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1111

Credit & Mortgage Market Credit & Mortgage Market Analysis & UpdateAnalysis & Update

James R. BarthAuburn University and Milken Institute

[email protected]

2009 Financial & Economic Crisis Bank Leadership SymposiumAlabama Bankers Association

Point Clear, AlabamaJune 4-7, 2009

22

BankingBankingWildcat

Savings and Loan Holding Company Act (1968)- Permit unitary SLHs to engage in any activity even those unrelated to S&L business

Phases out deposit rate ceiling by April 1, 1986

Monetary Control Act)---

--

-Creates the Federal Home Loan Bank Board- Creates the Federal Home Loan Banks

-

Bank Merger Acts(1960 & 1966)

-

Establishes merger guidelines

Federal Credit Union Act(1970)-Federal Deposit Insurance for CUs

International Banking Act(1978)-- Puts foreign banks on equal

footing with U.S. banks

NationalCurrency

(1863)

NationalBank Act(1864)

Office of the Comptroller of the Currency-Federally chartered banks-Uniform currency-Tax on state bank notes

1st Bank of the U.S.(1791-1811)

2nd Bank of the U.S.(1816-1836)

-Fiscal agent for U.S. Treasury- Loans to state banks with temporary liquidity problems- Limit state bank note issuance- Part private bank and part central bank

)

1st Commercial Bank(1781)

U.S. Constitution gives -Congress the power "to coin

money and regulate the value thereof"(1787)

1st Mutual Savings Bank(1816)

1st Savings & Loan (1831)

People begin using checks(1865)

1st Credit Union(1909)

Federal Reserve Act(1913)-Furnishes "elastic currency"-Establishes the Federal Reserves System as the central banking system of the U.S.

MacFadden Act (1927)-National banks could branch to same extent permitted state banks

Stock Market Crash(1929)

Bank Holding Company Acts(1956 & 1970)-Restricted interstate ownership of banks-BHCs could engage in activities deemedby the Federal Reserve to be "closely related to banking"-defined a bank

Riegle- Neil Interstate Bankingand Branching Efficiency Act(1994)-BHCscan acquire banks nationwide after Sept. 29, 1995-Branching nationwide after June 1, 1997 unless state opts out

Garn-St Germain Depository Institutions Act (1982)-Allows possibility of interstate and interinstitutionalmergers-Gives S&Ls authority to make some commercial loans

Financial Institutions Reform, Recovery, and Enforcement Act (1989)-Changes structure of S&L institution regulation-Replaces FHLBB with OTS-Replaces FSLIC with SAIF

Federal Home Loan Bank Act(1932)-Creates the Federal Home Loan Bank Board- Creates the Federal Home Loan Banks

Great Depression-Securities & Exchange Commission-Federal Deposit Insurance for CBs and SLs-Banking Act of 1933 (Glass Steagall) separates commercial banking from investment banking -Federal Home Loan Banking System

-and denotes competition as a criteria


Competitive Equality Bank Act (1987)- Limits growth of nonbank banks

Gramm-Leach-Bliley Financial Services Modernization Act (1999)-Repeal last vestiges of the Glass-Steagall Act of 1933

- Expands the permissible scope of activities for bank holding and bank subsidiaries

NationalCurrency Act

(1863)


Office of the Comptroller of the Currency---Tax on state bank notes



-Fiscal agent for U.S. -- Limit - Part private bank and part central bank

Federal Deposit Insurance Corporation Improvement Act (1991)-Mandates “prompt corrective action”

Federal Housing Finance Regulatory Reform Act (2008)

Emergency Economic

Stabilization Act (2008)

Savings-and-Loan Crisis

-- Allows NOW account at all depository institutions- Allows S&L to make consumer loans and issue credit cards




Wildcat

(1836 1863)



1986


--1986


--


-


-





NationalCurrency

(1863)




























(1863)








Emergency Economic


Depository Institutions Deregulation and





(1836 1863)


BankingBankingWildcat


Phases out deposit rate ceiling by April 1, 1986


--Phases out deposit rate ceiling by April 1, 1986


--


-


-





NationalCurrency

(1863)






)























(1863)








Emergency Economic







Wildcat

(1836 1863)



1986


--1986


--


-


-





NationalCurrency

(1863)




























(1863)








Emergency Economic


Depository Institutions Deregulation and





(1836 1863)


Major U.S. banking lawsMajor U.S. banking laws

33

Major U.S. banking lawsMajor U.S. banking laws

Federal Deposit Insurance CorporationImprovement Act (1991)-Mandates prompt corrective action

Federal Reserve Act (1913)-Furnishes “elastic currency”-Establishes the Federal Reserve System as the central banking system of the U.S.

Depository Institutions Deregulation and Monetary Control Act (1980)- Phases out deposit rate ceilings by April 1986- Allows NOW accounts at all depository institutions - Allows S&Ls to make consumer loans and issue credit cards

National Currency Act(1863)

National Bank Act

(1864)

Office of the Comptroller of the Currency- Federally chartered banks- Uniform currency- Tax on state bank notes

Bank Holding Company Acts (1956 and 1970)-BHCs could engage in business deemed to be “closely related to banking” by the Federal Reserve- Restricted interstate bank ownership- Defined a bank

Garn-St. Germain Depositary Institutions Act (1982)- Allows possibility interstate and interinstitutional mergers- Allows S&Ls to make some commercial loans

Great Depression- SEC- Federal deposit insurance for banks and S&Ls-Banking Act of 1933 (Glass-Steagall) separates commercial and investment banking- Federal Home Loan Bank System

Financial Institutions Reform, Recovery and, Enforcement Act (1989)- Changes structure of S&L institution regulation- Replaces FHLBB with OTS- Replaces FSLIC with SAIF

Riegle-Neil Interstate Banking and Branching Efficiency Act (1994)-BHCs can acquire banks nationwide-Nationwide branching after June, 1997 unless state opts out

Gramm-Leach-Bliley Financial Services Modernization Act (1999)- Repeals last vestiges of the Glass Steagall Act of 1933-Expands the permissible scope of activities for bank holding companies and bank subsidiaries

Sarbanes-Oxley Act (2002)-Establishes new or enhanced standards for all U.S. public company boards, management, and public accounting firms.

1860

1880

1900

1920

1940

1960

1980

2000


Emergency Economic StabilizationAct (2008)

44

Most U.S. banking laws response to crises

National Currency

Act(1863)

1860

1880

1900

1920

1940

1960

1980

2000

Federal Deposit Insurance Corporation

Improvement Act (1991)(Banking crisis)

Federal Reserve Act (1913)(Bank runs)

Depository Institutions

Deregulation and Monetary Control

Act (1980)(S&L crisis)

National Bank Act

(1864)

Garn-St. GermainDepository

Institutions Act (1982)

(S&L crisis)

Glass-Steagall Act & Federal Deposit Insurance & SEC(Great Depression)

Financial Institutions Reform, Recovery and

Enforcement Act (1989)(S&L crisis)

(Civil War & wildcat banking)

Sarbanes-Oxley Act (2002)(Enron and WorldCom bankruptcies)

Federal Housing FinanceRegulatory Reform Act (2008)

Emergency Economic Stabilization Act (2008)

55

Bank Holding Company Acts (1956 and 1970)

(Prevent nationwide banking)

Riegle-Neil Interstate Banking and Branching Efficiency Act (1994)

(Allows nationwide banking: but acquisitions limited to 10% of nationwide deposits and 30%

of individual state deposits )

1860

1880

1900

1920

1940

1960

1980

2000

Gramm-Leach-Bliley Financial Services

Modernization Act (1999)(Broadens allowable

activities)

Some U.S. banking laws not crisis response

Note: Bank acquisitions and mergers are subject to an evaluation of the impact on competition by bank supervisory

agencies and the Justice Department. If an increase in concentration is too large, “divestitures” of competing

branches may be required.

66

Dow Jones Industrial AverageCompared to the Great Depression, 1973 oil crisis, and dot-com crash

Sources: Datastream, The Milken Institute.

-95

-75

-55

-35

-15

5

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33

Percentage lost in value from the peak

Months after the peak

Crash of 1929 (9/1929-7/1932)

Dot com crash (3/2000-10/2002)

Current recession: - 54% peak at 10/9/2007: 14,165 trough at 3/9/2009: 6,547 (as of 05/20/2009)

-89%

- 47.9%

1973 oil crisis(1/1973-12/1974)

77

U.S. industrial production Compared to the Great Depression

Sources: St. Louis Federal Reserve, The Milken Institute.

-45-40-35-30-25-20-15-10

-50

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24Months after start of recession

Cumulative % decline since start of recession

Great Depression

Current recessionstarted in December 2007

1973 recession

88

Consumer price index: Great Depression vs. current recession

75

80

85

90

95

100

105

110

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Consumer price index, start of recession = 100

Great Depression

Current recession

Months after start of recessionSources: Bureau of Labor Statistics, Milken Institute.

99

One-year real interest rate

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

1925 1935 1945 1955 1965 1975 1985 1995 2005

Real interest rate

Note: The Federal Reserve Board discontinued its 6-month commercial paper rate series August 1997. After that, the 6-month Certificate of Deposit rate, secondary market, is used. Last observation: April 2009 (annualized). Sources: Robert Shiller, Federal Reserve, Bureau of Labor Statistics, Milken Institute.

1010

One-year nominal interest rate

0%2%4%6%8%

10%12%14%16%18%20%

1925 1935 1945 1955 1965 1975 1985 1995 2005

Nominal interest rate

Note: The Federal Reserve Board discontinued its 6-month commercial paper rate series August 1997. After that, the 6-month Certificate of Deposit rate, secondary market, is used. Last observation: April 2009 (annualized). Sources: Robert Shiller, Federal Reserve, Milken Institute.

1111

Civilian unemployment rate

0

5

10

15

20

25

30

1923-2

9 193

4 193

9 194

4 194

9 195

4 195

9 196

4 196

9 197

4 197

9 198

4 198

9 199

4 199

9 200

4April

2009

% of labor force

Sources: Bureau of Labor Statistics, Milken Institute.

1212

Great Depression: legislative response

The Civilian Conservation Corps (CCC) set up camps all over the United States to tackle the problem of unemployed young men aged between 18 and 25 years old. Between 1933 and 1941 over 3 million young men served in the CCC.

Civilian Conservation Corps Act (also known as Emergency Conservative Work Act)

March 31, 1933

Established twelve Federal Home Loan Banks under the supervision of the Federal Home Loan Bank Board to advance funds to savings-and-loan associations to promote homeownership.

Federal Home Loan Bank ActJuly 22, 1932

Created to loan up to $2 billion to aid banks, railroads, factories, farmers, and other sectors of the economy. It also allowed some loans to state and local governments that sponsored employment-generating construction projects.

Reconstruction Finance CorporationJanuary 15, 1932

Key provisionsLegislationDate of enactment

1313


Provided cash benefit payments to farmers to cut the production of major farm commodities to raise farm prices. The law was later declared unconstitutional by the Supreme Court but a new act correcting for the Court’s concerns was passed in 1935. At first, money for these payments to farmers came from special taxes on food processors, and later, after the correction in 1936, from the U.S. Treasury.

Agricultural Adjustment ActMay, 1933

Provided for the regulation of securities exchanges, and brokers and dealers in securities, to prevent manipulative and unfair practices in the securities markets. Established the Securities and Exchange Commission.

Securities ActSecurities and Exchange Act

May 27, 1933June 6, 1934

Provided funds to transform the economies of depressed, rural Southern states along the Tennessee River. The program included dam-building, electric power-generation, and flood control. It provided relatively high-wage jobs in construction in a region the President Roosevelt called “the nation’s number one economic problem.”

Tennessee Valley Authority ActMay 18, 1933


1414


Encouraged industry to avoid deflationary “cutthroat competition” by selling below cost to attract customers and driving weaker competitors out of business. The government temporarily suspended enforcement of anti-monopoly laws and sponsored what amounted to price-fixing as an emergency measure in an attempt to stimulate economic recovery.

National Industrial Recovery ActJune 16, 1933

Created the Federal Deposit Insurance Corporation (FDIC); prohibited the payment of interest-on-demand deposits; establishes Regulation Q (which limited the interest rates that U.S. banks and savings-and-loans could pay on deposits); and forced a separation between banking and the securities businesses.

Banking Act of 1933 (and Glass-SteagallAct)

June 16, 1933

Created federal savings-and-loan associations. Also created the Home Owners’ Loan Corporation to purchase delinquent home mortgages from financial institutions and refinance the mortgages over longer terms and at lower interest rates.

Home Owners’ Loan ActJune 13, 1933


1515


Set up the National Labor Relations Board to guarantee the right of collective bargaining for workers.

National Labor Relations ActJuly 5, 1935

Established the Work Progress Administration (WPA) to provided work for the unemployed. By 1936 over 3.4 million people were employed on various WPA programs.

The Emergency Relief Appropriation Act

April 8, 1935

Created the Federal Savings and Loan Insurance Corporation and authorized the FSLIC to regulate savings-and-loan holding companies.

National Housing ActJune 27, 1934

Authorized federal credit unions in all states. The initial maximum maturity of loans was two years.

Federal Credit Union ActJune 26, 1934


1616


Amends the Banking Act of 1933 and the Federal Reserve Act to restructure the Federal Open Market Committee and the Federal Reserve Board. Also permits national banks to make five-year real estate loans.

Banking Act of 1935August 23, 1935

Enacted to provide a steady income for retired workers aged 65 or older. Social Security ActAugust 14, 1935


1717


Seeks to prevent abuses through mandating disclosure regarding the investment company’s structure, operations, financial condition, and investment policies when shares of the investment company are initially offered to the public and, thereafter, on a regular periodic basis. Investment companies register with the SEC under the 1940 act and typically register their securities under the 1933 act.The provisions in the 1940 act govern, among other things: registration of investment companies; transactions between the investment company and an affiliate (e.g., the investment adviser to the investment company); purchases and sales of investment company shares; and responsibilities of the investment company’s directors or trustees. Congress, the SEC, the self-regulatory organizations (SROs), and state regulators are responding to allegations of recent wrongdoing within the mutual fund industry.

Investment Company Act of 1940August 22, 1940


1818


Requires the registration of certain investment advisers with the SEC. The act has rules covering such matters as: record-keeping; substantive content of advisory contracts; advertising; custody of client funds and assets; and proxy voting.In addition, the act imposes certain anti-fraud provisions upon individuals who meet the statute’s definition of “investment adviser,” even if the act does not require those persons to register with the SEC.

Investment Adviser Act of 1940August 22, 1940


1919

Deep recession, strong recovery?U.S. history shows strong recoveries after many recessions

Note: Shade areas represent the periods of recessions; Sources: Bureau of Economic Analysis, NBER, and The Milken Institute.

-15

-10

-5

0

5

10

15

20

1930 1936 1942 1948 1954 1960 1966 1972 1978 1984 1990 1996 2002 2008

Percent

2009 estimate

Real GDP growth rate

2020

Where we are in the current recession NBER business cycle dates

Start End Duration in monthsAugust 1929 March 1933 43May 1937 June 1938 13February 1945 October 1945 8November 1948 October 1949 11July 1953 May 1954 10August 1957 April 1958 8April 1960 February 1961 10December 1969 November 1970 11

November 1973 March 1975 16January 1980 July 1980 6

July 1981 November 1982 16July 1990 March 1991 8March 2001 November 2001 8

December 2007 ? Now: 18 monthsSource: National Bureau of Economic Research.

2121

Recoveries from financial crises take longer than other types of crises

Notes: Estimates are based on 122 recessions in 21 advanced economies.

Sources: International Monetary Fund.

Average time until recovery to previous peak (quarters)

2.8

3.0

3.6

4.0

5.6

0 1 2 3 4 5 6

External demand shocks

Fiscal policy contractions

Oil shocks

Monetary policy tightening

Financial crises

2222

The Current Crisis: The Rise and Fall of the

U.S. Mortgage and Credit Markets

2323

OverviewFactors that contributed to credit boom and bust

Lax monetary policy and global imbalancesReach for yield, short-term wholesale funding and risky/substantial leverageFinancial innovationOpacityProcyclicality of regulation and mark-to-market accountingToo big to failIncentive/compensation systemPublic policyFlight to safety

2424

Overview of the housing market

Note: total residential and commercial mortgages = $14.6 trillion at year-end 2008.

Sources: Federal Reserve, Milken Institute.

Equity in housing stock$7.8 trillion

Mortgage debt $10.5 trillion Prime

92.7%

Subprime7.3%

Securitized60%

Non-Securitized

40%

Government -controlled

48%

Privatesector -

controlled52%

2525

The mortgage problem in perspective

Note: The data is at year-end 2008.Sources: U.S. Census, Freddie Mac, Mortgage Bankers Association, Milken Institute.

25 million or 31% are paid off80 million houses

55 million have mortgages 49 million or 89% are paying on time

6 million are behind11% of 55 million with 3% in foreclosure

This compares to 50% seriously delinquent in the 1930s.

26262626

I. Low interest rates and a lending boom

27272727

Did the Fed lower interest rates too much and for too long?

Federal funds rate vs. rates on FRMs and ARMs

Sources: Federal Reserve, Mortgage Bankers Association, Moody’s Economy.com, Milken Institute.

30-year FRM rate

1-year ARM rate

Target federal funds rate

0

1

2

3

4

5

6

7

8

2001 2002 2003 2004 2004 2005 2006 2007 2008

Percent

April. 30, 2008: 2%Oct. 8, 2008: 1.5%Oct. 29, 2008: 1%Dec. 16, 200: 0-0.25%

April 24, 2009: 30-year FRM rate: 6.2% 1-year ARM rate: 4.6%

Record low from June 25, 2003 to June 30, 2004: 1%

2828

Home price bubble, credit boom and bust

Low interest rates, credit boom and bust

Sources: Inside Mortgage Finance, Mortgage Bankers Association, Moody’s Economy.com, S&P/Case-Shiller, Milken Institute.

Index, January 2000 = 100

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

2001 2002 2003 2004 2005 2006 2007 200850

75

100

125

150

175

200US$ trillions

Home mortgage

originations (left axis)

S&P/Case-Shiller National Home

Price Index (right axis)

US$ trillions

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

2001 2002 2003 2004 2005 2006 2007 20082.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

1-Year ARM mortgage rate

(right axis)

Home mortgage

originations (left axis)

Percent

29292929

II. Homeownership, prices, starts and sales take off

3030

64.0

65.0

66.0

67.0

68.0

69.0

70.0

199820002002200420062008

Percent

Q2 2004: 69.2%

Q1 2009: 67.3%

Average, 1965–Q1 2009: 65.2%

3030

Credit boom pushes homeownership rate

to historic high

Home price bubblepeaks in 2006

California and national home prices reach

record highs

Sources: U.S. Census Bureau, OFHEO, Moody’s Economy.com, S&P/Case-Shiller, California Association of Realtors, Milken Institute.

0

100

200

300

400

500

600

700

1998 2000 2002 2004 2006 2008

U.S. average, 1987-March 2009: $122,838

US$ thousands

California median home price

U.S. medianhome price

California average1987-March 2009$231,407

0

50

100

150

200

250

300

350

400

19982000200220042006 2008

Index, January 1987 = 100S&P/

Case-Shiller National Home

Price Index

OFHEO Home Price Index

31313131

Homes for sale Homes sales reach a new high

Housing starts hit a record in 2005

Sources: U.S. Census Bureau, OFHEO, Moody’s Economy.com, Milken Institute.

0

1

2

3

4

1998 2000 2002 2004 2006 20080.0

0.2

0.4

0.6

0.8Millions

Existing homes for sale (left axis)

New homes for sale (right axis)

Millions

0.0

1.4

2.8

4.2

5.6

7.0

1998200020022004200620080.0

0.3

0.6

0.9

1.2

1.5Millions Millions

New home sales (right axis)

Existing home sales (left axis)

0.0

0.5

1.0

1.5

2.0

199820002002 200420062008

January 2006: 1.8 million

March 2009: 358,000

Housing units, millions

Average starts, 1959–March 2009: 1.1 million

32323232

III. Subprime borrowers and subprime mortgages

33333333

National FICO scores display wide distribution

What goes into a FICO score?

Who is a subprime borrower?

Sources: myFICO.com, Milken Institute.

Amounts owed

30%

Payment history

35%

Length of credit history

15%

New credit10%

Types of credit in use

10%

25

812

1518

27

13

0

10

20

30

40

up to499

500-549

550-599

600-649

650-699

700-749

750-799

800+

Percentage of population

Subprime = 21%

Prime = 79%

25

812

1518

27

13

0

10

20

30

40

up to499

500-549

550-599

600-649

650-699

700-749

750-799

800+

Percentage of population

Subprime = 21%

Prime = 79%

34343434

Prime

Subprime

0

4

8

12

16

20

0 - 459

460 - 4

79480

- 499

500 - 5

19520

- 539

540 - 5

59560

- 579

580 - 5

99600

- 619

620 - 6

39640

- 659

660 - 6

79680

- 699

700 - 7

19720

- 739

740 - 7

59760

- 779

780 - 7

99800

- 900

Percent of total originations

FICO score

FICO below 620 Prime: 6.6%

Subprime: 45.2%

FICO above 620 Prime: 93.4%

Subprime: 54.8%

Prime and subprime mortgage originations by FICO score reveal substantial overlaps

Sources: LoanPerformance, Milken Institute.

35353535

ARMs look attractive to many borrowers

Sources: Mortgage Bankers Association, Moody’s Economy.com, Milken Institute.

2

4

6

8

10

1997 1998 1999 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

April 24, 20091-year ARM rate: 6.2%30-year FRM rate: 4.6%

30-year FRM rate

1-year ARM rate

Percent

3636

5

10

15

20

25

2001 2002 2003 2004 2005 2006 2007 2008

Percent of all outstanding home mortgages

Q4 2008: 18.5%

Q1 2001: 9.4%

Q1 2006: 21.7%

3636

ARM share grows, following low interest rates


3737

0

10

20

30

40

50

60

70

2001 2002 2003 2004 2005 2006 2007 2008

FHA ARM Prime ARM Subprime ARM

Percent of mortgage typeQ4 2008FHA ARM: 3.8%Prime ARM: 16.6%Subprime ARM: 45.9%

3737

Largest share of ARMsgo to subprime borrowers


38383838

Subprimes take an increasing shareof all home mortgage originations

Sources: Inside Mortgage Finance, Milken Institute.

0.0

1.0

2.0

3.0

4.0

2001 2002 2003 2004 2005 2006 2007 2008

Subprime

Prime

US$ trillions

Subprime'sshare:7.8%

7.4%

8.4%

18.2%21.3%

20.1%

7.9%

1.5%

0.0

1.0

2.0

3.0

4.0

2001 2002 2003 2004 2005 2006 2007 2008

Subprime

Prime

US$ trillions

Subprime'sshare:7.8%

7.4%

8.4%

18.2%21.3%

20.1%

7.9%

1.5%

39393939

Subprime mortgages increase rapidly before big decline

Originations Outstandings


160200

310

540

625 600

191

230

100

200

300

400

500

600

700

2001 2002 2003 2004 2005 2006 2007 Q22008

US$ billions

2008

US$ billions

479574

699

973

1,200 1,240

940 770

0

200

400

600

800

1,000

1,200

1,400

2001 2002 2003 2004 2005 2006 2007 2008

Average annual growth rates1995–2006: 14%2006– 2008: -21%

40404040

IV. Mortgage product innovation

4141

2008, $1.5 trillion

62%

3% 8% 19%1%

7%

4141

Subprime and Alt-A shares quadruple between 2001 and 2006, then fall in 2007

FHA & VAConventional, conforming primeJumbo prime

pSubprimeAlt-A Home equity loans


2001, $2.2 trillion

57.1%

2% 5%7.9%

7%

20%

2006, $3.0 trillion

33.2%

13%

14%2.7%

20% 16%

2007, $2.4 trillion

47.3%

11%

14% 4.9%

8%

14%

42424242

ARM hybrids dominate subprime originations (2006)

Fixed

Other ARM7%

23%

70%

ARM hybrids

Fixed

Other ARM7%

23%

70%

ARM hybrids

Other ARM7%

23%

70%

ARM hybrids

ARM balloon

Other ARM 4%

Fixed 9%

30-year

with 40- to 50-year

amortization26%

2- and 3-year hybrids 61%

ARM balloonARM balloon

Other ARM 4%

Fixed 9%

30-year

with 40- to 50-year

amortization26%


Other ARM 4%

Fixed 9%

30-year

with 40- to 50-year

amortization26%


Sources: Freddie Mac, Milken Institute.

SubprimePrime conventional Alt-A

Fixed 31%

Other ARM23%

ARM hybrids46%

Fixed 31%

Other ARM23%

ARM hybrids46%

43434343

V. Securitization

4444

The mortgage model switches fromoriginate-to-hold to originate-to-distribute


Household mortgage debt2008=$10.5 trillion

Held in portfolio40%

Securitized60%

Household mortgage debt1980=$958 billion


Securitized11%

Household mortgage debt2008=$10.5 trillion


Securitized60%

Household mortgage debt1980=$958 billion


Securitized11%

45454545

Securitization becomes the dominant funding source for subprime mortgages


31.1 29.432.9

39.744.6 42.9 42.4 44.7 47.0 50.0

56.761.6

65.1 67.8 68.0

0

10

20

30

40

50

60

70

80

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Percent of all subprime mortgages securitized since 1994

4646

The rise and fall of private-label securitizersOutstanding securities


26%

55%

6%

13%

39%

14% 18%

29%

33%

35%7%

25%

2006Total = $5.9T

37%

27% 9%

27%

2008Total = $6.8T

Ginnie Mae Freddie Mac Fannie Mae Private-label

26%

55%

6%

13%

1985Total = $390B

39%

14% 18%

29%

2001Total = $3.3T

33%

35%7%

25%

37%

27% 9%

27%

26%

55%

6%

13%

39%

14% 18%

29%

33%

35%7%

25%

2006Total = $5.9T

37%

27% 9%

27%

2008Total = $6.8T

Ginnie Mae Freddie Mac Fannie Mae Private-label

26%

55%

6%

13%

1985Total = $390B

39%

14% 18%

29%

2001Total = $3.3T

33%

35%7%

25%

37%

27% 9%

27%

4747

The rise and fall of private-label securitizersNew securities issuance


Fannie Mae, Freddie Mac, Ginnie MaePrivate-label

1985Total = $110 B

2001Total = $1.3 T

2006Total = $2.0 T

2008Total = $1.2 T

2%

98%

20%

80%

56%

44%

4%

96%

Fannie Mae, Freddie Mac, Ginnie MaePrivate-label

1985Total = $110 B

2001Total = $1.3 T

2006Total = $2.0 T

2008Total = $1.2 T

2%

98%

20%

80%

56%

44%

4%

96%

Private-label

1985Total = $110 B

2001Total = $1.3 T

2006Total = $2.0 T

2008Total = $1.2 T

2%

98%

20%

80%

56%

44%

4%

96%

48484848

VI. Affordability

49494949

2.5

3.0

3.5

4.0

4.5

5.0

1998 2001 2004 2007

Median home price/median household income

Average, 1967–2007: 3.38

2005: 4.69

2007: 4.29

Ratio of home price to household

income surges

Home mortgage share of household debts reaches

a new high in 2007

Debt-to-income ratio of households has increased rapidly

Sources: U.S. Census Bureau, OFHEO, Federal Reserve, Moody’s Economy.com, Milken Institute.

55

60

65

70

75

1998 2000 2003 2005 2008

Percent Q2 2007: 73.7%

Q4 2008: 73.4%

Average, 1952–2008: 64.3%

75

100

125

150

1998 2000 2003 2005 2008

Home mortgage debt/disposable personal income

Q4 2008: 133.7%

Average, 1957–2008: 77%

50505050

VII. Collapse

51515151

The recent run-up of home prices was extraordinary

Sources: Robert Shiller, Milken Institute.

0

50

100

150

200

250

1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

GreatDepression

WorldWar I

WorldWar II

1970’sboom

1980’sboom

Recentboom

Long-term trend line

Annualized growth rate of nominal home index, 1890–2008: 3.1% 2000-2006: 11.2%

Index, 2000 = 100

52525252

Home prices don’t go up foreverChange in home prices in 100-plus years

Sources: Robert Shiller, Milken Institute.

-20-15-10

-505

1015202530

1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

WorldWar I

GreatDepression

WorldWar II

1970’sBoom

1980’sBoom

RecentBoom

Average, 1890–2008: 3.5%

Percentage change in nominal home price, year ago

+/- one standard deviation

53535353

2005: The collapse begins

Sources: S&P/Case-Shiller, OFHEO, Moody’s Economy.com, Milken Institute.

-20

-15

-10

-5

0

5

10

15

20

25

1988 1992 1996 2000 2004 2008

Home price indices, percent change from a year earlier

OFHEO

S&P/Case-Shiller national

S&P/Case-Shiller 10-city

5454

All states had home price increasesFrom 4Q 2001 to 4Q 2006

Sources: Moody’s Economy.com, Milken Institute.

United States = 43%

5555

Forty-seven states had home price declines From 4Q 2006 to 4Q 2008


United States = -19%

5656

One year ago… Six years ago…

If you bought your house…

% change in price, January 2008-2009 % change in price, January 2003-2009Sources: S&P/Case-Shiller, Milken Institute.

-4.9-5.1-5.2

-7.3-8.2

-9.6-14.0-14.3

-15.0-16.4

-19.0-19.3-19.4

-20.4-22.6

-23.3-24.9

-25.8-29.4

-32.4-32.5

-35.0

DallasDenverClevelandBostonCharlotteNew YorkPortlandAtlantaSeattleChicagoComposite-20 WashingtonComposite-10MinneapolisDetroitTampaSan DiegoLos AngelesMiamiSan FranciscoLas VegasPhoenix

35.333.3

23.718.4

15.412.312.0

10.610.6

7.93.23.02.7

0.0-1.0

-2.0-4.6-4.9

-6.6-12.4

-13.3-32.9

PortlandSeattleNew YorkWashingtonLos AngelesCharlotteTampaComposite-10MiamiComposite-20 ChicagoLas VegasBostonPhoenixDallasDenverSan DiegoAtlantaClevelandSan FranciscoMinneapolisDetroit

35.333.3

23.718.4

15.412.312.0

10.610.6

7.93.23.02.7

0.0-1.0

-2.0-4.6-4.9

-6.6-12.4

-13.3-32.9

PortlandSeattleNew YorkWashingtonLos AngelesCharlotteTampaComposite-10MiamiComposite-20 ChicagoLas VegasBostonPhoenixDallasDenverSan DiegoAtlantaClevelandSan FranciscoMinneapolisDetroit

57575757

Housing startssharply decline

Homes sit longeron the market …

… as home appreciation slows

Note: Shaded area represents fluctuation within one standard deviation from mean (1.15%)Sources: Mortgage Bankers Association, OFHEO, Moody’s Economy.com, Milken Institute.

-60

-45

-30

-15

0

15

30

1998 2000 2002 2004 2006 2008

April 2008: -43.2%March 2008: -49.7%

Percent change, year ago

0

2

4

6

8

10

12

1998 2000 2002 2004 2006 2008

Number of months that homes sit on the market

Existing homes

New homes-20

-10

0

10

20

1999 2001 2003 2006 2008

0

2

4

6

8

10

12

Percentage change from year ago in median home sales price (left axis)

Number of months homes stay on

market (right axis)

Percent Months

5858

Real Commercial Property Price Index

Source: Moody's Economy.com.

50

100

150

200

2001 2002 2003 2004 2005 2006 2007 2008

ApartmentIndustrialOfficeRetail

Index (2000 Q4 = 100)

5959

Commercial mortgage asset-backed securities

Sources: Federal Reserve, IHS Global Insight.

20082007200620052004200320022001200019991998

200

150

100

50

0

-50

-100

US$ billions, SAAR

60606060

VIII. Delinquencies and foreclosures

6161

0

500

1,000

1,500

2,000

2,500

Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008

SubprimeFHA and VAPrime (includes Alt-A)

Number of home mortgage loan foreclosures started (annualized rate in thousands)

Q4 2008Subprime: 12% of loans serviced

6161

Subprime mortgages accounted for half or more of foreclosures since 2006

Sources: Mortgage Bankers Association, Milken Institute.

6262

Mortgage foreclosure rateThe latest survey (Q4 2008)

Sources: Mortgage Bankers Association.

0

1

2

3

4

Q12006

Q22006

Q32006

Q42006

Q12007

Q22007

Q32007

Q42007

Q12008

Q22008

Q32008

Q42008

Percent of total outstanding home mortgage loans

Foreclosure inventory

New foreclosuresForeclosure inventory jumped, but the rate of new foreclosures remained flat in the fourth quarter of 2008.

6363

Mortgage delinquency rateDelinquencies continue to climb in latest survey (Q4 2008)

Sources: Mortgage Bankers Association.

Total delinquency rate

0

1

2

3

4

5

6

7

8

9

Q1 Q22006

Q3 Q4 Q1 Q22007

Q3 Q4 Q1 Q22008

Q3 Q4

Percent of total outstanding home mortgages

7.88%

0

5

10

15

20

25

2000 2002 2004 2006 2008

Delinquency rate of subprime loans

Delinquency rate of prime loans

Percent of total outstanding home mortgages

64646464

Subprime ARMs have the worst default record

Sources: Mortgage Bankers Association, Milken Institute.

Home mortgage loans delinquent or in foreclosure (percent of number)

0

5

10

15

20

25

30

35

40

45

Q21998

Q11999

Q41999

Q32000

Q22001

Q12002

Q42002

Q32003

Q22004

Q12005

Q42005

Q32006

Q22007

Q12008

Q42008

Q4 2008Subprime ARM: 39.5%Subprime FRM: 16.0%FHA and VA: 7.2%Prime: 4.4%

6565

Delinquency rateAt all commercial banks

0

1

2

3

4

5

6

7

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Residential real estate loans

Commercial real estate loans

Percent

Source: Federal Reserve.

6666

Percentage of homes purchased between 2004 and 2008 that now have negative equity

Sources: Zillow.com, Milken Institute.

United States = 41%

67676767

Percentage of homes sold for a loss (Q2 2008)

< 15%>= 15% and < 30%>= 30% and < 45%>= 45%


United States = 32.7%

68686868

Percentage of homes sold that were in foreclosure (Q2 2008)

< 1%>= 1% and < 25%>= 25% and < 40%>= 40%


United States = 18.6%

69696969

IX. Damages scorecard

7070

Losses/write-downs, capital raised byfinancial institutions worldwide

Sources: Bloomberg, Milken Institute.

1,103.9 1,288.1 Grand total 633.2621Others23.742.2HSBC, United Kingdom78.542.7Bank of America, United States12.145.3Washington Mutual, United States32.150.6UBS, Switzerland29.955.9Merrill Lynch, United States30.871.3Fannie Mae, United States51.681.6Freddie Mac, United States91.787.3AIG, United States

109.388.3Citigroup, United States11.0101.9Wachovia, United States

Capital raisedLoses/Write-downsUS$ billions, through April 10, 2009

7171

0

200

400

600

800

1,000

1,200

1,400

Prior Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 20090

50

100

150

200

250

300

350Number of jobs cut (thousands)US$ billions

Jobs cut (right axis)April 10, 2009: 289 thousand

Losses/write-downs (left axis)April 10, 2009: $1,288 billion

Capital raised (left axis)April 10, 2009: $1,104 billion


Cumulative losses/write-downs, capital raised, and jobs cut by financial institutions worldwide

What is the cumulative damage?

7272

Total assets of selected failed or acquired financial institutions


Purchased by Wells Fargo

Total assets= $3.0 trillion

172

310

399

639

668

764

Countrywide,6/30/2008

Washington Mutual,6/30/2008

Bear Stearns,3/31/2008

Lehman Brothers,6/30/2008

Merrill Lynch,12/31/2008

Wachovia,9/30/2008

US$ billions

Acquired by Bank of America

Filed for bankruptcy

Sold to JPMorgan Chase

Purchased by Bank of America


Purchased by Wells Fargo


172

310

399

639

668

764






Wachovia,9/30/2008

US$ billions







172

310

399

639

668

764






Wachovia,9/30/2008

US$ billions






7373

Financial stocks take big hits

Note: Bear Stearns stock price is to May 2008. Countrywide stock price is to June 2008. Merrill Lynch and Wachovia stock prices are to December 2008.Sources: Bloomberg, Milken Institute.

-99.9-99.9-98.9-98.8-98.6

-94.3-90.3-90.0-87.5-87.2

-82.7-66.3

-60.0-46.8-45.0

Lehman BrothersWashington MutualFreddie MacFannie MaeAIGBear StearnsWachoviaCountrywideMerrill LynchBank of AmericaUBSMorgan StanleyWells FargoGoldman SachsJPMorgan & Chase

Percentage change in stock price, Dec. 2006-March 2009

1,446

1,070

461364

2006 2007 2008 2009 March

Total loss in market value: $1,081 billion from December 2006 to March 2009

Total market capitalization of these selectedfinancial institutions, US$ billions

7474

Global financial crisis has wiped out trillions of dollars in global stock market capitalization

Sources: Bloomberg.

20

30

40

50

60

70

2004 2005 2006 2007 2008

US$ trillions

Highest point: $62.6 trillion on October 31, 2007

7575

Emerging market bond spreads widened dramatically

Yield difference between emerging market bonds and U.S. Treasuries

Source: JP Morgan Emerging Markets Bond Index Global (EMBI Global).

0

500

1000

1500

2000

2500

Jan2007

Apr2007

Jul2007

Oct2007

Jan2008

Apr2008

Jul2008

Oct2008

Jan2009

Apr2009

B ratedBB ratedInvestment grade

U.S. financial crisis started, August 2007

Lehman Brothers filed for bankruptcy, September 14, 2008

Basis points

7676

Widen sovereign credit default swap premiums for many transition economies

0

1,000

2,000

3,000

4,000

5,000

6,000

01/07 07/07 01/08 07/08 01/090

200

400

600

800

1,000

1,200

Ukraine (right axis)Russia (left axis)

Basis points

Sources: International Monetary Fund; Datastream.

0

200

400

600

800

1,000

1,200

1,400

01/07 07/07 01/08 07/08 01/09

HungaryLatviaPoland

Basis points

7777

Government capital investments in financial firms

Most recently available data, as of March 2009 (US$ billions)

Source: Bloomberg.

United States: $392.5

Rest of the World: $25.0Belgium: $16.2

Netherlands: $21.6

Germany: $53.5

United Kingdom: $58.0

78787878

X. Credit crunch and liquidity freeze

79797979

Widening spreads betweenmortgage-backed and high-yield bonds

Sources: Merrill Lynch, Bloomberg, Milken Institute.

0

5001,000

1,500

2,0002,500

3,000

3,500

4,0004,500

5,000

01/2004 07/2004 01/2005 07/2005 01/2006 07/2006 01/2007 07/2007 01/2008 07/2008 01/2009

Basis points, spread over 10-year Treasury bond

Merrill Lynch Mortgage-Backed Securities IndexAverage, 2004–Januray 30, 2009: 503 bps

Merrill Lynch High-Yield Bond IndexAverage, 2004–Januray 30, 2009: 426 bps

Maximum spread: 01/30/2009: 3,647 bps

8080

Market for liquidity freezes Spread between 1-month LIBOR and OIS

Note: LIBOR: London Interbank Offered Rate; OIS: Overnight indexed swap.Sources: Bloomberg, Milken Institute.

EESA: Emergency Economic Stabilization Act. CPP: Capital Purchase Program TLGP: Temporary Liquidity Guarantee Program

0

100

200

300

400

January-07 July-07 January-08 July-08 January-09

1-month LIBOR-OIS spread, basis points

Bear Stearns IndyMac

FannieMae/Freddie Mac

Lehman Brothers

Wachovia

Washington Mutual AIG

CPP + TLGPEESA passed

Beginning of credit crisis

8181

TED Spread reached historical high in 2008Daily, December 31, 2005—March 31, 2009


050

100150200250300350400450500

12/2005 12/2006 12/2007 12/2008

Historical high before 2008November 1987: 255 bps

August 20, 2007: 240 bps

Average since 2005: 93 bps

Average since August 2007: 146 bps

Basis pointsOctober 10, 2008: 463.6 bps

Aug. 16, 2007: Countrywide takes emergency loan of $11 billion from a group of banks.

Sept. 16, 2008: Fed rescues AIG for $85 billion.

8282

TED spread dropped below 1% in Feb 2009 Measures the premium banks charge each other over U.S. T-bill rate


050

100150200250300350400450500

March2006

2007 2008 March2009

Basis pointsTED spread hit a record highon October 10, 2008: 463.6 bps

September 16, 2008: Fed rescues AIG for $85 billion

8383

Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate

Daily, July 1, 2007—March 31, 2009

0

50

100

150

200

250

300

350

400

07/2007 09/2007 11/2007 01/2008 03/2008 05/2008 07/2008 09/2008 11/2008 01/2009 03/2009

Average since December 2001: 31 bps

October 10, 2008: 364 bps

Basis points

Average since July 2007: 94 bps


8484

Run on money market funds Total money market mutual funds assets, weekly

Sources: Investment Company Institute, Milken Institute.

3,000

3,200

3,400

3,600

3,800

4,000

January-08 April-08 July-08 October-08 January-09 April-09

US$ billions Jan. 14, 2009: $3,919

April 15, 2009: $3,816 billion

October 1, 2008

Jan. 2, 2008: $3,159 billion

8585

Note: Counterparty Risk index averages the market spreads of the credit default swaps (CDS) of fifteen major credit derivatives dealers, including ABN Amro, Bank of America, BNP Paribas, Barclays Bank, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs Group, HSBC, Lehman Brothers, JPMorgan Chase, Merrill Lynch, Morgan Stanley, UBS, and Wachovia. Sources: Datastream, Milken Institute.

Counterparty risk increases

0

100

200

300

400

500

600

700

07/2007 09/2007 11/2007 01/2008 03/2008 05/2008 07/2008 09/2008 11/2008 01/2009 03/2009

Average CDS spread, basis points

Bear Stearns acquired

Government announces support for Fannie Mae and Freddie Mac

Lehman Brother files for bankruptcy and Merrill Lynch acquired

AIG rescuedCitigroup agreed to buy Wachovia

October 10, 2008: 607 bps

86868686

Rising riskThe credit default swap market nearly

doubled each year from June 2001 through October 2008

Sources: International Swaps and Derivatives Association, Milken Institute.

0.6 0.9 1.6 2.2 2.7 3.8 5.4 8.412.4

17.1

26.0

34.4

45.5

62.254.6

47.0

0

10

20

30

40

50

60

70

June2001

Dec.2001

June2002

Dec.2002

June2003

Dec.2003

June2004

Dec.2004

June2005

Dec.2005

June2006

Dec.2006

June2007

Dec.2007

June2008

Oct.2008

Notional amount of credit default swaps outstanding, US$ trillions

Annualized growth rateH1 2001–H2 2007: 102%H1 2001–H1 2008: 89%

8787

Commercial paper outstanding declines substantially

Outstanding asset-backed and unsecured commercial paper


0.5

0.7

0.9

1.1

1.3

Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09

Asset-backed commercial paperNon-asset-backed commercial paper

US$ trillions August 8, 2007: $1.2 trillion

April 15, 2009: $681 billionJan. 7, 2004: $659 billion

8888

Market for liquidity freezes30-day commercial paper yield spreads over 1-month Treasury


0

100

200

300

400

500

600

January-07 July-07 January-08 July-08 January-09

Asset-backed commercial paperFinancial commercial paper

AA rated, daily, basis points The Fed announced Commercial Paper Funding Facility (CPFF) on Oct. 7, 2008

89898989

Federal Reserve responds by cutting Fed funds rate, but mortgage rates remain relatively flat

Sources: Freddie Mac, Federal Reserve, Moody’s Economy.com, Milken Institute.

0

2

4

6

8

10

01/2007 03/2007 06/2007 09/2007 12/2007 02/2008 05/2008 08/2008 11/2008 01/20090

1

2

3

4

5

6

30-year FRM rate (left axis)

Federal funds rate (left axis)

Percent Percent

Spread (right axis)

9090

U.S. mortgage and securitization marketsMortgage rates and agency spreads starting to fall

Source: Bloomberg, Merrill Lynch.

30-year fixed conventional mortgage rate

4.5

5

5.5

6

6.5

7

2005 2006 2007 2008 2009

Percent

0

1,000

2,000

3,000

4,000

5,000

2006 2007 2008 20090

200

400

600

800

1000

1200Basic points, spread over 10-year treasury bond

U.S. consumer asset-backed securities (ABS)

(right axis)

U.S. mortgage-backed securities (MBS)

(left axis)

9191Sources: Federal Reserve, Freddie Mac, Merrill Lynch, Bloomberg, Milken Institute.

Increasing spreads between corporate bonds, mortgage securities, and target federal funds rate

0

4

8

12

16

20

24

01/2007 04/2007 07/2007 10/2007 01/2008 04/2008 07/2008 10/2008 01/2009

Freddie Mac 30-year fixed mortgage rate

Federal intended funds rate

High yield corporate bonds yield

AAA corporate bonds yield

Percent

92929292

Federal Reserve assets increased but asset quality deteriorated


0.0

0.5

1.0

1.5

2.0

2.5

2003 2004 2005 2006 2007 2008 2009

Total assets of Federal Reserve banksTreasury securities held outright

US$ trillions

December 17, 2008: $2.3 trillion

9393

Federal Reserve has little maneuvering room


0.00.51.01.52.02.53.03.54.04.5

01 02 03 04 05 06 07 08 09 10 11 12 01 02 03 04

Percent

Effective federal funds rate

Target federal funds rateApr. 30, 2008: 2%Oct. 8, 2008: 1.5%Oct. 29, 2008: 1%Dec. 16, 2008: 0-0.25%

2008 2009

9494

OverviewGovernment responses to liquidity freeze and credit crunch

Government/private sector purchases of toxic assetsGuarantees for selected assets and liabilities Capital injections into financial institutionsSubsidization of loan modifications by financial institutions Debt for equity swapsEasier monetary policies, including lowering interest rates and quantitative/ credit easingCoordinated responses by countries (e.g., central bank currency swaps)

9595

Estimated U.S. total bailout costs The government has extended the bailouts to nearly $US10 trillion

Source: The Milken Institute.

Federal Reserve, Treasury, FDIC:

$362

FDIC: $926

Treasury: $2,466Federal Reserve:

$6,139

Estimated U.S. total bailout costs as of March 2009 (including guarantees and all commitments):

US$9.9 trillion

US$ billions

9696

Federal Government Comes to the Rescue of Main Street and Wall Street

Upper limit to total funds provided/cost under these Upper limit to total funds provided/cost under these programsprograms……$9.9 trillion plus ?$9.9 trillion plus ?

Federal Reserve 6,139

Congress and White House 2,466

Federal Deposit Insurance Corporation 926Treasury, Federal Deposit Insurance Corporation and Federal Reserve 362

Total amount committed (US$ billions) 9,893

Source: Milken Institute.

9797

Federal Reserve programs

Announced on 12/12/2007. The Fed auctions off loans under the TAF every Thursday for a term of 28 days. Outstanding TAF credit may potentially be expanded up to $900 billion.469

Term Auction Facility (TAF)

ProgramAmount

committed (US$ billions)

Description

Term Discount Window Program (TDWP) 64

Announced on 10/17/2007. Extends the term of discount window loans from overnight to up to 90 days.

Term Securities Lending Facility (TSLF) 106

Announced on 3/11/2008. Establishes term swaps between the Fed and primary dealers. Collateral can be Treasury securities, federal agency securities, and other highly rated debt securities. On December 2, 2008, TSLF was extended through April 30, 2009.

9898


Announced on 3/16/2008. Extends overnight borrowing from the Federal Reserve to primary dealers. On December 2, 2008, PDCF was extended through April 30, 2009. As of 3/18/2009, credit extended under PDCF was less than $20.1 billion.20

Primary Dealer Credit Facility (PDCF)

Announced on 3/14/2008. The Fed acquired $29 billion in mortgage backed securities from JPMorgan Chase to fund its purchase of Bear Stearns. As of 3/18/2009, the market value of these mortgage-backed securities is $26.2 billion.29 Bear Stearns

Announced on 3/11/2008. Establishes term swaps between the Fed and primary dealers. Collateral can be Treasury securities, federal agency securities, and other highly rated debt securities. On December 2, 2008, TSLF was extended through April 30, 2009.

106 Term Securities Lending Facility (TSLF)

Announced on 12/12/2007. The Fed auctions off loans under the TAF every Thursday for a term of 28 days. Outstanding TAF credit may potentially be expanded up to $900 billion.469

Term Auction Facility (TAF)

Announced on 10/17/2007. Extends the term of discount window loans from overnight to up to 90 days.64

Term Discount Window Program (TDWP)

Description

Amount committed

(US$ billions)

Program

9999


First announced on 9/16/2008. AIG received an $85 billion, two-year secured loan on September 16, 2008, in exchange for warrants for a 79.9 percent equity stake in the firm. It was given an additional $37.8 billion on October 8, and another $20.9 billion credit line under CPFF on October 30, 2008. On November 10, Treasury purchased $40 billion of newly issued AIG preferred stock under the TARP (potentially reducing the original loan from $85 billion to $60 billion), terminated the $37.8 billion lending facility previously established, created a new lending facility to purchase up to $22.5 billion MBS from AIG, and another facility to lend up to $30 billion to purchase CDOs on which AIG had written CDSs. On 3/2/2009, Treasury announced it would exchange its existing $40 billion cumulative perpetual preferred shares for new preferred shares with revised terms. Also, the Treasury will create a new equity capital facility, which allows AIG to draw down up to $30 billion as needed over time in exchange for non-cumulative preferred stock to the U.S. Treasury. As of 3/18/2009, $18.4 billion was extended to purchase MBSs, and $27.6 billion was extended to purchase CDOs.

185 AIG

Description

Amount committed

(US$ billions)

Program

100100


Announced on 9/29/2008. The Federal Open Market Committee authorized a $330 billion expansion of its swap lines for U.S. dollar liquidity operations by other central banks, raising the total cap to $620 billion (up to $30 billion by the Bank of Canada, $80 billion by the Bank of England, $120 billion by the Bank of Japan, $15 billion by DanmarksNationalbank, $240 billion by the ECB, $15 billion by the Norges Bank, $30 billion by the Reserve Bank of Australia, $30 billion by the SverigesRiksbank, and $60 billion by the Swiss National Bank).

620

Expansion of the Federal Open Market's temporary reciprocal currency arrangements (swap lines)

Announced on 9/19/2008. Loans to banks so that they can buy asset-backed commercial paper from money market funds. On December 2, 2008, AMLF was extended through April 30, 2009. As of 3/18/2009,credit extended under AMLF was $7.6 billion.

53

Asset Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF)

Description

Amount committed

(US$ billions)

Program

101101


Announced on 10/7/2008. The CPFF is a credit facility to a special purpose vehicle (SPV). The SPV purchases from eligible issuers three-month U.S. dollar-denominated commercial paper through the New York Fed's primary dealers. Eligible issuers are U.S. issuers ofcommercial paper, including U.S. issuers with a foreign parent company. The SPV only purchases U.S. dollar-denominated commercial paper (including asset-backed commercial paper (ABCP)) that is rated at least A-1/P-1/F1 by a major nationally recognized statistical rating organization (NRSRO) and, if rated by multiple major NRSROs, is rated at least A-1/P-1/F1 by two or more major NRSROs. The maximum amount of a single issuer's commercial paper the SPVmay own at any time is greatest amount of U.S. dollar-denominated commercial paper the issuer had outstanding on any day between January 1 and August 31, 2008. The SPV does not purchase additional commercial paper from an issuer whose total commercial paper outstanding to all investors (including the SPV) equals or exceeds the issuer's limit. As of 3/18/2009, $240.7 billion was outstanding.

1,777

Commercial Paper Funding Facility (CPFF)

Description

Amount committed

(US$ billions)

Program

102102


Announced on 10/21/2008. The MMIFF provides assurance that moneymarket mutual funds can liquidate their investments if cash is needed to cover withdrawals from customers. On 1/7/2009, the set of eligible institutions was expanded to also include a number of other money market investors, including U.S. based securities-lending cash-collateral reinvestment funds, portfolios, and accounts; and U.S. –based investment funds that operate in a manner similar to moneymarket mutual funds such as certain local government investment pools, common trust funds, and collective investment funds. As of 3/18/2009, outstanding amount was zero.

540

Money Market Investor Funding Facility (MMIFF)

Description

Amount committed

(US$ billions)

Program

103103


Announced on 11/25/2008. TALF loans will have a one-year term, will be non-recourse to the borrower, and will be fully secured by eligible ABS. Treasury will provide $20 billion of credit protection to the Fed in connection with the TALF. Eligible collateral will include U.S. dollar-denominated cash (that is, not synthetic) ABS that have a long-term credit rating in the highest investment-grade rating category (for example, AAA) from two or more major nationally recognized statistical rating organizations (NRSROs) and do not have a long-term credit rating of below the highest investment-grade rating category from a major NRSRO. The underlying credit exposures of eligible ABS initially must be auto loans, student loans, credit card loans, or small business loans guaranteed by the U.S. Small Business Administration. All U.S. persons that own eligible collateral may participate in the TALF. Collateral haircuts will be established by the FRBNY for each class of eligible collateral. Haircuts will be determined based on the price volatility of each class of eligible collateral. On December 19, 2008, it was announced that TALF loan maturity was extended from one to three years, and TALF loans would be provided to all eligible borrowers with eligible collateral rather than distributed through an auction. On 2/10/2009, the size of TALF was increased to $1 trillion. On 3/3/2009, TALF was formally launched. As of 03/19/2009, $4.7 billion was requested.

1,000

Term Asset-Backed Securities Loan Facility (TALF)

Description

Amount committed

(US$ billions)

Program

104104


Announced on 11/25/2008. The Fed will purchase the direct obligations of housing-related government-sponsored enterprises (GSEs)--Fannie Mae, Freddie Mac, and the Federal Home Loan Banks--and mortgage-backed securities (MBS) backed by Fannie Mae, Freddie Mac, and Ginnie Mae. Purchases of up to $100 billion in GSE direct obligations under the program will be conducted with the Fed's primary dealers through a series of competitive auctions and will begin in the first week of December. Purchases of up to $500 billion in MBS will beconducted by asset managers selected via a competitive process with a goal of beginning these purchases before year-end 2008. Purchases of both direct obligations and MBS are expected to take place over several quarters. On 3/18/2009, the FOMC decides to increase the size of the Federal Reserve's balance sheet by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion.

1,450

Purchase of GSE direct obligations and MBS

Description

Amount committed

(US$ billions)

Program

105105

Congress and White House

Announced on 7/30/2008. Designed to shore up Fannie Mae and Freddie Mac. 25

Purchase of GSE Debt and Equity

Announced on 7/30/2008. The CBO estimates that the Act will increase budget deficits by about $24.9 billion over the 2008 to 2018 period. 525

Housing and Economic Recovery Act of 2008

Announced on 2/13/2008. Provided tax rebates in 2008. Most taxpayers below the income limit received rebates of $300-$600. Also gave businesses a one-time depreciation tax deduction on specific new investment and raised the limits on the value of new productive capital that may be classified as business expenses during 2008. The Congressional Budget Office (CBO) estimates the net cost of the stimulus to be $124 billion.

124 Economic Stimulus Act

Announced on 8/31/2007. Guarantees $50 billion in mortgages.50 FHA Secure

Description

Amount committed

(US$ billions)

Program

106106


Announced on 9/7/2008. Treasury and FHFA established contractualagreements to ensure that each company maintains a positive net worth. They are indefinite in duration and have a capacity of $100 billion each. Treasury also established a new secured lending credit facility, available to Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. Funding is provided directly by Treasury in exchange for eligible collateral from the GSEs (guaranteed mortgage backed securities issued by Freddie Mac and Fannie Mae, as well as advances made by the Federal Home Loan Banks). To further support the availability of mortgage financing, Treasury is initiating a temporary program to purchase GSE MBS, with the size and timing subject to the discretion of the Treasury Secretary. On 2/18/2009, an additional $200 billion investment was made in Fannie Mae and Freddie Mac under Housing and Economic Recovery Act of 2008.

400

Conservatorship of Fannie Mae and Freddie Mac

Announced on 7/30/2008. This voluntary program encourages lenders to write down the loan balances of borrowers in exchange for FHA-guaranteed loans up to 90 percent of the newly appraised home value. Program runs through September 2011.

300 HOPE for Homeowners

DescriptionAmount


Program

107107


Announced on 10/14/2008 as part of the EESA. On November 25, Treasury purchased $40 billion of preferred shares from AIG. As of December 31, 2008, there are four programs under the TARP: Capital Purchase Program (CPP), Automobile Industry Financing Program (AIFP), Targeted Investment Program (TIP), and Asset Guarantee Program (AGP). TARP also includes on initiative: providing $20 billion to support the Fed's Term Asset-Backed Securities Loan Facility

392

Troubled Assets Relief Program (TARP)

Announced on 10/3/2008. Empowers Treasury to use up to $700 billion to inject capital into financial institutions, to purchase or insure mortgage assets, and to purchase any other troubled assets necessary to promote financial market stability.

700

Emergency Economic Stabilization Act

Announced on 9/30/2008. Allows banks to offset their profits with losses from the loan portfolio of banks they acquire. Initial media reports indicate that Wells Fargo alone may be able to claim more than $70 billion in losses from its acquisition of Wachovia, obtaining tax savings that exceed the market value of Wachovia as of November 7, 2008.

? IRS Notice 2008-83

Announced on 9/19/2008. To restore confidence in money market funds, Treasury made available up to $50 billion from the Exchange Stabilization Fund.50

Guaranty Program for Money Market Funds

DescriptionAmount


Program

108108


On 12/19/2008, Treasury announced a plan to make emergency loans available to General Motors and Chrysler. GM was provided with up to a total of $13.4 billion in short-term financing. Treasury funded $4 billion of this loan immediately, and an additional $5.4 billon on 1/16/2009. Treasury will provide an additional $4 billion on 2/17/2009. On 12/29/2008, Treasury also purchased $5 billion of senior preferred equity from GMAC. Additionally, Treasury agreed to lend up to $1 billion of TARP funds to GM so that GM can participate in a rights offering by GMAC in support of GMAC’s reorganization as a bank holding company. On 1/2/2009, Treasury provided a 3-year $4 billion loan to Chrysler, secured by various collateral, including parts inventory, real estate, and certain equity interests. On 1/19/2008, Treasury announced that a $1.5 billion loan to a SPV created by Chrysler Financial to finance the extension of new consumer auto loans as part of a broader program to assist the domestic automotive industry in becoming financially viable.

25

Automotive Industry Financing Program (AIFP)

Under CPP, Treasury was allowed to purchase up to $250 billion of senior preferred shares in selected banks. The first $125 billion was allocated to nine of the nation's largest financial institutions on October 28, 2008. As of 3/18/2009, $198.5 billion has been distributed to 510 institutions.

250 Capital Purchase Program (CPP)

DescriptionAmount


Program

109109


On 12/31/2008, Treasury transmitted to Congress a report that describes the Asset Guarantee Program (AGP). This program provides guarantees for assets held by systemically significant financial institutions that face a risk of losing market confidence due in large part to a portfolio of distressed or illiquid assets. On 1/16/2009, $5 billion guarantee was provided Citigroup.

5

Asset Guarantee Program (AGP)

Treasury may invest in any financial instrument, including debt, equity, or warrants, that the Secretary of the Treasury determines to be a troubled asset, after consultation with the Chairman of the Board of Governors of the Federal Reserve System and notice to Congress. Institutions participating in this program are required to provide Treasury with warrants or alternative consideration as necessary. They also need to adhere to rigorous executive compensation standards. In addition, Treasury will consider other measures, including limitations on the institution's expenditures, or other corporate governance requirements. The $20 billion investment in Citigroup that was announced on Nov. 23 was made under the TIP. On 1/16/2009, $20 billion investment was made in Bank of America.

40

Targeted Investment Program (TIP)

DescriptionAmount


Program

110110


Announced on 2/10/2009. This program include: 1) A new Capital Assistance Program; 2) A new Public-Private Investment Fund; 3) A new Treasury and Federal Reserve imitative to expand the existing TALF; 4) An extension of the FDIC's Temporary Liquidity Program; 5) A new framework of governance and oversight for banking industry; and 6) Affordable Housing Support and Foreclosure Prevention Plan. This plan uses EESA funds as well as other resources.

1,375 Financial Stability Plan

Signed by President Obama on February 17, 2009.787

American Recovery and Reinvestment Act of 2009

Signed by President Obama on February 18, 2009. This program: 1) provides refinancing for up to 4 to 5 million responsible homeowners to make their mortgages more affordable; 2) establishes a $75 billion homeowner stability initiative to reach up to 3 to 4 million at-risk homeowners; and 3) supports low mortgage rates by strengthening confidence in Freddie Mac and Fannie Mae. This plan is supplemented by $200 billion in additional funding to Fannie Mae and Freddie Mac by Treasury under Housing and Economic Recovery Act.

75

Homeowner Affordability and Stability Plan

DescriptionAmount


Program

111111111111


This new program will be designed with a public-private financing component, which could involve putting public or private capital side-by-side and using public financing to leverage private capital on an initial scale of up to $500 billion, with the potential to expand up to $1 trillion.

500

New Public-Private Investment Fund (PPIF)

Capital Assistance Program under Financial Stability Trust will provide a capital buffer that will operate as a form of “contingent equity” to ensure firms the capital strength to preserve or increase lending in a worse than expected economic downturn. Firms will receive a preferred security investment from Treasury in convertible securities that they can convert into common equity if needed to preserve lending in a worse-than-expected economic environment. This convertible preferred security will carry a dividend to be specified later and a conversion price set at a modest discount from the prevailing level of the institution’s stock price as of February 9, 2009. All banking institutions with assets in excess of $100 billion will be required to participate. Banking institutions with consolidated assets below $100 billion will also be eligible to obtain capital from the CAP after a supervisory review.

? Capital Assistance Program (CAP)

Description

Amount committed

(US$ billions)

Program

112112112112


This program includes: 1) Jumpstart credit markets for small businesses by purchasing up to $15 billion in securities; 2) Temporarily raise guarantees to up to 90 percent in SBA's 7(a) loan program; 3) Temporarily eliminate certain SBA loan fees to reduce the cost of capital; 4) Call by Secretary Geithner for new reporting requirements on bank lending to small businesses and greater efforts to extend small business loans; 5) Issue guidance for an expanded carryback provision as part of the Recovery Act's comprehensive tax cut package for small businesses.

15

Unlocking Credit for Small Businesses Program

This program includes: 1) A home affordable refinance program toprovide access to low-cost refinancing for responsible homeowners suffering from falling home prices; 2) a $75 billion home affordable modification program to prevent foreclosures and help responsible families stay in their homes; and 3)support low mortgage rates by strengthening confidence in Fannie Mae and Freddie Mac.

75

Making Home Affordable Program

DescriptionAmount


Program

113113113113


Announced on 10/14/2008. This program includes two parts: 1) Debt Guarantee Program (DGP); 2) Transaction Account Guarantee Program (TAG). The TLGP temporarily guarantees the senior debt of all FDIC-insured institutions and their holding companies, as well as deposits in non-interest bearing deposit transaction accounts. On November 21, 2008, FDIC strengthened TLGP. Chief among the changes is that the debt guarantee will be triggered by payment default rather than bankruptcy or receivership. Another change is that short-term debt issued for one month or less will not be included in the TLGP. Eligible entities will have until December 5, 2008 to opt out of TLGP. On 2/10/2009, the program was extended through October 2009. As of 1/31/2009, $253 billion worth of debt was outstanding under the TLGP.

926

Temporary Liquidity Guarantee Program (TLGP)

Announced on 10/3/2008. A provision of EESA temporarily raised the basic limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor. Limits are scheduled to return to $100,000 after December 31, 2009.

? Increase FDIC insurance coverage

Description

Amount committed

(US$ billions)

Program

114114114114


The TAG provided for a temporary full guarantee by the FDIC for funds held at FDIC-insured depository institutions in noninterest-bearing transaction accounts above the existing deposit insurance limit. This coverage became effective on October 14, 2008, and would continue through December 31, 2009.

926

Transaction Account Guarantee Program (TAG)

The DGP temporarily guarantees the senior debt of all FDIC-insured institutions and their holding companies, as well as deposits in non-interest bearing deposit transaction accounts. Certain newly issued senior unsecured debt on or after October 14, 2008, and before June 30, 2009, would be fully protected in the event the issuing institution subsequently fails, or its holding company files for bankruptcy. This includes promissory notes, commercial paper, interbank funding, and any unsecured portion of secured debt. Coverage would be limited to June 30, 2012. As of 1/31/2009, $253 billion of debt was outstanding under the program.

253+? Debt Guarantee Program (DGP)

Description

Amount committed

(US$ billions)

Program

115115115115

Treasury, Federal Deposit Insurance Corporation and Federal Reserve

Program Amount committed (US$ billions) Description

Guarantee a portion of an asset pool of loans and securities backed by residential and commercial real estate and other such assets on Citigroup's balance sheet

249

Announced on 11/23/2008. Up to $306 billion of Citigroup's assets are guaranteed. Citigroup takes the first loss up to $29 billion, and any loss in excess of that amount is shared by the government (90%) and Citigroup (10%). Treasury (via TARP) takes the second loss up to $5 billion, while FDIC takes the third loss up to $10 billion. The Federal Reserve funds the remaining pool of assets with a non-recourse loan, subject to Citigroup's 10 percent loss sharing, at a floating rate of overnight interest swap plus 300 basis points.

116116

Treasury, Federal Deposit Insurance Corporation and Federal Reserve

Program

Amount committed

(US$ billions)

Description

Provide a package of guarantees, liquidity access, and capital to the Bank of America

138

Announced on 1/16/2009. Treasury and FDIC will provide protection against the possibility of unusually large losses on an asset pool of approximately $118 billion of loans, securities backed by residential and commercial real estate loans, and other such assets, all of which have been marked to market value. The large majority of these assets were assumed by BOA as a result of its acquisition of Merrill Lynch. The assets will remain on BOA’s balance sheet. As a fee for this arrangement, BOA will issue preferred shares to the Treasury andFDIC. In addition and if necessary, The Federal Reserve stands ready to backstop residual risk in the asset pool through a non-recourse loan.In addition, Treasury will invest $20 billion in BOA from the TARP program in exchange for preferred stock with an 8 percent dividend to the Treasury. The investment was made under the Targeted Investment Program.

Loans, guarantees and investments committed 9,893 The final tab for taxpayers will only become known once the crisis is

over.

117117

TARP allocated so farStatus of Troubled Asset Relief Program funds as of March 27, 2009

Source: Wall Street Journal.US$ billions

40

24.5

238.9

0 100 200 300 400 500 600

Already disbursed

Maximum announced funding level

15

Banking system

AIG

Auto companies and suppliers

Small business

Life insurers (estimated)

522.5

70

29.9

25

118118Source: US Treasury.

Lending by TARP recipient banksUS$ millions

BankOctober lending

November lending

Oct.-Nov. % change

December lending

Nov.-Dec. % change

January lending

Dec.-Jan. % change

February lending

Jan.-Feb. % change

Oct.-Feb % change

American Express Co. $1,366 $889 -34.9 $845 -4.9Bank of America Corp $70,569 $48,862 -30.8 $61,427 25.7 $56,277 -8.4 $56,184 -0.2 -20.4Bank of New York Mellon Corp. $879 $800 -9 $849 6.1 $730 -14 $816 11.8 -7.2BB&T Corp. $5,929 $4,901 -17.3 $6,197 26.4 $5,976 -3.6 $6,398 7.1 7.9Capital One Financial Corp. $3,478 $2,825 -18.8 $3,024 7 $2,531 -16.3 $2,275 -10.1 -34.6CIT Group Inc. $5,317 $4,232 -20.4 $4,182 -1.2 $3,429 -18 $3,497 2 -34.2Citigroup Inc. $19,373 $17,854 -7.8 $22,865 28.1 $18,816 -17.7 $14,691 -21.9 -24.2Comerica Inc. $3,830 $2,300 -39.9 $3,242 41 $1,425 -56 $1,661 16.6 -56.6Fifth Third Bancorp $7,025 $6,414 -8.7 $7,121 11 $5,071 -28.8 $5,467 7.8 -22.2Goldman Sachs Group Inc. $1,491 $1,665 11.7 $2,550 53.2 $6,488 154.4 $744 -88.5 -50.1J.P. Morgan Chase & Co. $61,192 $51,202 -16.3 $52,376 2.3 $46,785 -10.7 $39,682 -15.2 -35.2KeyCorp $3,238 $2,670 -17.5 $4,518 69.2 $3,066 -32.1 $2,241 -26.9 -30.8Marshall & Ilsley Corp. $1,332 $1,181 -11.3 $1,206 2.1 $960 -20.4 $898 -6.5 -32.6Morgan Stanley $1,787 $6,303 252.7 $3,170 -49.7 $3,551 12 $2,614 -26.4 46.3Northern Trust Corp. $1,985 $1,365 -31.2 $1,810 32.6 $1,270 -29.8 $1,279 0.7 -35.6PNC Financial Services Group Inc. $11,274 $6,313 -44 $8,076 27.9 $8,170 1.2 $7,991 -2.2 -29.1Regions Financial Corp. $5,995 $4,665 -22.2 $5,833 25 $4,982 -14.6 $4,867 -2.3 -18.8State Street Corp. $604 $796 31.8 $1,403 76.3 $289 -79.4 $1,170 304.8 93.7SunTrust Banks Inc. $7,612 $4,827 -36.6 $6,514 34.9 $6,511 $7,586 16.5 -0.3U.S. Bancorp $13,371 $11,244 -15.9 $17,262 53.5 $13,866 -19.7 $13,256 -4.4 -0.9Wells Fargo & Co. $35,073 $26,873 -23.4 $31,063 15.6 $50,560 62.8 $56,051 10.9 59.8

119119Source: US Treasury.

Lending by TARP recipient banksUS$ millions

BankOctober lending

November lending

Oct.-Nov. % change

December lending

Nov.-Dec. % change

January lending

Dec.-Jan. % change

February lending

Jan.-Feb. % change

Oct.-Feb % change

Median (With WFC) -17.4 26.1 -16.3 -2.2 -23.2Median (No WFC) -17.3 26.4 -17 -2.2 -24.2TOTAL (w ith WFC) $261,354 $207,292 -26.1 $246,054 18.7 $241,642 -1.8 $230,213 -4.7 -11.9TOTAL (no WFC) $226,281 $180,419 -25.4 $214,991 19.2 $191,082 -11.1 $174,162 -8.9 -23

120120120120

XI. When will we hit bottom?

121121

How far do home prices have to fall?Average = 100


60

80

100

120

140

160

1981 1988 1995 2002 2009

OFHEO

Case-Shiller: 20-metro

Case-Shiller: 10-metro

Case-Shiller National

Price/rent

60

80

100

120

140

160

1981 1988 1995 2002 2009

OFHEO Case-Shiller: 20-metro Case-Shiller: 10-metro Case-Shiller National

Price/disposable income per capita

122122

Alternative measures for the affordability ofmortgage debt for California

Mortgage payment assumptions:

* Home is purchased at median price

* Buyer takes out a 30-year

conforming, fixed-rate loan

* Payment also includes 1% property

tax per year, 0.1% property

insurance


20%

30%

40%

50%

60%

70%

80%

2000 2002 2004 2006 2008

Estimated monthly payment / monthly household income

100% LTV

Maximum affordablility limit is 38%of median household income

90% LTV

80% LTV

123123123123

XII. What went wrong

124124124124

2,443

879

1,410

2,067

944886

0

500

1,000

1,500

2,000

2,500

3,000

Fannie Mae:total assets

Fannie Mae:total MBS

outstanding

Freddie Mac:total assets

Freddie Mac:total MBS

outstanding

Commercialbanks: total

residential realestate assets

Savingsinstitutions:

totalresidential realestate assets

US$ billions

The importance of Fannie Mae and Freddie Mac

Sources: Freddie Mac, Fannie Mae, FDIC, Milken Institute.

125125125125

Fannie Mae and Freddie Mac: Too big with too little capital?

Sources: Freddie Mac, Fannie Mae, Milken Institute.

133 41

675459

1,022803 912 851

288 316

707 576

1,301

752

1,403

2,289

0

500

1,000

1,500

2,000

2,500

FannieMae 1990

FreddieMac 1990

FannieMae 2000

FreddieMac 2000

FannieMae 2003

FreddieMac 2003

FannieMae 2008

FreddieMac 2008

US$ billions

Total assetsTotal MBS outstanding

126126126126

Fannie Mae and Freddie Mac are highly leveraged


60x 56x 48x 55x60x 58x 52x 57x64x 81x 56x

167x

-360x

-168x

-72x-30x

-400

-300

-200

-100

0

100

200

300

Core capital Fair value Core capital Fair value

2005 2006 2007 2008

Mortgage book of business over capital measures

Fannie Mae Freddie Mac

127127

Freddie Mac’s and Fannie Mae's retained private-label portfolios: Too much risk?


Fannie Mae, 2008

Fannie Mae, 2007

Fannie Mae, 2006

Fannie Mae, 2005

Freddie Mac, 2008

Freddie Mac, 2007

Freddie Mac, 2006

Subprime Alt-A All others

46.3% 23.4% 30.3%

33.8% 34.3% 32.0%

46.4% 36.1% 17.5%

32.1% 37.4% 30.5%

40.5% 24.1% 35.4%

54.4% 25.0% 20.6%$224.6 billion

$218.9 billion

$86.9 billion

$97.3 billion

$94.8 billion

$185.0 billion

29.4% 33.4% 37.2%$83.4 billion

128128

Leverage ratios of selected financial firms December 2008

Note: Leverage ratios for Freddie Mac and Fannie Mae are as of June 2008. The two institutions have negative common equities as of December 2008.Sources: FDIC, FHL Banks Office of Finance, National Credit Union Administration, Freddie Mac, Fannie Mae, Milken Institute.

9.3

10.6

11.1

31.6

26.2

21.5

67.9

0 10 20 30 40 50 60 70 80

Credit unions

Commercial banks

Saving institutions

Brokers/hedge funds

Federal Home Loan Banks

Fannie Mae

Freddie Mac

Leverage ratio, total assets/common equity

(June 2008)

(June 2008)(June 2008)

129129

Too much dependence on debt?Leverage ratios at biggest investment banks

2219

28 26

18

31

19

2724 23

33 32 3431

13

33 34

2422

13

0

5

10

15

20

25

30

35

40

Morgan Stanley Merrill Lynch Bear Stearns Lehman Brothers Goldman Sachs

2000 2005 2007 2008

Total assets/total shareholder equity

March 2008

June 2008


130130

Too much dependence on debt?Leverage ratios at bank holding companies


13

17

1311

19

14 13 1312 13

10

13

0

5

10

15

20

25

Citigroup Bank of America JPMorgan Chase

2000 2005 2007 2008


13

17

1311

19

14 13 1312 13

10

13

0

5

10

15

20

25

Citigroup Bank of America JPMorgan Chase

2000 2005 2007 2008


131131131131

Leverage vs. issuer rating


18

19

20

21

22

23

24

10 15 20 25 30 35Total assets/total equity capital

Fitch long term issuer default rating

Citigroup

JP Morgan

Bank of America

Lehman Brothers

Morgan Stanley

Bear Stearns

Merrill Lynch

Morgan Stanley

Goldman Sachs

Merrill Lynch

Merrill Lynch

● 2000 ● 2005 ● 2007AAA

AA+

AA

AA-

A+

A

A-

132132132132

Leverage vs. issuer rating




2000 2005 2007 2000 2005 2007

Bear Stearns 27.8 26.6 33.5 A+ A+ A+

Merrill Lynch 19.4 19.1 31.9 AA AA- A+

Morgan Stanley 21.6 30.7 33.4 AA AA- AA-

Lehman Brothers 26.0 24.4 30.7 A A+ AA-

Goldman Sachs 17.5 22.7 22.4 AA- AA- AA-

Citigroup 12.7 13.3 19.3 AA AA+ AA

Bank of America 13.5 12.7 11.7 AA- AA- AA

JPMorgan Chase 16.7 11.2 12.7 AA- A+ AA-

133133133133

AAA

AA+

AA

AA-

A+

A

A-

CDS premiums vs. issuer rating

Sources: Datastream, Milken Institute.

0 10 20 30 40 50 60 70 80 90Average CDS premium, basis points


Citigroup

JPMorgan

Bank of America

Lehman BrothersBear Stearns

Morgan Stanley

Goldman Sachs

Merrill Lynch

● 2004 ● 2005 ● 2007

Lehman Brothers

Merrill Lynch

134134134134

Credit default swap premiumsbasis points

Sources:Datastream, Milken Institute.

2004 2005 2006 2007 2008

Bear Stearns 35.97 29.65 23.48 79.62 155.64

Merrill Lynch 33.37 27.19 20.34 57.62 231.03

Morgan Stanley 33.39 27.81 22.42 52.20 289.61

Lehman Brothers 35.91 29.88 23.53 68.95 936.23

Goldman Sachs 34.04 27.53 22.58 46.25 189.79

Citigroup 22.17 17.01 10.69 30.05 165.20

Bank of America 22.52 17.27 11.06 26.11 113.09

JPMorgan Chase 31.23 27.30 16.83 31.11 105.75

135135

Leverage vs. CDS premiums

Sources: Datastream, Bloomberg, Milken Institute.

0

20

40

60

80

100

10 15 20 25 30 35Total assets/total equity capital

Average CDS premium, basis points

JP Morgan

Bank of America

Morgan Stanley

Bear Stearns

Merrill LynchGoldman Sachs

● 2004 ● 2005 ● 2007

Lehman Brothers

Bear StearnsLehman Brothers

Merrill LynchCitigroup

Morgan Stanley

136136

Leverage vs. CDS premium

Sources: Datastream, Bloomberg, Milken Institute.


Average CDS premiumbasis points

2004 2005 2007 2004 2005 2007

Bear Stearns 28.5 26.6 33.5 35.97 29.65 79.62

Merrill Lynch 20.0 19.1 31.9 33.37 27.19 57.62

Morgan Stanley 26.4 30.7 33.4 33.39 27.81 52.2

Lehman Brothers 23.9 24.4 30.7 35.91 29.88 68.95

Goldman Sachs 19.8 22.7 22.4 34.04 27.53 46.25

Citigroup 13.6 13.3 19.3 22.17 17.01 30.05

Bank of America 11.1 12.7 11.7 22.52 17.27 26.11

JPMorgan Chase 11.0 11.2 12.7 31.23 27.3 31.11

137137137137

Credit default swap premiums for large banks

Sources: Datastream, Milken Institute.

0

100

200

300

400

500

12/2005 04/2006 08/2006 12/2006 04/2007 08/2007 12/2007 04/2008 08/2008 12/2008

JP Morgan ChaseWells FargoBank of AmericaCitigroup

Credit default swap premium, basis points

138138138138

Standard & Poor’s ratingsNew issues: 1/1/2000 to 9/30/2008


Investment-grade securities

AAA 16,907

AA+ 240

AA 2,098

AA- 3,414

A+ 2,623

A 2,602

A- 2,027

BBB+ 903

BBB 1,371

BBB- 1,359

Non-investment-grade securitiesBB+ 238BB 313BB- 331B+ 339B 330B- 1,189CCC+ 293CCC 214CCC- 104CC 36C 11D 303

139139139139

15

38

63

76

17

50

71

84

24

66

8794

0

10

20

30

40

50

60

70

80

90

100

AAA AA(+/-) A(+/-) BBB(+/-)

S&PMoody’sFitch

Percent downgraded

Subprime mortgage-backed securities downgrades

2005–2007 issuance

56 percent of MBS issued were eventually downgraded

2005–2007 issuance

Sources: Sources: Inside Mortgage Finance, Milken Institute.

S&P Total DowngradedDowngraded as a percentage of

total

AAA 1,032 156 15.1%

AA(+/-) 3,495 1,330 38.1%

A(+/-) 2,983 1,886 63.2%

BBB(+/-) 2,954 2,248 76.1%

BB(+/-) 789 683 86.6%

B(+/-) 8 7 87.5%

Total 11,261 6,310 56.0%

140140140140

Credit ratings of selected S&P 500 companies and associated CDS spreads as of October 17, 2008

S&P's Number of companies

CDS spreads (basis points)S&P's Number of

companiesCDS spreads (basis points)

Highest Lowest Average Highest Lowest AverageAAA 3 56 15 41 BB+ 12 795 130 419AA+ 1 95 95 95 BB 14 938 168 522AA 5 86 49 74 BB- 8 1,352 337 713AA- 9 265 54 118 B+ 4 3,925 418 1,612A+ 17 2,999 12 346 B 3 2,686 894 1,523A 36 1,040 38 151 B- 2 4,718 3,701 4,209A- 34 2,557 51 427

BBB+ 43 1,114 38 222BBB 41 1,210 61 271BBB- 17 1,235 89 359

Note: Credit ratings of S&P 500 companies and the associated CDS spreads for those firms for which both ratings and CDS spreads are available.A bond is considered investment grade if its credit rating is BBB- or higher by S&P.

Sources: S&P, Bloomberg, Datastream, Milken Institute.

Speculative gradeInvestment grade

141141141141

When is a AAA not a AAA?Multilayered mortgage products

Sources: International Monetary Fund, Milken Institute.

Origination ofmortgage loans High-grade CDO

Senior AAA 88%Junior AAA 5%

Pool of mortgage AA 3%loans: prime or subprime A 2%

BBB 1%Unrated 1%

Mortgage bonds

AAA 80%AA 11%A 4% Mezzanine CDO

BBB 3% CDO-squaredBB-unrated 2% Senior AAA 62%

Junior AAA 14% Senior AAA 60%AA 8% Junior AAA 27%A 6% AA 4% CDO-cubed…

BBB 6% A 3%Unrated 4% BBB 3%

Unrated 2%

142142

Historical CMBS rating actions Fixed-rate conduit transactions

Sources: Wachovia Capital Markets, LLC.

2009200820072006200520042003200220012000

3000

2500

2000

1500

1000

500

0

Number of rating actions

DowngradesUpgrades

143143143143

XIII. Policy lessons from the current crisis and

proposals for reform in regulatory oversight

144144

Balance sheet information on FDIC-insured institutions

Sources: FDIC, Milken Institute.

0

5

10

15

20

25

1992 1994 1996 1998 2000 2002 2004 2006 20080102030405060708090

Percent Percent

Equity capital-to-asset ratio (right axis)

Cash-to-asset ratio(left axis)

Deposits-to-asset ratio (right axis)

Insured deposits-to-asset ratio (right axis)

Borrowed funds-to-asset ratio (left axis)

145145

Name Total assets($US billions)

Deposits to total assets

(percent)

Short-term borrowing to total assets

(percent)

Long-termborrowing to total

assets(percent)

Cash and equivalents to

total assets(percent)

JPMorgan Chase 2,175 46.4 18.3 11.3 1.2

Citigroup 1,938 39.8 28.0 14.0 1.5

Bank of America 1,818 48.6 25.6 12.4 1.8

Wells Fargo 1,310 59.7 12.4 16.3 1.8

Goldman Sachs 885 n.a. 38.3 21.0 1.8

Morgan Stanley 659 n.a. 43.9 21.5 11.9

PNC Financial 291 66.3 6.6 14.8 1.5

US Bancorp 266 59.9 16.7 10.5 2.6

Bank of NY Mellon 238 67.2 4.9 9.0 24.5

SunTrust Banks 189 59.9 5.0 14.2 3.0

Selected information for U.S. banksDecember 31, 2008


146146

Name

Alternative capital ratios (percent)Market value

(as of 3/11/2009) to total assets

(percent)

Total risk-based

capital ratio

Tier 1 risk-based capital ratio

Tier 1 risk-based capital ratio without

TARP capital

Total equity to total assets

ratio

Tangible common

equity ratio

JPMorgan Chase 14.8 10.9 8.9 7.7 3.8 3.8

Citigroup 15.7 11.9 9.9 7.3 1.6 0.4

Bank of America 13.0 9.2 7.9 9.7 2.8 2.0

Wells Fargo 11.8 7.8 5.6 7.6 1.6 4.1

Goldman Sachs 18.9 15.6 13.1 7.5 4.9 5.4

Morgan Stanley 26.8 17.9 14.3 7.7 4.4 3.9

PNC Financial 13.2 9.7 6.6 9.5 1.9 4.1

US Bancorp 14.3 10.6 7.7 9.9 2.6 8.5

Bank of NY Mellon 17.1 13.3 10.7 11.8 1.6 11.6

SunTrust Banks 14.0 10.9 7.9 11.8 5.0 2.3

Sources: Bloomberg, company data, Milken Institute.

Selected information for U.S. banksDecember 31, 2008

147147

A question of equity: Stress tests?U.S. regulatory capital requirements and selected equity ratios

Sources: FDIC, Bloomberg, Milken Institute.

Tier 1leverage

Tier 1 risk-based

Total risk-based

Well capitalized >= 5% >= 6% >= 10%

Adequately capitalized >= 4% >= 4% >= 8%

Undercapitalized < 4% < 4% < 8%

Significantly undercapitalized < 3% < 3% < 6%

Critically undercapitalized

Tangible equity capital ratio that is <= 2%

0 5 10 15 20

Citigroup

Wells Fargo

Bank NY Mellon

PNC Financial Services

US Bancorp

Bank of America

JPMorgan Chase

Morgan Stanley

Goldman Sachs

SunTrust Banks

Tier 1 capital ratioTangible common equity ratio

148148

0

5

10

15

20

25

30

1896 1905 1914 1923 1932 1941 1950 1959 1968 1977 1986 1995 2004

Equity capital/asset ratio, percent

Average, 1896 - 2008: 10.9%

1945: 5.5% 1979: 5.75%

1932: 16.2% 2008: 9.4%

1896: 28.1%

Equity capital-asset ratio for commercial banksQuarterly, Q1 1896–Q4 2008

Sources: Historical Statistics of the United States, FDIC, Milken Institute.

149149

Reserve coverage ratio ofall FDIC-insured institutions

Sources: Quarterly Banking Profile, FDIC, Milken Institute .

0

50

100

150

200

250

2005 2006 2007 2008020406080100120140160180200

US$ billions Percent

Noncurrent loans (left axis)

Loan-loss reserves (left axis)

Coverage ratio (right axis)

150150150150

The U.S. regulatory regime: In need of reform?

Sources: Financial Services Roundtable (2007), Milken Institute.

National banks State commercial and savings banks

Federal savings banks

Insurance companies

Securities brokers/dealers

Other financial companies, including mortgage

companies and brokers

• Fed• OTS

• OCC• FDIC

• State bankregulators

• FDIC• Fed--state member

commercial banks

• OTS• FDIC

• 50 State insuranceregulators plusDistrict of Columbiaand Puerto Rico

• FINRA• SEC• CFTC• State securities

regulators

• Fed• State licensing

(if needed)• U.S. Treasury

for some products

• OCC• Host county

regulator

• Fed• Host county

regulator

• OTS• Host county

regulator

Federal branch

Foreignbranch

Limited foreign branch

Fed is the umbrella or consolidated regulator

Primary/secondaryfunctionalregulator

Notes:Justice Department: Assesses effects of mergers and acquisitions on competitionFederal Courts: Ultimate decider of banking, securities, and insurance productsCFTC: Commodity Futures Trading CommissionFDIC: Federal Deposit Insurance CorporationFed: Federal ReserveFINRA: Financial Industry Regulatory Authority GSEs: Government Sponsored Enterprises OCC: Comptroller of the CurrencyOTS: Office of Thrift SupervisionSEC: Securities and Exchange Commission

• Federal Housing Finance Agency

Fannie Mae, Freddie Mac, and Federal Home Loan Banks

Financial, bank and thrift holding companies

Justice Department• Assesses effects of mergers and acquisitions on competition

Federal courts• Ultimate decider of banking, securities, and insurance products

151151

OverviewReforms to prevent/mitigate credit booms and busts

Macro-prudential regulation (i.e., establish a systemic risk regulator or market stability regulator)A liquidity regulation to take into account maturity mismatches due to short-term funding of longer-term, illiquid assetsCountercyclical regulation (e.g., dynamic capital and/or provisioning regulations)A regulation that internalizes (taxes) a financial institution’s contribution to systemic risk (to address too-big-to-fail issue)Greater transparency by requiring clearing and settling of credit default swaps to be conducted through clearing houses or on exchanges, which provides for greater monitoring of exposures and posting of necessary collateral

152152

OverviewReforms to prevent/mitigate credit booms and busts (Continued)

Change fee structure for credit rating agencies, eliminate the Nationally Recognized Statistical Rating Organization (NRSRO) designation, and decrease use of ratings in regulatory system Consider eliminating treatment of residential mortgages as non-recourse loans (i.e., secured only by the underlying property), merging Freddie Mac and Fannie Mae, and requiring mortgage originators to have “skin in the game”Consider modifying incentive/compensation systems to discourage excessive risk takingReform structure of regulatory systemConsider establishing greater co-operation among regulators in countries or establish centralized supervision or deposit insurer in some regions

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