Wednesday, February 25, 2009 An overview of the events that forever changed the financial system

October 2007  Housing bubble “bursts”  Problems originate with subprime mortgages  “Subprime” = loans to those who are considered VERY risky.  Low/no income  Have defaulted on loans before  Wall St – banks begin writing down assets from CDOs & MBSs

Sub Prime Mortgages  A mortgage is a loan to buy a home  Typically were for a fixed interest rate, over 30 years, with 20% paid at the beginning  SUB PRIME – a way to sell mortgages to those who otherwise could not get one.  “no money down”  Interest Only loan  Poor Credit Scores

Credit Score - Three companies keep track of all your credit transactions - credit cards, loans, rentals, paying bills on time - They generate a numerical score - This score is used in all lending to determine if you qualify and your interest rate

Credit Default Swaps  Subprime mortgages are very risky  High chance borrower will default (fail to repay the loan)  Lenders buy 'insurance' against bad loans  Investors bundle these insurance plans and sell them  VERY profitable when housing was going well  VERY bad when things go bad  Called 'Toxic Assets'

Bear Stearns  March 2007  Too many 'Toxic Assets'  First Investment Bank to go under  JPMorgan buys Bear Stearns for $1B in government arranged sale – Fed funnels JPM the other $29B  Question: Did speculators “murder” Bear?  Result: Credit crisis accelerates as investors begin to worry

Fannie Mae & Freddie Mac  The government seizes the two largest mortgage companies  No exact price tag on the deal – commits up to $100B to each  Fannie & Freddie own ~1/2 of $12 trillion US mortgage market  Implications: new mortgages grind to a near stand still, investor confidence hurt

Lehman Brothers  9/11 – states they are actively looking for a buyer  BofA expresses interest and walks away  9/15 – files for bankruptcy (largest bankruptcy filing in US history)  9/17 – Barclays buys NA investment banking division  Implications: market panic ensues, Lehman’s creditors hurt, insurance protection (swaps) market goes crazy

Merrill Lynch  Merrill has experienced second highest losses of any financial institution in 2008 and to avoid Lehman’s fate, looks for buyer  Sold to BofA for $29/share ($50B deal)  Government encouraged deal  Result: BofA still dealing with souring Countrywide acquisition now faces speculation that B/S is too big and filled with too many toxic assets

American International Group (AIG)  Speculation on inability to honor swap insurance contracts cause downward spiral in a matter of days  Fed afraid that insurance giant failure will cripple US & international markets  Receive $85B initial emergency loan – this amount goes up to $150B in later months  Government now has 70% equity stake in largest global insurance company

Goldman Sachs & Morgan Stanley  9/21 - announce they will convert to bank holding companies  Ends the traditional investment banking model that held strong for nearly the last century  The last 2 of the “Big 5” investment banks  Now subject to increased Fed oversight and have to deleverage

Washington Mutual  Nation’s largest savings and loan seized  Government organizes fire sale to JPM  Biggest bank failure in American history  Puts bailout plan talks on hold

Bush Bailout  9/29: Initial plan rejected – Dow plunges points – the largest one-day plunge in history  S&P suffers largest point drop ever and 2 nd biggest in history  10/1: After heated debate and much opposition, Congress approves $700B bailout plan  TARP (Toxic Asset Relief Program) provision

Obama  Administered TARP bank bailouts started by Bush to combat the credit crisis  Bailed out the auto industry  Saved a 1-3 million jobs throughout the auto industry supply chain  Prevented a $1 trillion loss in the credit default swap market  Passed $787 billion stimulus (Feb. 2009)  1/3 to states to prevent the layoff of police officers, teachers, etc. at risk of losing their jobs because of state budget shortfalls ($300 Billion)  1/3 in tax cuts for working-class families (over $200 Billion)  1/3 to states for infrastructure projects ($300 Billion)

Obama  Extended unemployment benefits  Payroll tax cut  Middle class tax cuts affecting 95% of taxpayers  Small business tax cuts  Small business loans  Passed banking regulation (Dodd-Frank)

Global Markets Plummet  UK banks reeling from losses: Govt forced to intervene  Spain, China, Germany, France – only a few of countries that are forced to step in and assist failing financial institutions  Central banks coordinate rate cuts  Iceland financial crisis: hit hardest by crisis, entire country goes into bankruptcy

Bailout Plans  Financial crisis stems to overall economy – affecting consumers, homeowners, auto industry  Global leaders are struggling with jumpstarting economies and thawing credit markets  Lending grinds to virtual standstill