1 MIM 574 – Current Financial Condition of The United States Financial Crises Of The Great Recession

2 Causes 1. Housing Bubble – subprime mortgages a. R eckless and unsustainable lending practices b. Deregulation and securitization of mortgages c. Global speculative bubble in real estate d. Increase in oil and food prices 2. Greed – Wall Street and Investment Banking

3 Housing Bubble Subprime Lending High-risk borrowers with imperfect credit Increased demand in The Housing Market ARM – 43% of foreclosures in 2007 Risk – higher interest and fees

4 Securitization Securitization - originate to distribute model, in which banks essentially sell the mortgages and distribute credit risk to investors through mortgage-backed securities, instead of holding the mortgage to maturity. Homeowners, bondholders, corporations and consumers were $25 trillion, $10 trillion from securitized markets, frozen in Investment banks issued debt at a low interest rate and invested the proceeds at a higher interest rate is a form of financial leverage in MBS (2.5% - 7%, unsecured to 12%). This is analogous to an individual taking out a second mortgage on his residence to invest in the stock market or investment property. MBS were fixed income securities for pension and mutual funds, insurance companies, investment banks and other fixed income investors. Service providers like investment banks generate fees at every level. Speculation bubble, investment properties, flipping after built.

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11 Toxic Assets ABS Housing Market Mortgage Backed- Securities

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15 Market and Foreclosure Residential Mortgage Market – $10.6 trillion, (about $2.0 trillion subprime) 14.4% by September 2009, were in foreclosure California and Florida hardest hit

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18 The risks to the broader economy $ 8 trillion in losses, U.S. Stocks – 2008 Losses in the stock markets and housing value declines place downward pressure on consumer spending Negative equity Unemployment Add: Detroit, outsourcing, foreign debt and, budget and trade deficit

19 Major Players Lehman Brothers Holdings Inc. - BNC Mortgage – subprime lender Merrill Lynch - First Franklin (from National City Bank) Bear Stearns - Hedge Funds Citibank Countrywide UBS Washington Mutual

20 Results to Major Players Lehman Brothers - bankruptcy Bear Stearns - fire sale to J.P. Morgan Merrill Lynch - sold under distress to Bank of America Morgan Stanley - converted from an investment bank to a bank holding company Goldman Sachs (since 1869) - converted from an investment bank to a bank holding company Wachovia -sold to Wells Fargo Bank Washington Mutual - sold to J.P. Morgan; - $224 bil. Toxic, $85 FDIC remaining Countrywide Financial Corporation - Indy Mac seized by regulators and remaining sold to BofA

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22 Government Sponsored Entities In 1995, Fannie Mae and Freddie Mac owned, either directly or through mortgage pools they sponsored, $5.1 trillion in residential mortgages, about half the total U.S. mortgage market ($10.6 trillion). In 2008, The Federal government was forced to place the companies into a conservatorship, effectively nationalizing them at the taxpayers' expense. The Glass-Steagall Act was enacted after the Great Depression. It separated commercial banks and investment banks

23 TARP The Troubled Asset Relief Program A program of the United States government to purchase assets and equity from financial institutions to strengthen its financial sector; mostly, to address the subprime mortgage crises. TARP allows the United States Department of the Treasury to purchase or insure up to $700 billion of troubled (Toxic) assets. Senior preferred stock in the nine largest American banks Equity and debt The Treasury will receive warrants for non-voting shares, or will agree not to vote the stock

24 Beneficiaries of TARP Citigroup $45 billion AIG (American International Group) $40 billion JPMorgan Chase $25 billion Wells Fargo $25 billion General Motors $13.4 billion Goldman Sachs $10 billion Morgan Stanley $10 billion Chrysler $4 billion

25 Bonuses and Other Compensation AIG is notable for bonuses for the entire company reaching $1.2 billion, after receiving bailout funding. These bonuses were paid during a loss of $61.7 billion in 2008, the greatest ever for any corporation. Banks that are getting taxpayer bailouts awarded their top executives nearly $1.6 billion in salaries, bonuses, and other benefits last year, an Associated Press analysis reveals. Purchase of shares in the stock market on the way back up. Retreat for $425 million – AIG. Purchase of other troubled companies. Benefits included cash bonuses, stock options, personal use of company jets and chauffeurs, home security, country club memberships and professional money management.

26 Take Away’s 1. R eckless and unsustainable lending practices 2. Greed – fees and speculation 3. Redistribution vs. creation of wealth - Speculation vs. real GDP growth - Michael Milken, Boesky, Madoff, Tyco, Enron - Finance for business strategy and wealth creation - Maximize wealth from assets under management’s control