Unfit to Survive Wall Streets Darwinian Lessons New America Foundation Washington, DC. December 17, 2008 Leo M. Tilman President, L.M.Tilman & Co. Adjunct Faculty, Columbia University

2 The Challenge Macroeconomic Forces Low Return Environment Bretton Woods II Imbalances US Housing & Deficits Monetary Policies Financial Instruments Derivatives CDOs ABCP & SIVs Subprime MBS Financial Institutions Investment Banks Commercial Banks Hedge Funds SWFs & Pension Plans Intellectual Paradigm Accounting Earnings Financial Disclosures Credit Ratings Equity Market Valuations The Challenge: Complexity + Risk + Deficient Lens

3 Secular forces (globalization, disintermediation, informational availability, greater market efficiency, alternative investments, deregulation, financial convergence, derivatives and increasingly complex financial products) Period-specific forces (Bretton Woods II, global savings glut, disinflation exporting) Cyclical factors (monetary policies, interest rates, yield curves, default rates) The Great Moderation

4 Fees Compress Secular Forces Funding Advantages Decrease Secular Forces Greater Liquidity & Funding Risks More Complex & Opaque Investments Risk Exposures Increase Compensation for Risk Declines Vicious Circle Cyclical Forces Period-Specific Forces Static Business Models Alternative Investments More Leverage & Risk The Culmination: Financial Crisis

5 Risk Aversion and Deleveraging Exogenous Catalyst Illiquidity: Prices Decline On Thin Trading Margin Calls and Forced Liquidations Contagion: Other Assets Are Sold Across Markets Inability to Borrow: Haircuts Increase, Lenders Shrink Balance Sheets More Price Declines and Margin Calls Deleveraging of Modern Financial Crises Vicious Circle

6 The Greed and Complacency Narrative

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9 Greed and ComplacencyFinancial Darwinism

10 Greed and ComplacencyFinancial Darwinism

11 Strategic Vision and Systemic Knowledge (or lack thereof )

12 The Blue Ocean Strategy

13 Financial Industry – Acquire new kind of strategic vision – Redesign their business models – Make risk management the framework for executive decisions – Position for sustainable and real value creation that benefits all stakeholders Risk-Based Transparency – Business model- and risk-focused regulation What is a breakdown of economic performance by revenue sources? What are the risks taken on in the process – by revenue sources and in total? – Systemic effects and fair value accounting Economic Dynamism – A system conducive of discovery, development, financing and production of viable commercial innovations Economic Policy A Unique Opportunity

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