New York-FRB Empire State Manufacturing Survey (Indicator of New York Manufacturing Activity) Web: Slight month-to-month revisions. ESMS determines present and future condition of NY’s manufacturing industries. ESMS is correlated with the Philadelphia-FRB, Chicago-FRB and ISM surveys. ESMS gives early indications of manufacturing strength or weakness and incipient signs of inflation. NY-FRB polls 175 manufacturing CEOs on 1 st business day of every month. Survey asks how manufacturing conditions have changed in the month and what changes they expect to see in 6 months. Three possible answers: increasing activity, decreasing activity, no change in activity. The NY-FRB uses a diffusion index = percentage of positive scores minus percentage of negative scores. A diffusion index of zero is the breakeven point. Index greater than zero is expansion, less than zero is contraction. The larger the index, the greater the consensus. To detect an underlying trend, calculate 3-month and 6-month moving averages. Key Survey Questions: General business conditions – measure of current and future factory activity. New orders – harbinger of business confidence. Increase in new orders => increase future production, employment and capital spending. Unfilled orders – If increase in demand is greater than production => overburdened manufacturers =>  unfilled orders =>  in delay in deliveries to wholesalers =>  capital expenditures =>  production capacity. Prices paid – Seeds of inflation begin here at this first stage of the production process. Increase in prices paid =>  prices charged to wholesales =>  prices charged to retailers =>  prices charged to consumers. Prices received – measures manufacturers’ ability to set prices (pricing power). Increase in prices received => increase corporate earnings and profit margins. Global competition and a weak economy can reduce pricing power. Number of employees – early indicator of manufacturing job market and labor market conditions Market Analysis: Bonds: If ESMS Index/Prices paid/Prices received increases =>   P/P =>  D Bonds =>  i Bonds Stocks:  ESMS Index =>  profits =>  P Stocks Dollar:  ESMS Index =>  manufacturing sector =>   Y/Y =>   P/P =>  D Bonds =>  i Bonds =>  dollar New Orders Unfilled Orders Shipments = Production –  Inventory

Broken Investment Banking Model Deregulation (FMA 1999) Leverage (40 : 1) Mortgage Securitization (Separation of loan origination from loan holder) Falling Home Prices Balance Sheet Goldman Sachs Morgan Stanley Merrill Lynch Lehman Brothers Bear Stearns ++ + Capital Wholesale Funding Base Commercial Paper Repurchase Agreements Unstable Non-insured Short term Asset Portfolio MBS/ABS/CDO/CLOs Illiquid Long term Assets Liabilities + Capital

D 06 Funds Flow of Funds Interest Rate Credit Crunch Factors Subprime/jumbo mortgage default concerns Balance sheet asymmetric information Weakening economy i 06 Funds 08 Dysfunctional Credit Markets Subprime mortgage Jumbo mortgage Interbank Funds 06 i 08 S 06 Funds S 08 Funds Fund flows dried up

Term Asset-backed Security Loan Facility (TALF) (Restore credit flows to HHs and Firms through the Securitization Market) Loan F. I.s Hedge Funds Investment Funds Borrowers FRB-NY Special Purpose Vehicle TALF Loans $200B to $1000 B ABS (Secured by Loan pool) Receive $$ Reserves Fed Borrowings $92 million ABS Auto C.C. Student Business $100 mil Recession =>  defaults =>  demand for ABS => mkt dislocation  credit availability &  interest rates => economic slowdown TALF Loans Non-recourse (Fed can only seize ABS) Secured by eligible collateral (AAA) 3-yr term Interest rate = 1-mo LIBOR bps Loan-to-values and Haircuts (4-12%) Interest payable monthly Borrower has option to prepay loan ABS capital remittance must be used to pay down TALF loan Lenders Risk Capital $8 million Sell Loans Loan Pool Originate Loans Revive the Shadow Banking System : $1 trill/year in funding Auto Washington Maxim: Temporary solution => Permanent fixture ABS Loans bundled into securities

Repurchase Agreements (Repo) (Sale and repurchase of securities agreement) Fed MMMFs Bank Repo: Seller/Borrower Buyer/Lender Repo = Cash Transaction + Forward Contract (Loan origination) (Loan repayment) (Spot price) (Forward price) (Near leg) (Far leg) (Settlement date) Repos began in 1917 by Fed to lend to banks $5 Trillion Repo market today Secured cash loan Legal transfer of security to lender Repurchase price > Original price (gap = interest) 1-7 day term typically, up to 2 years Typically over collateralized to mitigate credit risk Fed describes transaction from the counterparty’s viewpoint, rather than from their own. Fed Collateral: T-Bills/Bonds Repo: Fed adds reserves Reverse Repo: Fed initially drains reserves Adds reserves back later Used to target i ff Reverse Repo: Buyer/Lender $ $ T-Bill