Leverage and Risk of Financial Institutionswebhome.auburn.edu/~barthjr/papers/Barth_Amsterdam_Final...
Transcript of Leverage and Risk of Financial Institutionswebhome.auburn.edu/~barthjr/papers/Barth_Amsterdam_Final...
11
Leverage and Risk of Leverage and Risk of Financial InstitutionsFinancial Institutions
James R. BarthAuburn University and Milken Institute
Conference on Procyclicality in the Financial SystemAmsterdam, Netherlands
February 9-10, 2009
22
“Any real estate investment is a good investment … ”
33
“Any real estate investment is a good investment … ”
… Really?!
44
Subprime mortgage meltdown timelineDecember 2006–October 2008
Sources: BusinessWeek, S&P, Global Insight, Milken Institute.
Oct. 12, 2008: Finance leaders endorse G7 plan to calm markets.
Oct. 27, 2008: Down Jones U.S. Financial Index=230
Oct. 31, 2008:Dow Jones U.S. Financial Index=269
200
300
400
500
600
700
12/2006 02/2007 04/2007 06/2007 08/2007 10/2007 12/2007 02/2008 04/2008 06/2008 08/2008 10/2008
Dow Jones U.S. Financial Index
June 9, 2008:Lehman announces a $2.8 billion loss.
July 11, 2008: IndyMac is seized by FDIC.
Aug. 1, 2008: First Priority Bank closes.
Mar. 11, 2008: Fed offers troubled banks as much as $200 billion in loans; Fed introduces Term Securities Lending Facility.
Oct. 24, 2007: Merrill announces $7.9 billion in subprime write-downs, surpassing Citi’s $6.5 billion.
Feburary–March 2007: More than 25 subprime lenders declare bankruptcy.
Aug. 6, 2007: American Home Mortgage files for bankruptcy.
Sept. 30, 2007: NetBank goes bankrupt.
July 30, 2008: President Bush signs a housing rescue law.
Sept. 7, 2008: U.S. seizes Fannie Mae and Freddie Mac.
Dec. 2006: Ownit Mortgage, a subprime lender, files for bankruptcy.
Apr. 2007: New Century, a mortgage broker, files for bankruptcy.
Feb. 2007: HSBC sets aside $10.6 billion for bad loans, including subprime.
July 31, 2007: Two Bear Stearns hedge funds file for bankruptcy.
Aug. 17, 2007: Fed cuts discount rate to 5.75%; Fed introduces Term Discount Window Program.
Jan. 11, 2008: Bank of America agrees to buy Countrywide.Jan. 30, 2008: Fed cuts discount rate to 3.5%.
Dec. 12, 2007: Fed introduces Term Auction Facility.
Feb. 13, 2008: President Bush introduces tax rebate stimulus program of $168 billion.
Aug. 16, 2007: Countrywide gets emergency loan of $11 billion from a group of banks.
Sept. 14, 2008: Lehman files for bankruptcy.
Mar. 18, 2008: Fed cuts discount rate to 2.5%; Fed funds rate to 2.25%.
Mar. 16, 2008: JP Morgan Chase offers to buy Bear Stearns; Fed introduces Primary Dealer Credit Facility.
April. 30, 2008: Fed cuts discount rate to 2.25%; Fed funds rate to 2%.
Oct. 3, 2008: President Bush signs Emergency Economic Stabilization Act, authorizing bailout of $700 billion.Also, Citigroup sues after Wachovia agrees tie-up with Wells Fargo.
Sept. 16, 2008: Fed loans AIG $85 billion.
Sept. 23, 2008: Washington Mutual is seized by FDIC.
Sept. 29, 2008: Citigroup agrees to buy Wachovia.
Oct. 8, 2008: Fed cuts discount rate to 1.75%; Fed funds rate to 1.5%.
55
Overview
66
Home mortgages: Who borrows, how much has been borrowed, and who funds them?
Note: total residential and commercial mortgages = $14.7 trillion; 5 percent = $700 billion
Government-controlled
46%
Privatesector-
controlled54%
Total value of housing stock = $19.3 trillion
Equity in housing stock$8.7 trillion
Mortgage debt $10.6 trillion
Prime 91.6%
Subprime8.4% Securitized
58%
Non-securitized42%
Sources: Federal Reserve, Milken Institute.
77
The mortgage problem in perspective
80 million houses27 million are paid off
53 million have mortgages 48 million are paying on time
5 million are behind
This compares to 50% seriously delinquent in the 1930s.
(10% of 53 million with 3% in foreclosure)
Sources: U.S. Treasury, Milken Institute.
88
I. Low interest rates and a lending boom
99
Did the Fed lower interest rates too much and for too long?Federal funds rate vs. rates on FRMs and ARMs
Sources: Federal Reserve, Mortgage Bankers Association, Moody’s Economy.com, Milken Institute.
Target federal funds rate
0
1
2
3
4
5
6
7
8
2001 2002 2003 2004 2005 2006 2007 2008 2009
Percent
Record low from June 25, 2003 to June 30, 2004: 1%
30-year FRM rate
Apr. 30, 2008: 2%Oct. 8, 2008: 1.5%Oct. 29, 2008: 1%Dec. 16, 2008: 0-0.25%
1-year ARM rate
January 30, 200930-year FRM rate: 5.1%1-year ARM rate: 4.9%
1010
Home price bubble and credit boom
Low interest rates and credit boom
Sources: Inside Mortgage Finance, Mortgage Bankers Association, Moody’s Economy.com, S&P/Case-Shiller, Milken Institute.
Index, January 2000 = 100
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
2001 2004 2007 Q3 20080
50
100
150
200
250US$ 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 2004 2007 Q3 20083.0
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
Note: Data for Q1-Q3 2008 are annualized.
1111
II. Homeownership, prices, starts and sales take off
1212
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
US$ thousands
California m edian hom e price
U.S. m edianhom e price
U.S. average, 1987-2008: $121,714
California average1987-2008$230,599
80
130
180
230
280
330
380
1998 2000 2002 2004 2006 2008
Index, January 1987 = 100S&P/
Case-Shiller National Hom e
Price Index
OFHEO Hom e Price Index
64
65
66
67
68
69
70
1998 2000 2002 2004 2006 2008
Percent
Q2 2004: 69.2%
Q4 2008: 67.5%
Average, 1965–Q4 2008: 65.2%
1313
0.0
1.4
2.8
4.2
5.6
7.0
1998 2000 2002 2004 2006 20080.0
0.3
0.6
0.9
1.2
1.5Millions Millions
New hom e sales (right axis )
Exis ting hom e sales (le ft axis)
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
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.
0.0
0.5
1.0
1.5
2.0
1998 2000 2002 2004 2006 2008
January 2006: 1.8 m illion
Oct. 2008: 536,000
Housing units, millions
Average starts , 1959–Oct. 2008: 1.1 m illion
1414
III. Subprime borrowers and subprime mortgages
1515
National FICO scores display wide distribution What goes into a FICO score?
Who is a subprime borrower?
Sources: myFICO.com, Milken Institute.
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%
Amounts owed
30%
Payment history
35%
Length of credit history
15%
New credit10%
Types of credit in use
10%
1616
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.
1717
ARMs look attractive to many borrowers
Sources: Mortgage Bankers Association, Moody’s Economy.com, Milken Institute.
3
4
5
6
7
8
2001 2002 2003 2004 2005 2006 2007 2008 2009
Percent
30-year FRM rate
1-year ARM rate
January 30, 200930-year FRM rate: 5.1%1-year ARM rate: 4.9%
1818
ARM share grows, following low interest rates
Sources: Mortgage Bankers Association, Moody’s Economy.com, Milken Institute.
0
5
10
15
20
25
2001 2002 2003 2004 2005 2006 2007 2008
Percent of all outstanding home mortgages
1919
0
10
20
30
40
50
60
2001 2002 2003 2004 2005 2006 2007 2008
FHA ARM Prime ARM Subprime ARM
Percent of mortgage type
Largest share of ARMs go to subprime borrowers
Sources: Mortgage Bankers Association, Moody’s Economy.com, Milken Institute.
2020
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 Q1-Q3 2008
Subprime
Prime
US$ trillions
Subprime'sshare:7.8%
7.4%
8.4%
18.2%21.3%
20.1%
7.9%
1.3%
2121
160200
310
540
625 600
191
140
100
200
300
400
500
600
700
2001 2002 2003 2004 2005 2006 2007 Q22008
US$ billions US$ billions
479574
699
973
1,200 1,240
940 895
0
200
400
600
800
1,000
1,200
1,400
2001 2002 2003 2004 2005 2006 2007 Q12008
Average annual growth rates1995–2006: 14%2006–Q1 2008: -23%
Subprime mortgages increase rapidly before big declineOriginations Outstandings
Sources: Inside Mortgage Finance, Milken Institute.
H22008
2222
IV. Mortgage product innovation
2323
Subprime and Alt-A shares quadruple between 2001 and 2006, then fall in 2007
FHA & VAConventional, conforming primeJumbo prime
pSubprimeAlt-A Home equity loans
Sources: Inside Mortgage Finance, Milken Institute.
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%
Q1 2008, $480 billion
67.2%
4% 9% 9.6%2%
8%
2424
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%
2- and 3-year hybrids 61%
Other ARM 4%
Fixed 9%
30-year
with 40- to 50-year
amortization26%
2- and 3-year hybrids 61%
Sources: Freddie Mac, Milken Institute.
SubprimePrime conventional Alt-A
Fixed 31%
Other ARM23%
ARM hybrids46%
Fixed 31%
Other ARM23%
ARM hybrids46%
2525
V. Securitization
2626
The mortgage model switches fromoriginate-to-hold to originate-to-distribute
Held in portfolio
84.4%
Securitized15.6%
Held in portfolio
41%
Securitized59%
Residential mortgage loans1980: Total = $958 billion
Residential mortgage loansQ3 2008: Total = $11.3 trillion
Sources: Federal Reserve, Milken Institute.
2727
31 2933
4045 43 42 45 47
5057
6265 68 68 68
0
10
20
30
40
50
60
70
80
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Q12008
Q22008
Percent of all subprime mortgages securitized since 1994
Securitization becomes the dominant funding source for subprime mortgages
Sources: Inside Mortgage Finance, Milken Institute.
2828
The rise and fall of private-label securitizersNew securities issuance
Sources: Inside Mortgage Finance, Milken Institute.
35%
42%2%
21%
1985Total = $110B
38%
20% 13%
29%
2001Total = $1.4T
22%
56%
4%
18%
2006Total = $2.0T
31%
19%
45%
5%
Q1–Q3 2008Total = $1.0T
Ginnie Mae Freddie Mac Fannie Mae Private-label
2929
The rise and fall of private-label securitizersOutstanding securities
Ginnie Mae Freddie Mac Fannie Mae Private-label
13%
6%
55%
26%
1985Total = $390B
39%
14% 18%
29%
2001Total = $3.3T
33%
35%7%
25%
2006Total = $5.9T
37%
30%7%
26%
First half 2008Total = $6.8T
Sources: Inside Mortgage Finance, Milken Institute.
3030
Mortgage-backed securities issued by issuer
Sources: Inside Mortgage Finance, Milken Institute.Note: 2008 data are annualized.
0
500
1,000
1,500
2,000
2,500
3,000
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007
Private label
Ginnie Mae
Freddie Mac
Fannie Mae
US$ billions
3131
VI. Affordability
3232
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.
75
100
125
150
1998 2001 2004 2007
Home mortgage debt/disposable personal income
Q4 2007: 139.5%
Average, 1957–2007: 79.7%
60
65
70
75
1998 2001 2004 2007
Percent Q2 2007: 73.7%
Q2 2008: 73.4%
Average, 1952–2008: 64.2%
3333
VII. Collapse
3434
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
WorldWar I World
War II1970’sboom
1980’sboom
Currentboom
Long-term trend line
Annualized growth rate of nominal home index, 1890–June 2008: 3.3%
Index, 2000 = 100
GreatDepression
3535
Home prices don’t go up foreverChange in home prices in 100-plus years
Sources: Robert Shiller, Milken Institute.
-20
-15
-10
-5
0
5
10
15
20
25
30
1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
WorldWar I
GreatDepression
WorldWar II
1970’sBoom
1980’sBoom
CurrentBoom
Average, 1890–June 2008: 3.6%
Percentage change in nominal home price, year ago
+/- one standard deviation
3636
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 on a year earlier
OFHEO
S&P/Case-Shiller national
S&P/Case-Shiller 10-city
3737
Forty-six states had falling prices in the fourth quarter 2007
United States: - 9.3% (fourth-quarter annualized growth)
Source: Freddie Mac.
3838
One year ago… Five years ago…If you bought your house…
% change in price, August 07-08 % change in price, August 03-08Sources: S&P/Case-Shiller, Milken Institute.
-2.7-2.8
-4.7-5.1
-6.6-6.9
-7.6-8.5-8.8
-9.8-13.8
-15.4-16.6
-17.2-17.7
-18.1-25.8
-26.7-27.3
-28.1-30.6-30.7
DallasCharlotteBostonDenverClevelandNew YorkPortlandAtlantaSeattleChicagoMinneapolisWashingtonComposite-20 DetroitComposite-10TampaSan DiegoLos AngelesSan FranciscoMiamiLas VegasPhoenix
43.843.3
24.424.3
22.820.7
18.317.916.9
15.014.213.8
12.46.55.65.04.7
1.8-1.8-2.6
-4.3-21.9
SeattlePortlandTampaNew YorkWashingtonCharlotteMiamiPhoenixLos AngelesComposite-10Las VegasComposite-20 ChicagoDallasAtlantaBostonDenverSan FranciscoSan DiegoMinneapolisClevelandDetroit
3939
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.
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
-60
-45
-30
-15
0
15
30
1998 2000 2002 2004 2006 2008
Sept. 2008: -41.2%Oct. 2008: -39.4%
Percent change, year ago
4040
VIII. Delinquencies and foreclosures
4141
400
650
900
1,150
1,400
1,650
1,900
2,150
Q2 1999
Q4 1999
Q2 2000
Q4 2000
Q2 2001
Q4 2001
Q2 2002
Q4 2002
Q2 2003
Q4 2003
Q2 2004
Q4 2004
Q2 2005
Q4 2005
Q2 2006
Q4 2006
Q2 2007
Q4 2007
Q2 2008
Thousands of foreclosures per year
Average 661,362 annual foreclosures from Q2 1999 to Q2 2006
Foreclosures are nothing new, but …
Sources: Mortgage Bankers Association, Milken Institute.
4242
… their numbers have doubled
Sources: Mortgage Bankers Association, Milken Institute.
400
650
900
1,150
1,400
1,650
1,900
2,150
2,400
Q2 1999
Q4 1999
Q2 2000
Q4 2000
Q2 2001
Q4 2001
Q2 2002
Q4 2002
Q2 2003
Q4 2003
Q2 2004
Q4 2004
Q2 2005
Q4 2005
Q2 2006
Q4 2006
Q2 2007
Q4 2007
Q2 2008
Thousands of foreclosures per year
Average 661,362 annual foreclosures from Q2 1999 to Q2 2006
Average 1,412,656 annual forclosures from Q3 2006 to Q3 2008
4343
Subprime mortgages accounted for half or more of foreclosures since 2006
Sources: Mortgage Bankers Association, Milken Institute.
0
500
1,000
1,500
2,000
2,500
Q12003
Q32003
Q12004
Q32004
Q12005
Q32005
Q12006
Q32006
Q12007
Q32007
Q12008
Q32008
SubprimeFHA and VAPrime (includes Alt-A)
Number of home mortgage loan foreclosures started (annualized rate in thousands)
Q3 2008Subprime: 12% of loans serviced
4444
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
Q21998
Q11999
Q41999
Q32000
Q22001
Q12002
Q42002
Q32003
Q22004
Q12005
Q42005
Q32006
Q22007
Q12008
Q3 2008, Subprime ARM: 35.3%
Subprime FRM: 13.5%
Prime: 3.5%
FHA and VA: 6.3%
4545
Percentage of homes purchased between Q2 2001 and Q2 2006 that now have negative equity
< 20%>= 20% and < 35%>= 35% and < 50%>= 50%
Sources: Zillow.com, Milken Institute.
United States = 44.8%
4646
Percentage of homes sold for a loss (Q2 2008)
< 15%>= 15% and < 30%>= 30% and < 45%>= 45%
Sources: Zillow.com, Milken Institute.
United States = 32.7%
4747
Percentage of homes sold that were in foreclosure (Q2 2008)
< 1%>= 1% and < 25%>= 25% and < 40%>= 40%
Sources: Zillow.com, Milken Institute.
United States = 18.6%
4848
IX. Damages scorecard
4949
Losses/write-downs, capital raised, and jobs cut by financial institutions worldwide
Sources: Bloomberg, Milken Institute.
060
120180240300360420480
Priorquarters
Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 ThroughFeb. 4,2009
0153045607590105120
Number of jobs cut (thousands) US$ billions
Losses/write-downs(left axis)
Capital raised(left axis)
Jobs cut (right axis)
5050
What is the cumulative damage?
Sources: Bloomberg, Milken Institute.
Cumulative losses/write-downs, capital raised, and jobs cut by financial institutions worldwide
0
200
400
600
800
1,000
1,200
Priorquarters
Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 ThroughFeb. 4,2009
0
50,000
100,000
150,000
200,000
250,000
300,000Number of jobs cut US$ billions
Losses/write-downs (left axis)February 4, 2009: $1068.4 billion
Capital raised (left axis)February 4, 2009: $969.2 billion
Jobs cut (right axis)February 4, 2009: 269.1 thousand
5151
Recent losses/write-downs and capital raised by selected financial institutions
Sources: Bloomberg, Milken Institute.
US$ billions, through February 4, 2009 Losses /write-downs Capital raisedWachovia, United States 97.9 11
Citigroup, United States 85.4 109.3
AIG, United States 60.9 65.7
Freddie Mac, United States 58.4 20.8
Fannie Mae, United States 56.0 15.6
Merrill Lynch, United States 55.9 29.9
UBS, Switzerland 48.6 32.0
Washington Mutual, United States 45.6 12.1
Bank of America, United States 40.2 78.5
HSBC, United Kingdom 33.1 4.9
Others 486.4 589.4
Grand total (US$ billions) 1,068.40 969.2
5252
Worldwide capital raised by sourceJuly 2007–July 2008
Sovereign wealth funds
60%Public
investors12%
Other institutional
investors28%
July 2007–December 2007Total = $56 billion
Public investors
69%
Other institutional
investors24%
Sovereign wealth funds
7%
January 2008–July 2008Total = $300 billion
Source: International Monetary Fund.
Percentage change in stock price, December 2006–January 2009
-99.1-99.0-98.2
-94.3-90.3-90.0
-87.7
-77.8-70.1
-59.5-47.2-46.9
-99.9
-87.5
-99.9Lehman BrothersWashington mutualFreddie MacFannie MaeAIGBear StearnsWachoviaCountrywideBank of AmericaMerrill LynchUBS EquityMorgan StanleyGoldman SachsJP Morgan & ChaseWells Fargo
5353
Financial stock prices take big hits
Note: Bear Stearns stock price is to May 2008. Countrywide stock price is to June 2008. Merrill Lynch stock price is to December 2008. Wachovia stock price is to December 2008. Sources: Bloomberg, Milken Institute.
-21.4-23.9
-40.1-41.4-42.9
-45.1-47.9
-54.7-63.7-64.1
-72.3-96.6
-112.9-169.2
-197.9
Bear StearnsCountrywideWells FargoLehman BrothersWashington mutualFreddie MacGoldman SachsFannie MaeMorgan StanleyMerrill LynchJP Morgan & ChaseWachoviaUBS EquityAIGBank of America
US$ billions
Total loss in market value: $1,094 billion, December 2006–January 2009
5454
Financial market capitalization takes big hit
Note: Bear Stearns stock price is to May 2008. Countrywide stock price is to June 2008. Merrill Lynch stock price is to December 2008. Wachovia stock price is to December 2008. Sources: Bloomberg, Milken Institute.
5555
X. Credit crunch and liquidity freeze
5656
Tightened standards for real estate loans
Sources: Federal Reserve, Milken Institute.
-40
-20
0
20
40
60
80
100
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
Net percentage of domestic respondents tightening standards for commercial real estate loans
LTCM Dotcom SubprimeThe end of S&L crisis
5757
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
5858
Liquidity freezeSpread between 3-month LIBOR and
overnight index swap rate
Sources: Bloomberg, Milken Institute.
Spread between 3-month LIBOR and T-bill rate
0
50
100
150
200
250
300
350
400
2006 2007 2008 2009
Average since December 2001: 29 bps
October 10, 2008: 364 bps
Basis points
Average since August 2007: 97 bps
050
100150200250300350400450500
2006 2007 2008 2009
August 20, 2007: 240 bps
Average since 1985: 92 bps
Average since August 2007: 150 bps
Basis points
October 10, 2008: 463.6 bps
5959
Counterparty risk increases
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.
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
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
January 30, 2009: 422 bps
6060
Rising risk: The 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%
6161
Commercial paper issuance dries up
Sources: Federal Reserve, Milken Institute.
-200
-150
-100
-50
0
50
100
150
Q1 2006 Q2 2006 Q3 2006 Q4 2006 Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008
Issuers of asset-backed securities
Other issuers
Quarterly change in outstanding amount, US$ billions
6262
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)
6363
Increasing spreads between corporate bonds, mortgage securities, and target federal funds rate
Sources: Federal Reserve, Freddie Mac, Merrill Lynch, Bloomberg, Milken Institute.
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 intented funds rate
High yield corporate bonds yield
AAA corporate bonds yield
Percent
6464
Federal Reserve assets increased but asset quality deteriorated
Sources: Federal Reserve, Milken Institute.
0
400
800
1,200
1,600
2,000
2,400
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
US$ billions
Total assets of Federal Reserve banks
U.S. Treasury securities held outright11/12/2008: $2.21 trillion
12/17/2008: $2.31 trillion
1/28/2009: $1.93 trillion
1/28/2009: $475 billion
6565
Federal Reserve has little maneuvering room
Sources: Federal Reserve, Milken Institute.
0
1
2
3
06/01/08 07/01/08 07/31/08 08/30/08 09/29/08 10/29/08 11/28/08 12/28/08 01/27/09
Effective federal funds rate
Percent
Target federal funds rateApr. 30, 2008: 2%Oct. 8, 2008: 1.5%Oct. 29, 2008: 1%Dec. 16, 2008: 0-0.25%
6666
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……$7.52 trillion plus ?$7.52 trillion plus ?
Federal Reserve 4,549Congress and White House 1,149Federal Deposit Insurance Corporation 1,465Treasury, Federal Deposit Insurance Corporation and Federal Reserve 362Total amount committed (US$ billions) 7,525
6767
Federal Reserve programsProgram Amount committed
(US$ billions) Description
Term Discount Window Program (TDWP) 62.898
Announced on 10/17/2007. Extends the term of discount window loans from overnight to up to 90 days.
Term Auction Facility (TAF) 416.031
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.
Term Securities Lending Facility (TSLF) 133.1
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.
Bear Stearns 29
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 January 21, 2009, the market value of these mortgage-backed securities is $27.2 billion.
6868
Federal Reserve programs
ProgramAmount
committed (US$ billions)
Description
Primary Dealer Credit Facility (PDCF) 58
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 January 21, 2009, credit extended under PDCF was less than $33.3 billion.
AIG 173.4
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. As of January 21, 2009, $79.6 billion of credit was extended to AIG, $19.8 billion was extended to purchase MBSs, and $26.9 billion was extended to purchase CDOs.
6969
Federal Reserve programsProgram Amount committed
(US$ billions) Description
Asset Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF)
53
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 January 21, 2009, credit extended under AMLF was $14.8 billion.
Expansion of the Federal Open Market's temporary reciprocal currency arrangements (swap lines)
620
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 Danmarks Nationalbank, $240 billion by the ECB, $15 billion by the Norges Bank, $30 billion by the Reserve Bank of Australia, $30 billion by the Sveriges Riksbank, and $60 billion by the Swiss National Bank).
7070
Federal Reserve programsProgram Amount committed
(US$ billions) Description
Commercial Paper Funding Facility (CPFF) 1777.2
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 of commercial 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 SPV may 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 1/21/2009, $350 billion was outstanding.
7171
Federal Reserve programsProgram Amount committed
(US$ billions) Description
Money Market Investor Funding Facility (MMIFF) 540
Announced on 10/21/2008. The MMIFF provides assurance that money market 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 money market mutual funds such as certain local government investment pools, common trust funds, and collective investment funds. As of 1/21/2009, outstanding amount was zero.
7272
Federal Reserve programsProgram Amount committed
(US$ billions) Description
Term Asset-Backed Securities Loan Facility (TALF)
200
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 $20 billion of credit protection to the Fed in connection with the TALF. Eligible collateral will include U.S. dollar-denominated cash (that is, not synthetic) ABS that have a long-term credit rating in the highest investment-grade rating category (for example, AAA) from two or more major nationally recognized statistical rating organizations (NRSROs) and do not have a long-term credit rating of below the highest investment-grade rating category from a major NRSRO. The underlying credit exposures of eligible ABS initially must be auto loans, student loans, credit card loans, or small business loans guaranteed by the U.S. Small Business Administration. All U.S. persons that own eligible collateral may participate in the TALF. Collateral haircuts will be established by the FRBNY for each class of eligible collateral. Haircuts will be determined based on the price volatility of each class of eligible collateral. On December 19, 2008, it was announced that TALF loan maturity was extended from one to three years, and TALF loans would be provided to all eligible borrowers with eligible collateral rather than distributed through an auction.
Federal Reserve programs
Program Amount committed(US$ billions) Description
Purchase of GSE direct obligations and MBS
600
Announced on 11/25/2008. The Fed will purchase the directobligations 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 $500 billion in MBS will be conducted by asset managers selected via a competitive process with a goal of beginning these purchases before year-end 2008. Purchases of both direct obligations and MBS are expected to take place over several quarters.
7474
Congress and White HouseProgram Amount committed
(US$ billions) Description
FHA Secure 50 Announced on 8/31/2007. Guarantees $50 billion in mortgages.
Economic Stimulus Act 124
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.
Housing and Economic Recovery Act of 2008
24.9Announced on 7/30/2008. The CBO estimates that the Act will increase budget deficits by about $24.9 billion over the 2008 to2018 period.
Purchase of GSE Debt and Equity 25 Announced on 7/30/2008. Designed to shore up Fannie Mae and
Freddie Mac.
HOPE for Homeowners 300
Announced on 7/30/2008. This voluntary program encourages lenders to write down the loan balances of borrowers in exchangefor FHA-guaranteed loans up to 90 percent of the newly appraised home value. Program runs through September 2011.
7575
Congress and White HouseProgram Amount committed
(US$ billions) Description
Conservatorship of Fannie Mae and Freddie Mac 200
Announced on 9/7/2008. Treasury and FHFA established contractual agreements 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.
Guaranty Program for Money Market Funds 50
Announced on 9/19/2008. To restore confidence in money market funds, Treasury made available up to $50 billion from the Exchange Stabilization Fund.
7676
Congress and White HouseProgram Amount committed
(US$ billions) Description
IRS Notice 2008-83 ?
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.
Emergency Economic Stabilization Act
700
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.
Troubled Assets Relief Program (TARP)
272.9
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 $20 billion to support the Fed's Term Asset-Backed Securities Loan Facility
Congress and White HouseProgram Amount committed
(US$ billions) Description
Capital Purchase Program (CPP)
192
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 January 23, 2009, $192 billion has been distributed to 296 institutions.
Automotive Industry Financing Program (AIFP)
20.9
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 $1.5 billion loan to a SPV created by Chrysler Financial to finance the extension of new consumer auto loans as part of a broader program to assist the domestic automotive industry in becoming financially viable.
Congress and White HouseProgram Amount committed
(US$ billions) Description
Targeted Investment Program (TIP)
20
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 $20 billion investment in Citigroup that was announced on Nov. 23 was made under the TIP.
Asset Guarantee Program (AGP)
?
On 12/31/ 2008, Treasury transmitted to Congress a report that describes the Asset Guarantee Program (AGP). This program provides guarantees for assets held by systemically significant financial institutions that face a risk of losing market confidence due in large part to a portfolio of distressed or illiquid assets.
7979
Federal Deposit Insurance CorporationProgram Amount committed
(US$ billions) Description
Increase FDIC insurance coverage
? 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 $100,000 after December 31, 2009.
Temporary Liquidity Guarantee Program (TLGP)
1465
Announced on 10/14/2008. Temporarily guarantees the senior debt of all FDIC-insured institutions and their holding companies, as well as deposits in non-interest bearing deposit transaction accounts. Certain newly issued senior unsecured debt issued on or before June 30, 2009, would be fully protected in the event the issuing institution subsequently fails, or its holding company files for bankruptcy. This includes promissory notes, commercial paper, interbank funding, and any unsecured portion of secured debt. Coverage would be limited to June 30, 2012. On November 21, 2008, FDIC strengthened TLGP. Chief among the changes is that the debt guarantee will be triggered by payment default rather than bankruptcy or receivership. Another change is that short-term debt issued for one month or less will not be included in the TLGP. Eligible entities will have until December 5, 2008 to opt out of TLGP. The other part of the program provides for a temporary unlimited guarantee of funds in noninterest-bearing transactions accounts (the Transaction Account Guarantee Program, or TAG)
8080
Treasury, Federal Deposit Insurance Corporation and Federal Reserve
Program Amount committed (US$ 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
249.3
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 $10 billion. The Federal Reserve funds the remaining pool of assets with a non-recourse loan, subject to Citigroup's 10 percent loss sharing, at a floating rate of overnight interest swap plus 300 basis points.
Treasury, Federal Deposit Insurance Corporation and Federal Reserve
Program Amount committed (US$ 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 and FDIC. 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 $20 billion in BOA from the TARP program in exchange for preferred stock with an 8 percent dividend to the Treasury. The investment was made under the Targeted Investment Program.
Loans, guarantees and investments committed (US$ billions)
7524.929 The final tab for taxpayers will only become known once the crisis is over.
8282
XI. When will we hit bottom?
8383
Looking for a bottom?Economists say the economy isn’t at its low point yet, and house prices likely won’t get there until 2009
Does this feel like the bottom to a downturn?
Yes 27%
No 73%
When will home prices hit bottom?
4%
17%
38%
29%
6%
1st half2008
2nd half2008
1st half2009
2nd half2009
1st half2010
Source: Wall Street Journal.
8484
How far do home prices have to fall?
Sources: Davisa, Lehnertb, Martin (2007), Milken Institute.
3.0
3.5
4.0
4.5
5.0
5.5
6.0
6.5
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Q2 1971: 6.08%Annual rents as percent of home prices
Q4 2006: 3.48%
Q1 2008: 3.93%Average, 1960–Q1 2008: 5.04%
Average, 2000–Q1 2008: 4.06%
8585
Declines in home prices and the time it takes to get the rent-to-price ratio to a targeted value
(5.04 is the longer-run average ratio) Annual home price decline
-2.0% -5.0% -10.0% -15.0% -20.0%
3.80% 2010 Q3 2008 Q4 2008 Q2 2008 Q2 2008 Q2
4.00% 2013 Q1 2009 Q4 2008 Q3 2008 Q2 2008 Q2
5.00% 2024 Q1 2014 Q1 2010 Q4 2009 Q3 2009 Q1
5.04% average 2024 Q3 2014 Q2 2010 Q4 2009 Q3 2009 Q1
Ren
t-to-
pric
e ra
tio
6.00% 2026 Q4 2017 Q3 2012 Q3 2010 Q4 2009 Q4
Annual home price decline required
Sources: Davisa, Lehnertb, Martin (2007), Milken Institute.
8686
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007
US$/month
Payment with 100% LTVPayment with 90% LTVPayment with 80% LTV
Maximum affortablility limit is 38% of median household
Mortgage payment assumptions: Every month, a home is purchased at median price, buyer takes out a 30-year conforming, fixed-rate loan with 80% LTV. Payment also includes 1% property tax per year, 0.1% property insurance.
Alternative measures of the affordability of mortgage debt for California
Sources: Moody’s Economy.com, Milken Institute.
8787
XII. What went wrong
8888
2,443
879
1,410
2,067
944886
0
500
1,000
1,500
2,000
2,500
3,000
Fannie Mae:total assets
Fannie Mae:total MBS
outstanding
Freddie Mac:total assets
Freddie Mac:total MBS
outstanding
Commercialbanks: total
residential realestate assets
Savingsinstitutions:
totalresidential realestate assets
US$ billions
The importance of Fannie Mae and Freddie Mac
Sources: Freddie Mac, Fannie Mae, FDIC, Milken Institute.
8989
Fannie Mae and Freddie Mac: Too big with too little capital?
Sources: Freddie Mac, Fannie Mae, Milken Institute.
133
1,022844 897
41
803 805 804
288
1,301
1,778
2,278
316
752
1,459
1,123
0
500
1,000
1,500
2,000
2,500
3,000
1990 2003 2006 Q3 2008 1990 2003 2006 Q3 2008
US$ billions
Total assets Total MBS outstanding
Fannie Mae Freddie Mac
9090
Fannie Mae and Freddie Mac are highly leveraged
Sources: Freddie Mac, Fannie Mae, FDIC, Milken Institute.
60x 56x 48x 55x60x 58x 52x 57x64x 81x56x
167x185x
-66x
203x
-52x-100
-50
0
50
100
150
200
250
300
Core capital Fair value Core capital Fair value
2005 2006 2007 Q3 2008
Mortgage book of business over capital measures
Fannie Mae Freddie Mac
9191
Freddie Mac’s and Fannie Mae's retained private-label portfolios
Sources: Freddie Mac, Fannie Mae, FDIC, Milken Institute.
Fannie Mae, Q3 2008
Fannie Mae, 2007
Fannie Mae, 2006
Fannie Mae, 2005
Freddie Mac, Q3 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%
41.7% 24.0% 34.3%
54.4% 25.0% 20.6%$224.6 billion
$218.9 billion
$86.9 billion
$97.3 billion
$94.8 billion
$191.5 billion
30.3% 33.4% 36.4%$85.7 billion
9292
9.1
9.8
9.4
31.6
23.7
21.5
67.9
Credit unions
Commercial banks
Savings institutions
Brokers/hedge funds
Federal Home Loan Banks
Fannie Mae
Freddie Mac
Leverage ratio, total assets/common equtity
Leverage ratios of different types of financial firms (June 2008)
Sources: Federal Deposit Insurance Corporation, Office of Federal Housing Enterprise Oversight, National Credit Union Administration, Bloomberg, Google Finance, Milken Institute.
9393
Too much dependence on debt?Leverage ratios at biggest investment banks
Sources: Bloomberg, Milken Institute.
28
1922
26
18
27
19
31
2423
34 32 3331
2223
2824
22
0
5
10
15
20
25
30
35
40
Bear Stearns Merrill Lynch Morgan Stanley Lehman Brothers Goldman Sachs
2000 2005 2007 Sept. 2008Total assets/total shareholder equity
n.a
June 2008
9494
Debt dependenceLeverage ratios at bank holding companies
Sources: Bloomberg, Milken Institute.
13 13
17
13 1311
19
12 1311
1516
0
5
10
15
20
25
Citigroup Bank of America JP Morgan Chase
2000 2005 2007 Sept. 2008
Total assets/total shareholder equity
9595
Leverage vs. issuer rating
Sources: Bloomberg, Milken Institute.
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-
9696
Leverage vs. issuer rating
Sources: Bloomberg, Milken Institute.
Total assets/total shareholder equity
Fitch long term issuer default 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
JP Morgan Chase 16.7 11.2 12.7 AA- A+ AA-
9797
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
Fitch long term issuer default rating
Citigroup
JPMorgan
Bank of America
Lehman BrothersBear Stearns
Morgan Stanley
Goldman Sachs
Merrill Lynch
● 2004 ● 2005 ● 2007
Lehman Brothers
Merrill Lynch
9898
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
JP Morgan Chase 31.23 27.30 16.83 31.11 105.75
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
Leverage vs. CDS premium
Sources: Datastream, Bloomberg, Milken Institute.
Total assets/total shareholder equity
Average CDS premiumbasis points
2004 2005 2007 2004 2005 2007
Bear Stearns 28.4678 26.6 33.5 35.97 29.65 79.62
Merrill Lynch 20.0223 19.1 31.9 33.37 27.19 57.62
Morgan Stanley 26.4337 30.7 33.4 33.39 27.81 52.2
Lehman Brothers 23.9389 24.4 30.7 35.91 29.88 68.95
Goldman Sachs 19.7627 22.7 22.4 34.04 27.53 46.25
Citigroup 13.5794 13.3 19.3 22.17 17.01 30.05
Bank of America 11.0783 12.7 11.7 22.52 17.27 26.11
JP Morgan Chase 10.9533 11.2 12.7 31.23 27.3 31.11
101101
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
102102
Standard & Poor’s ratingsNew issues: 1/1/2000 to 9/30/2008
Sources: Bloomberg, Milken Institute.
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
103103
56 percent of MBS issued from 2005 to 2007 were eventually downgraded
S&P Total Downgraded Downgraded 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%
Sources: Inside Mortgage Finance, Milken Institute.Note: A bond is considered investment grade if its credit rating is BBB- or higher by S&P.
104104
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
S&P Rating
Number of companies
CDS spread
Highest Lowest Average
AAA 3 56 15 41
AA+ 1 95 95 95AA 5 86 49 74AA- 9 265 54 118A+ 17 2,999 12 346A 36 1,040 38 151A- 34 2,557 51 427
BBB+ 43 1,114 38 222
BBB 41 1,210 61 271BBB- 17 1,235 89 359
Investment grade S&P 500 companies’ credit ratings and
associated CDS spreads
Note: As of October 17, 2008.Sources: S&P, Datastream, Milken Institute.
105105
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
Sources: S&P, Bloomberg, Datastream, Milken Institute.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.
Speculative gradeInvestment grade
106106
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%
107107
Dollar losses in reported cases of mortgage fraud
US$ millions
293225
429
1,014946
813
0
200
400
600
800
1,000
1,200
2002 2003 2004 2005 2006 2007
Mortgage loan fraud surges
Sources: Financial Crimes Enforcement Network, Federal Bureau of Investigation, Milken Institute.
1.7
2.3 2.9 3.5 4.7 5.49.5
18.4
26.0
37.3
52.9
0
10
20
30
40
50
60
1997 1999 2001 2003 2005 2007
Number of cases reported, thousands
1.7
2.3 2.9 3.5 4.7 5.49.5
18.4
26.0
37.3
52.9
0
10
20
30
40
50
60
1997 1999 2001 2003 2005 2007
Number of cases reported, thousands
108108
Is adequate information disclosed to consumers?
Sources: Federal Trade Commission, Milken Institute.
20202123
303233
3751
6874
7984
8795
APR amountCash due at closing amount
Monthly payment (including whether it includes taxes and insurance)Settlement charges amount
Balloon payment (presence and amount)Interest rate amount
Whether loan amount included finances settlement chargesWhich loan was less expensive
Loan amountPresence of prepayment penalty for refinance in two years
Presence of charges for optional credit insuranceReason why the interest rate and APR sometimes differProperty tax and homeowner’s insurance cost amount
Total up-front cost amountPrepayment penalty amount
Percent of respondents who could not correctly identify various loan costs using current disclosure forms
109109
Drivers of foreclosures:Strong appreciation or weak economies?
Sources: U.S. Treasury Department, RealtyTrac, Office of Federal Housing Enterprise Oversight, Milken Institute.
0
5
10
15
20
25
-20 0 20 40 60 80 100 120 140
Five-year price gain, Q3 2002–Q3 2007 (percent)
Detroit
MiamiBakersfield
Riverside
Fresno
Fort Lauderdale
Orlando
Phoenix
Las Vegas
Palm Beach
Tampa
Stockton
San Diego
Oakland
Sacramento
Atlanta
MemphisColumbus
Indianapolis
ToledoDaytonDenver
Cleveland
Akron
Warren
Weak economies Housing bubbles
Foreclosures per 1,000 homes
National average
110110
After housing bubble burst in 2007: Foreclosures highest for areas with biggest price declines
Sources: RealtyTrac, Office of Federal Housing Enterprise Oversight, Milken Institute.
0
5
10
15
20
25
30
35
40
45
-30 -25 -20 -15 -10 -5 0 5
Price change, 2007–June 2008 (percent, annualized)
Weak economies strengthenStockton
Miami
Orlando
Bakersfield
Phoenix
RiversideLas Vegas
Fort Lauderdale
Fresno
SacramentoOakland
San DiegoDetroit
Warren ClevelandDayton
Columbus Indianapolis
Palm BeachTampa
ToledoAkron
Denver
Atlanta
Memphis
Foreclosures per 1,000 homes
National average
Collaping housing bubbles
111111
XIII. Policy lessons from the current crisis and proposals for reform in
regulatory oversight
112112
Balance sheet information on FDIC-insured institutions
Sources: FDIC, Milken Institute.
Cash-to-asset ratio (left axis)
Borrowed funds-to-asset ratio (left axis)
Deposits-to-asset ratio (right axis)
Equity capital-to-asset ratio (right axis)
Insured deposits-to-asset ratio (right axis)
0
2
4
6
8
10
12
14
16
18
20
1992 1994 1996 1998 2000 2002 2004 2006 Q3 20080
10
20
30
40
50
60
70
80
90Percent Percent
113113
U.S. regulatory capital requirements and prompt corrective action categories
Tier 1leverage
Tier 1 risk-based Total risk-based
Well capitalized >= 5% and >= 6% and >= 10%
Adequately capitalized >= 4% and >= 4% and >= 8%
Undercapitalized < 4% or < 4% or < 8%
Significantly undercapitalized < 3% or < 3% or < 6%
Critically undercapitalized Tangible equity capital ratio that is <= 2%
Source: FDIC.
114114
Selected information for U.S. banks December 31, 2008
$US billions Percent
Name Total assets
Total equity
Market capitalization
(Jan. 30, 2009)
Deposits to total assets
Long-term borrowing
to total assets
Short-term borrowing to total assets
Cash/total assets
JP Morgan Chase 2,175 167 95 46.4 12.9 18.8 1.2
Citigroup 1,945 151 21 39.8 18.5 29.3 1.5
Bank of America 1,818 177 43 48.6 14.8 23.2 1.8
Wells Fargo 1,310 99 79 59.7 20.4 8.3 1.8
US Bancorp 266 26 26 59.9 14.4 12.8 2.6
SunTrust Banks 189 22 5 59.9 14.2 5.0 3.0
BB&T Corp 152 16 11 64.9 11.9 7.1 1.1
Regions Financial 146 17 3 62.2 13.1 10.8 1.8
Fifth Third Bancorp 120 12 2 65.6 11.3 8.6 2.3
KeyCorp 105 10 4 62.4 14.3 9.6 1.2
Sources: Bloomberg, Milken Institute.
115115
Selected information for U.S. banksDecember 31, 2008
Regulatory capital ratios Alternative capital adequacy assessment
Name
Total risk-based capital ratio
Tier 1 risk-based
capital ratio
Tangible equity capital ratio
Equity to total
assets ratio
Tangible common
equity ratio
Credit rating
Moody's issuer
S&P issuer
JP Morgan Chase 14.7 10.8 6.9 7.7 3.4 Aa3 A+
Citigroup 15.6 11.8 6.0 7.8 1.5 N.A. A
Bank of America 13.0 9.2 6.4 9.7 2.8 A1 A+
Wells Fargo 11.9 7.9 n.a. 7.6 3.5 Aa3 AA
US Bancorp 14.3 10.6 9.8 9.9 2.7 Aa2 AA
SunTrust Banks 14.0 10.9 10.4 11.8 5.0 A1 A
BB&T Corp 17.1 12.0 9.7 10.5 6.9 Aa3 A+
Regions Financial n.a. n.a. n.a. 11.5 5.2 A2 A
Fifth Third Bancorp 14.8 10.6 10.3 10.1 7.9 A2 A-
KeyCorp 14.7 10.8 11.0 10.0 5.9 A2 A-Sources: Bloomberg, Milken Institute.
116116
Equity capital-asset ratio for commercial banks
Sources: Historical Statistics of the United States, FDIC, Milken Institute.
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 - Q3 2008: 10.9%
1945: 5.5% 1979: 5.8%
1932: 16.2% Q3 2008: 9.7%
1896: 28.1%
117117
Leverage ratio for commercial banks
Sources: Historical Statistics of the United States, FDIC, Milken Institute.Note: The leverage ratio is the reciprocal of the capital-asset ratio.
0
2
4
6
810
12
14
16
18
20
1896 1905 1914 1923 1932 1941 1950 1959 1968 1977 1986 1995 2004
Asset/equity capital ratio
Average, 1896 - Q3 2008: 11.0x
1945: 18.2x 1979: 17.4x
1932: 6.2xQ3 2008: 10.3x
1896: 3.6x
Reserve coverage ratio ofall FDIC-insured institutions
Sources: Quarterly Banking Profile, FDIC, Milken Institute .
020406080
100120140160180200
03/2005 09/2005 03/2006 09/2006 03/2007 09/2007 03/2008 09/2008020406080100120140160180200
US$ billions Percent
Noncurrent loans (left axis)
Loan-loss reserves (left axis)
Coverage ratio (right axis)
119119
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 bank regulators• FDIC• Fed--state member commerical banks
• OTS• FDIC
• 50 State insurance regulators plus District of Columbia and 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
Foreign branch
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
120120
Countries with the Central Bank as a supervisory authority Income
level Central bank only
(75 countries)
Central bank among multiple
supervisors (7 countries)
Central bank not a supervisory authority
(52 countries)
Anguilla Estonia Israel Montserrat Slovenia Netherlands South Korea Australia Denmark Isle of Man Norway
Antigua and
Barbuda Germany Italy New
Zealand Spain Saudi Arabia United States Bahrain Finland Japan Sweden
Austria Greece Kuwait Portugal Taiwan, China Belgium France Luxembourg Switzerland
Cyprus Hong Kong, China Liechtenstein Singapore Trinidad &
Tobago Canada Iceland Macau, China United Kingdom
High income
Czech Republic Cayman
Islands Ireland Malta
Argentina Bulgaria Lithuania Russia St. Kitts and Nevis Malaysia Chile Gabon Latvia Panama
Belize Croatia Mauritius Seychelles St. Lucia Costa Rica Hungary Lebanon Poland
Botswana Dominica Oman Slovak Republic
St. Vincent and the
Grenadines Equatorial
Guinea Kazakhstan Mexico
Brazil Grenada Romania South Africa Uruguay
Upper middle income
Algeria
Angola Egypt Jamaica Maldives Sri Lanka Bolivia China Dominican Republic Honduras
Armenia Fiji Jordan Moldova Suriname Bosnia and Herzegovina Colombia El Salvador Nicaragua
Belarus Guyana Lesotho Morocco Syrian Cameroon Congo Guatemala Peru
Lower middle income
Bhutan Indonesia Macedonia, FYR Philippines Thailand
Bangladesh Ghana Kyrgyz Republic Tajikistan Pakistan Nigeria Zimbabwe Benin Chad Mali Senegal
Burundi India Malawi Tanzania Uganda Burkina Faso Côte d'Ivoire Niger Togo Low income
Ethiopia Kenya Mozambique Central African Republic
Guinea-Bissau
121121
Countries with single vs. multiple supervisory authorities Income
level Single supervisor
(127 countries) Multiple supervisors
(7 countries) Anguilla Cyprus Hong Kong,
China Liechtenstein Singapore Netherlands Saudi Arabia
Antigua and Barbuda Czech Republic Iceland Luxembourg Slovenia South Korea United States Australia Denmark Ireland Macau, China Spain Austria Estonia Isle of Man Malta Switzerland Bahrain Finland Israel Montserrat Taiwan, China Belgium France Italy New Zealand Trinidad & Tobago Canada Germany Japan Norway United Kingdom
High income
Cayman Islands Greece Kuwait Portugal Sweden Argentina Costa Rica Grenada Lithuania Seychelles Malaysia
Belize Croatia Hungary Mauritius Slovak Republic Botswana Dominica Kazakhstan Mexico St. Kitts and Nevis
Brazil Equatorial Guinea Latvia Oman St. Lucia Bulgaria Romania Lebanon Poland St. Vincent and the Grenadines
Chile Gabon South Africa Russia Uruguay
Upper middle income
Panama
Guatemala Bosnia and Herzegovina Egypt Lesotho Peru
Algeria Cameroon El Salvador Macedonia, FYR Philippines
Angola China Fiji Maldives Sri Lanka Armenia Colombia Guyana Moldova Suriname Belarus Jordan Honduras Morocco Syrian Bhutan Congo Indonesia Nicaragua Thailand
Lower middle income
Bolivia Dominican Republic Jamaica
Bangladesh Chad India Pakistan Togo Nigeria Zimbabwe Benin Côte d'Ivoire Kenya Senegal Uganda
Burkina Faso Ethiopia Kyrgyz Republic Tajikistan Mali Burundi Ghana Malawi Tanzania Niger
Low income
Central African Republic Guinea-Bissau Mozambique
122122
Scope of supervisory authority for countries Income
level Only banks
(96 countries) All of the main financial institutions
(38 countries) Anguilla Greece Luxembourg Slovenia Australia Denmark Japan Singapore
Antigua and Barbuda Hong Kong, China Montserrat South Korea Austria Estonia Liechtenstein Sweden
Canada Isle of Man Netherlands Spain Bahrain Germany Macau, China Taiwan, China
Cyprus Israel New Zealand Switzerland Belgium Iceland Malta Trinidad & Tobago
Finland Italy Portugal United States Cayman Islands Ireland Norway United Kingdom
High income
France Kuwait Saudi Arabia Czech Republic Argentina Croatia Mauritius Seychelles Hungary Kazakhstan Latvia Malaysia
Belize Dominica Mexico Slovak Republic Uruguay Botswana Equatorial Guinea Oman South Africa
Brazil Gabon Panama St. Kitts and Nevis Bulgaria Grenada Poland St. Lucia
Chile Lebanon Romania St. Vincent and the Grenadines
Upper middle income
Costa Rica Lithuania Russia Algeria Congo Jamaica Sri Lanka Armenia Colombia Honduras Nicaragua
Angola Dominican Republic Jordan Suriname Bhutan Fiji Lesotho Peru
Belarus Egypt Macedonia, FYR Syrian Bosnia and
Herzegovina Guatemala Maldives
Bolivia El Salvador Moldova Thailand Cameroon Guyana Morocco
Lower middle income
China Indonesia Philippines
Bangladesh Côte d'Ivoire Kyrgyz Republic Senegal Malawi
Benin Ethiopia Mali Tajikistan Burkina Faso Ghana Mozambique Tanzania
Burundi Guinea-Bissau Niger Togo Central African
Republic India Nigeria Uganda
Low income
Chad Kenya Pakistan Zimbabwe