall Street
later felt on Main Street
– Government failed to provide liquidity –
JPMorgan did!
• But, there were NO:
– FedReserve, FDIC, “Priming the Pump”
(deficit spending) knowledge, or
understanding of economics!

24. Who’s to blame?
• No one. The market is a system that gets
out of equilibrium at time.
• Some people.
– Should the government have regulated
better?
– Should people have borrowed less?
• Everyone.
– Global refusal to take responsibility for our
own actions

25. What to do?
• Not sure… just because we know more
doesn’t mean we know all
• “When in you find yourself in a hole that’s
getting deeper… just stop digging!”
– Confidence in the system needs rebuilding
– We need to get banks lending again
– We need to get ready for an economic
recession by fixing macro system and quickly

26. Future?

27. Questions