James R. Barth Auburn University and Milken Institute College of Business University of Nevada, Las Vegas March 19, 2009

Transcription

1 The Rise and Fall of the U.S. Mortgage and Credit Markets James R. Barth Auburn University and Milken Institute College of Business University of Nevada, Las Vegas March 19,

2 Any real estate investment is a good investment 2

3 Any real estate investment is a good investment Really?! 3

4 Subprime mortgage meltdown timeline December 2006 October 2008 Oct. 24, 2007: Mar. 11, 2008: Dow Jones U.S. Financial Index Feburary March 2007: More than 25 subprime lenders declare bankruptcy. Dec. 2006: Ownit Mortgage, a subprime lender, files for bankruptcy. Feb. 2007: HSBC sets aside $10.6 billion for bad loans, including subprime. Aug. 6, 2007: American Home Mortgage files for bankruptcy. Apr. 2007: New Century, a mortgage broker, files for bankruptcy. July 31, 2007: Two Bear Stearns hedge funds file for bankruptcy. Sept. 30, 2007: NetBank goes bankrupt. Aug. 16, 2007: Countrywide gets emergency loan of $11 billion from a group of banks. Merrill announces $7.9 billion in subprime writedowns, surpassing Citi s $6.5 billion. Sources: BusinessWeek, S&P, Global Insight, Milken Institute. Dec. 12, 2007: Fed introduces Term Auction Facility. Jan. 11, 2008: Bank of America agrees to buy Countrywide. Jan. 30, 2008: Fed cuts discount rate to 3.5%. Fed offers troubled banks as much as $200 billion in loans; Fed introduces Term Securities Lending Facility. Aug. 17, 2007: Fed cuts discount rate Feb. 13, 2008: to 5.75%; Fed introduces President Bush Term Discount W indow introduces tax rebate Program. stimulus program of $168 billion. Mar. 16, 2008: JP Morgan Chase offers to buy Bear Stearns; Fed introduces Primary Dealer Credit Facility. Mar. 18, 2008: Fed cuts discount rate to 2.5%; Fed funds rate to 2.25%. April. 30, 2008: Fed cuts discount rate to 2.25%; Fed funds rate to 2%. June 9, 2008: Lehman announces a $2.8 billion loss. July 11, 2008: IndyMac is seized by FDIC. July 30, 2008: President Bush signs a housing rescue law. Aug. 1, 2008: First Priority Bank closes. Sept. 29, 2008: Citigroup agrees to buy Wachovia. Sept. 23, 2008: Washington Mutual is seized by FDIC. Sept. 16, 2008: Fed loans AIG $85 billion. Oct. 8, 2008: Fed cuts discount rate to 1.75%; Fed funds rate to 1.5%. Oct. 3, 2008: President Bush signs Emergency Economic Stabilization Act, authorizing bailout of $700 billion. Also, Citigroup sues after Wachovia agrees tie-up with W ells Fargo. Sept. 7, 2008: U.S. seizes Fannie Mae Sept. 14, 2008: and Freddie Mac. Lehman files for bankruptcy. 12/ / / / / / / / / / / /2008 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 4

5 Overview 5

6 Home mortgages: Who borrows, how much has been borrowed, and who funds them? Total value of housing stock = $19.3 trillion Mortgage debt $10.6 trillion Subprime 8.4% Securitized 58% Prime 91.6% Equity in housing stock $8.7 trillion Non-securitized 42% Governmentcontrolled 46% Private sectorcontrolled 54% Note: total residential and commercial mortgages = $14.7 trillion; 5 percent = $700 billion Sources: Federal Reserve, Milken Institute. 6

7 The mortgage problem in perspective 80 million houses 27 million are paid off 53 million have mortgages 48 million are paying on time 5 million are behind (10% of 53 million with 3% in foreclosure) This compares to 50% seriously delinquent in the 1930s. Sources: U.S. Treasury, Milken Institute. 7

8 I. Low interest rates and a lending boom 8

9 Did the Fed lower interest rates too much and for too long? Federal funds rate vs. rates on FRMs and ARMs Percent Record low from June 25, 2003 to June 30, 2004: 1% 30-year FRM rate 1-year ARM rate Target federal funds rate January 30, year FRM rate: 5.1% 1-year ARM rate: 4.9% Apr. 30, 2008: 2% Oct. 8, 2008: 1.5% Oct. 29, 2008: 1% Dec. 16, 2008: % Sources: Federal Reserve, Mortgage Bankers Association, Moody s Economy.com, Milken Institute. 9

10 US$ trillions 4.0 Low interest rates and credit boom Percent 6.0 Home price bubble and credit boom US$ trillions Index, January 2000 = Year ARM mortgage rate (right axis) Home mortgage originations (left axis) Q Note: Data for Q1-Q are annualized. Sources: Inside Mortgage Finance, Mortgage Bankers Association, Moody s Economy.com, S&P/Case-Shiller, Milken Institute S&P/Case-Shiller National Home Price Index (right axis) Home mortgage originations (left axis) Q

11 II. Homeownership, prices, starts and sales take off 11

12 Credit boom pushes homeownership rate to historic high Home price bubble peaks in 2006 California and national home prices reach record highs Percent Q2 2004: 69.2% Q4 2008: 67.5% Ave rage, 1965 Q4 2008: 65.2% Index, January 1987 = S&P/ Case-Shiller National Hom e Price Index OFHEO Hom e Price Index US$ thousands California m edian hom e price California ave rage $230,599 U.S. m e dian hom e price U.S. ave rage, : $121, Sources: U.S. Census Bureau, OFHEO, Moody s Economy.com, S&P/Case-Shiller, California Association of Realtors, Milken Institute. 12

13 Housing starts hit a record in 2005 Housing units, millions January 2006: 1.8 m illion Millions 4 Existing homes for sale (left axis) 3 Homes for sale Millions Millions 7.0 Exis ting hom e sale s (le ft axis) Homes sales reach a new high Millions Average starts, 1959 Oct. 2008: 1.1 m illion Oct. 2008: 536, New homes for sale (right axis) Ne w hom e s ales (right axis) Sources: U.S. Census Bureau, OFHEO, Moody s Economy.com, Milken Institute. 13

14 III. Subprime borrowers and subprime mortgages 14

15 Who is a subprime borrower? National FICO scores display wide distribution Percentage of population 40 Prime = 79% What goes into a FICO score? Types of credit in use Subprime = 21% New credit 10% Length of credit history 15% 10% Payment history 35% 0 up to Amounts owed 30% Sources: myfico.com, Milken Institute. 15

16 Percent of total originations Prime and subprime mortgage originations by FICO score reveal substantial overlaps FICO below 620 Prime: 6.6% Subprime: 45.2% FICO above 620 Prime: 93.4% Subprime: 54.8% 12 Subprime Prime FICO score Sources: LoanPerformance, Milken Institute.

17 ARMs look attractive to many borrowers Percent year FRM rate January 30, year FRM rate: 5.1% 1-year ARM rate: 4.9% year ARM rate Sources: Mortgage Bankers Association, Moody s Economy.com, Milken Institute. 17

18 ARM share grows, following low interest rates Percent of all outstanding home mortgages Sources: Mortgage Bankers Association, Moody s Economy.com, Milken Institute. 18

19 Largest share of ARMs go to subprime borrowers Percent of mortgage type 60 FHA ARM Prime ARM Subprime ARM Sources: Mortgage Bankers Association, Moody s Economy.com, Milken Institute. 19

20 US$ trillions Subprimes take an increasing share of all home mortgage originations % Subprime Prime 21.3% 3.0 Subprime's 7.4% 18.2% 20.1% share: 7.8% 7.9% % Q1-Q Sources: Inside Mortgage Finance, Milken Institute. 20

21 US$ billions Subprime mortgages increase rapidly before big decline Originations US$ billions 1,400 Average annual growth rates : 14% 1,200 1,240 1, Q1 2008: -23% 1,000 Outstandings Q2 H Sources: Inside Mortgage Finance, Milken Institute Q

22 IV. Mortgage product innovation 22

23 Subprime and Alt-A shares quadruple between 2001 and 2006, then fall in % 20% 2001, $2.2 trillion 2% 5% 7.9% 57.1% 13% 2006, $3.0 trillion 14% 2.7% 33.2% 11% FHA & VA Conventional, conforming prime Jumbo prime 8% 2007, $2.4 trillion 14% 4.9% 2% 8% Q1 2008, $480 billion 4% 9% Jumbo prime Subprime Alt-A Home equity loans 9.6% 20% 16% 14% 47.3% 67.2% Sources: Inside Mortgage Finance, Milken Institute. 23

24 ARM hybrids dominate subprime originations (2006) Prime conventional Alt-A Subprime Other ARM 7% ARM hybrids 23% Fixed 70% Other ARM 23% Fixed 31% Fixed 9% 30-year ARM balloon with 40- to 50-year amortization 26% ARM hybrids 46% Other ARM 4% 2- and 3-year hybrids 61% Sources: Freddie Mac, Milken Institute. 24

25 V. Securitization 25

26 The mortgage model switches from originate-to-hold to originate-to-distribute Residential mortgage loans 1980: Total = $958 billion Residential mortgage loans Q3 2008: Total = $11.3 trillion Securitized 15.6% 11% Held in portfolio 41% Sources: Federal Reserve, Milken Institute. Held in portfolio 84.4% 89% Securitized 59% 26

27 Percent of all subprime mortgages securitized since Securitization becomes the dominant funding source for subprime mortgages Q Q Sources: Inside Mortgage Finance, Milken Institute. 27

28 The rise and fall of private-label securitizers New securities issuance 21% 2% 42% 20% 13% 56% 4% 18% 5% 19% 1985 Total = $110B 2001 Total = $1.4T 2006 Total = $2.0T Q1 Q Total = $1.0T 35% 38% 29% 22% 45% 31% Ginnie Mae Freddie Mac Fannie Mae Private-label Sources: Inside Mortgage Finance, Milken Institute. 28

29 The rise and fall of private-label securitizers Outstanding securities 13% 6% 55% 14% 18% 35% 7% 25% 30% 7% 26% 1985 Total = $390B 2001 Total = $3.3T 2006 Total = $5.9T First half 2008 Total = $6.8T 26% 39% 29% 33% 37% Ginnie Mae Freddie Mac Fannie Mae Private-label Sources: Inside Mortgage Finance, Milken Institute. 29

30 US$ billions 3,000 Mortgage-backed securities issued by issuer 2,500 2,000 1,500 Private label Ginnie Mae Freddie Mac Fannie Mae 1, Sources: Inside Mortgage Finance, Milken Institute. Note: 2008 data are annualized. 30

31 VI. Affordability 31

32 Ratio of home price to household income surges Debt-to-income ratio of households has increased rapidly Home mortgage share of household debts reaches a new high in 2007 Median home price/ median household income : 4.69 Home mortgage debt/disposable personal income 150 Q4 2007: 139.5% Percent 75 Q2 2007: 73.7% Q2 2008: 73.4% : Average, : 79.7% Average, : Average, : 64.2% Sources: U.S. Census Bureau, OFHEO, Federal Reserve, Moody s Economy.com, Milken Institute. 32

33 VII. Collapse 33

34 The recent run-up of home prices was extraordinary Index, 2000 = Annualized growth rate of nominal home index, 1890 June 2008: 3.3% World War I Great Depression World War II 1970 s 1980 s boom boom Current boom Long-term trend line Sources: Robert Shiller, Milken Institute. 34

35 Home prices don t go up forever Change in home prices in 100-plus years Percentage change in nominal home price, year ago 30 World Great World 25 War I Depression War II 1970 s Boom 1980 s Boom Current Boom Average, 1890 June 2008: 3.6% /- one standard deviation Sources: Robert Shiller, Milken Institute. 35

36 : The collapse begins Home price indices, percent change on a year earlier 25 S&P/Case-Shiller 10-city 20 S&P/Case-Shiller national OFHEO Sources: S&P/Case-Shiller, OFHEO, Moody s Economy.com, Milken Institute. 36

37 Forty-six states had falling prices in the fourth quarter 2007 United States: - 9.3% (fourth-quarter annualized growth) Source: Freddie Mac. 37

38 One year ago If you bought your house Dallas Charlotte Boston Denver Cleveland New York Portland Atlanta Seattle Chicago Minneapolis Washington Composite-20 Detroit Composite-10 Tampa San Diego Los Angeles San Francisco Miami Las Vegas Phoenix Five years ago % change in price, August % change in price, August Sources: S&P/Case-Shiller, Milken Institute Seattle Portland Tampa New York W ashington Charlotte Miami Phoenix Los Angeles Composite-10 Las Vegas Composite-20 Chicago Dallas Atlanta Boston Denver San Francisco San Diego Minneapolis Cleveland Detroit 38

39 Housing starts sharply decline Percent change, year ago Sept. 2008: -41.2% Oct. 2008: -39.4% Homes sit longer on the market Number of months that homes sit on the market 12 Existing homes New homes as home appreciation slows Percent Months Percentage change from year ago in median home sales price (left axis) Number of months homes stay on market (right axis) Note: Shaded area represents fluctuation within one standard deviation from mean (1.15%) Sources: Mortgage Bankers Association, OFHEO, Moody s Economy.com, Milken Institute. 39

40 VIII. Delinquencies and foreclosures 40

41 Foreclosures are nothing new, but Thousands of foreclosures per year 2,150 1,900 1,650 1,400 1,150 Average 661,362 annual foreclosures from Q to Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Sources: Mortgage Bankers Association, Milken Institute. 41

42 Thousands of foreclosures per year 2,400 their numbers have doubled 2,150 1,900 Average 1,412,656 annual forclosures from Q to Q ,650 1,400 1,150 Average 661,362 annual foreclosures from Q to Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Sources: Mortgage Bankers Association, Milken Institute. 42

43 2,500 2,000 1,500 Subprime mortgages accounted for half or more of foreclosures since 2006 Number of home mortgage loan foreclosures started (annualized rate in thousands) Subprime FHA and VA Prime (includes Alt-A) Q Subprime: 12% of loans serviced 1, Q Q Q Q Q Q Q Q Q Q Q Q Sources: Mortgage Bankers Association, Milken Institute. 43

44 Subprime ARMs have the worst default record Home mortgage loans delinquent or in foreclosure (percent of number) 40 Q3 2008, Subprime ARM: 35.3% 35 Subprime FRM: 13.5% 30 FHA and VA: 6.3% Prime: 3.5% Q Q Q Q Q Q Q Q Q Q Q Q Q Q Sources: Mortgage Bankers Association, Milken Institute. 44

45 Percentage of homes purchased between Q and Q that now have negative equity United States = 44.8% < 20% >= 20% and < 35% >= 35% and < 50% >= 50% Sources: Zillow.com, Milken Institute. 45

46 Percentage of homes sold for a loss (Q2 2008) United States = 32.7% < 15% >= 15% and < 30% >= 30% and < 45% >= 45% Sources: Zillow.com, Milken Institute. 46

47 Percentage of homes sold that were in foreclosure (Q2 2008) United States = 18.6% Sources: Zillow.com, Milken Institute. < 1% >= 1% and < 25% >= 25% and < 40% >= 40% 47

48 IX. Damages scorecard 48

49 US$ billions Losses/write-downs, capital raised, and jobs cut by financial institutions worldwide Capital raised (left axis) Losses/write-downs (left axis) Prior quarters Jobs cut (right axis) Number of jobs cut (thousands) 120 Q Q Q Q Q Q Through Feb. 4, Sources: Bloomberg, Milken Institute. 49

50 US$ billions 1,200 1,000 What is the cumulative damage? Cumulative losses/write-downs, capital raised, and jobs cut by financial institutions worldwide Jobs cut (right axis) February 4, 2009: thousand Number of jobs cut 300, , Capital raised (left axis) February 4, 2009: $969.2 billion Losses/write-downs (left axis) February 4, 2009: $ billion 200, , ,000 50,000 0 Prior quarters Sources: Bloomberg, Milken Institute. Q Q Q Q Q Q Through Feb. 4,

51 Recent losses/write-downs and capital raised by selected financial institutions US$ billions, through February 4, 2009 Losses /write-downs Capital raised Wachovia, United States Citigroup, United States AIG, United States Freddie Mac, United States Fannie Mae, United States Merrill Lynch, United States UBS, Switzerland Washington Mutual, United States Bank of America, United States HSBC, United Kingdom Others Grand total (US$ billions) 1, Sources: Bloomberg, Milken Institute. 51

52 Worldwide capital raised by source July 2007 July 2008 July 2007 December 2007 Total = $56 billion January 2008 July 2008 Total = $300 billion Other institutional investors 28% Other institutional investors 24% Sovereign wealth funds 7% Public investors 12% Sovereign wealth funds 60% Public investors 69% Source: International Monetary Fund. 52

53 Financial stock prices take big hits Percentage change in stock price, December 2006 January Note: Bear Stearns stock price is to May Countrywide stock price is to June Merrill Lynch stock price is to December Wachovia stock price is to December Sources: Bloomberg, Milken Institute. Lehman Brothers W ashington mutual Freddie Mac Fannie Mae AIG Bear Stearns W achovia Countrywide Bank of America Merrill Lynch UBS Equity Morgan Stanley Goldman Sachs JP Morgan & Chase W ells Fargo 53

54 Financial market capitalization takes big hit Total loss in market v alue: $1,094 billion, December 2006 January US$ billions Note: Bear Stearns stock price is to May Countrywide stock price is to June Merrill Lynch stock price is to December Wachovia stock price is to December Sources: Bloomberg, Milken Institute Bank of America AIG UBS Equity Wachovia JP Morgan & Chase Merrill Lynch Morgan Stanley Fannie Mae Goldman Sachs Freddie Mac W ashington mutual Lehman Brothers Wells Fargo Countrywide Bear Stearns 54

55 X. Credit crunch and liquidity freeze 55

56 Tightened standards for real estate loans Net percentage of domestic respondents tightening standards for commercial real estate loans The end of S&L crisis LTCM Dotcom Subprime Sources: Federal Reserve, Milken Institute. 56

57 4,000 3,500 3,000 Widening spreads between mortgage-backed and high-yield bonds Basis points, spread over 10-year Treasury bond 5,000 Maximum spread: 01/30/2009: 3,647 bps 4,500 2,500 2,000 1,500 1, Merrill Lynch Mortgage-Backed Securities Index Average, 2004 Januray 30, 2009: 503 bps Merrill Lynch High-Yield Bond Index Average, 2004 Januray 30, 2009: 426 bps 01/ / / / / / / / / / /2009 Sources: Merrill Lynch, Bloomberg, Milken Institute. 57

58 Spread between 3-month LIBOR and T-bill rate Basis points October 10, 2008: bps Sources: Bloomberg, Milken Institute. August 20, 2007: 240 bps Average since August 2007: 150 bps Average since 1985: 92 bps Liquidity freeze Spread between 3-month LIBOR and overnight index swap rate Basis points October 10, 2008: 364 bps Average since August 2007: 97 bps Average since December 2001: 29 bps

59 Average CDS spread, basis points Counterparty risk increases Lehman Brother files for bankruptcy and Merrill Lynch acquired Government announces support for Fannie Mae and Freddie Mac Citigroup agreed to buy Wachovia AIG rescued October 10, 2008: 607 bps January 30, 2009: 422 bps 200 Bear Stearns acquired / / / / / / / / / /2009 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. 59

60 Rising risk: The credit default swap market nearly doubled each year from June 2001 through October 2008 Notional amount of credit default swaps outstanding, US$ trillions Annualized growth rate H H2 2007: 102% H H1 2008: 89% June 2001 Dec June 2002 Dec June 2003 Dec June 2004 Sources: International Swaps and Derivatives Association, Milken Institute. 8.4 Dec June Dec June 2006 Dec June 2007 Dec June 2008 Oct

61 Commercial paper issuance dries up Quarterly change in outstanding amount, US$ billions Issuers of asset-backed securities Other issuers Q Q Q Q Q Q Q Q Q Q Sources: Federal Reserve, Milken Institute. 61

62 Federal Reserve responds by cutting Fed funds rate, but mortgage rates remain relatively flat Percent 10 Percent year FRM rate (left axis) Federal funds rate (left axis) Spread (right axis) / / / / / / / / / / Sources: Freddie Mac, Federal Reserve, Moody s Economy.com, Milken Institute. 62

63 Increasing spreads between corporate bonds, mortgage securities, and target federal funds rate Percent High yield corporate bonds yield Freddie Mac 30-year fixed mortgage rate 4 0 Federal intented funds rate AAA corporate bonds yield 01/ / / / / / / / /2009 Sources: Federal Reserve, Freddie Mac, Merrill Lynch, Bloomberg, Milken Institute. 63

64 US$ billions 2,400 2,000 1,600 1,200 Federal Reserve assets increased but asset quality deteriorated Total assets of Federal Reserve banks U.S. Treasury securities held outright 11/12/2008: $2.21 trillion 12/17/2008: $2.31 trillion 1/28/2009: $1.93 trillion /28/2009: $475 billion Sources: Federal Reserve, Milken Institute. 64

65 Federal Reserve has little maneuvering room Percent 3 2 Effectiv e federal funds rate Target federal funds rate Apr. 30, 2008: 2% Oct. 8, 2008: 1.5% Oct. 29, 2008: 1% Dec. 16, 2008: % /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 Sources: Federal Reserve, Milken Institute. 65

66 Federal Government Comes to the Rescue of Main Street and Wall Street Federal Reserve 5,365 Congress and White House 2,436 Federal Deposit Insurance Corporation 1,465 Treasury, Federal Deposit Insurance Corporation and Federal Reserve 362 Total amount committed (US$ billions) 9,628 Upper limit to total funds provided/cost under these programs $9.6 trillion plus? 66

67 Program Federal Reserve programs Amount committed (US$ billions) Description Term Discount Window Program (TDWP) Term Auction Facility (TAF) Announced on 10/17/2007. Extends the term of discount window loans from overnight to up to 90 days. 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. Need to Update details Announced on 3/11/2008. Establishes term swaps to be $9.6 trillion between the Fed and primary dealers. Collateral can Term Securities Lending be Treasury securities, federal agency securities, Facility (TSLF) Slides Bear Stearns 29 and other highly rated debt securities. On December 2, 2008, TSLF was extended through April 30, 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. 67

68 Federal Reserve programs Program Amount committed (US$ billions) Description Primary Dealer Credit Facility (PDCF) 58 AIG 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, As of January 21, 2009, credit extended under PDCF was less than $33.3 billion. 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, 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. 68

69 Program Federal Reserve programs 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, 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). 69

70 Program Commercial Paper Funding Facility (CPFF) Federal Reserve programs Amount committed (US$ billions) Description 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. dollardenominated commercial paper the issuer had outstanding on any day between January 1 and August 31, 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. 70

71 Federal Reserve programs Program Amount committed (US$ billions) Description Money Market Investor Funding Facility (MMIFF) 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, 540 including U.S. based securities-lending cashcollateral 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. 71

72 Program Federal Reserve programs 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. 72

73 Federal Reserve programs Program Purchase of GSE direct obligations and MBS Amount committed (US$ billions) 600 Description 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 be conducted by asset managers selected via a competitive process with a goal of beginning these purchases before year-end Purchases of both direct obligations and MBS are expected to take place over several quarters.

74 Congress and White House Program Amount committed (US$ billions) Description FHA Secure 50 Announced on 8/31/2007. Guarantees $50 billion in mortgages. Economic Stimulus Act Housing and Economic Recovery Act of 2008 Purchase of GSE Debt and Equity HOPE for Homeowners 300 Announced on 2/13/2008. Provided tax rebates in 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 The Congressional Budget Office (CBO) estimates the net cost of the stimulus to be $124 billion. 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. Announced on 7/30/2008. Designed to shore up 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

75 Program Congress and White House 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. 75

76 Program Congress and White House Amount committed (US$ billions) Description IRS Notice ? 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, Emergency Economic Stabilization Act 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. 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 76

77 Program Congress and White House Amount committed (US$ billions) Description Capital Purchase Program (CPP) 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, As of January 23, 2009, $192 billion has been distributed to 296 institutions. 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.

78 Program Congress and White House Amount committed (US$ billions) Description 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 Targeted Investment 20 program are required to provide Treasury with warrants or alternative consideration as necessary. They also need to Program (TIP) 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.

79 Program Federal Deposit Insurance Corporation Amount committed (US$ billions) Description Increase FDIC insurance coverage Temporary Liquidity Guarantee Program (TLGP)? 1465 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, Announced on 10/14/2008. Temporarily guarantees the senior debt of all FDICinsured institutions and their holding companies, as well as deposits in noninterest 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, 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) 79

80 Treasury, Federal Deposit Insurance Corporation and Federal Reserve Program 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 Amount committed (US$ billions) Description 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 nonrecourse loan, subject to Citigroup's 10 percent loss sharing, at a floating rate of overnight interest swap plus 300 basis points. 80

81 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) The final tab for taxpayers will only become known once the crisis is over.

82 XI. When will we hit bottom? 82

83 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? When will home prices hit bottom? Yes 27% 1st half % 2nd half % 1st half % No 73% 2nd half st half % 17% Source: Wall Street Journal. 83

84 How far do home prices have to fall? Annual rents as percent of home prices 6.5 Q2 1971: 6.08% 4.5 Q1 2008: 3.93% Average, 1960 Q1 2008: 5.04% Average, 2000 Q1 2008: 4.06% 3.0 Q4 2006: 3.48% Sources: Davisa, Lehnertb, Martin (2007), Milken Institute. 84

85 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 Annual home home price price decline decline required -2.0% -5.0% -10.0% -15.0% -20.0% Rent-to-price ra atio 3.80% 2010 Q Q Q Q Q2 4.00% 2013 Q Q Q Q Q2 5.00% 2024 Q Q Q Q Q1 5.04% average 2024 Q Q Q Q Q1 6.00% 2026 Q Q Q Q Q4 Sources: Davisa, Lehnertb, Martin (2007), Milken Institute. 85

86 US$/month 4,000 3,500 3,000 2,500 2,000 1,500 1, Alternative measures of the affordability of mortgage debt for California Payment with 100% LTV Payment with 90% LTV Payment with 80% LTV M ortgage payment assumptions: Every month, a home is purchased at median price, buyer takes out a 30-year conforming, fixed-rate loan with 80% LT V. Payment also includes 1% property tax per year, 0.1% property insurance. Maximum affortablility limit is 38% of median household Sources: Moody s Economy.com, Milken Institute. 86

87 XII. What went wrong 87

88 The importance of Fannie Mae and Freddie Mac US$ billions 3,000 2,500 2,000 1,500 1, , ,410 2, Fannie Mae: total assets Fannie Mae: total MBS outstanding Freddie Mac: total assets Freddie Mac: total MBS outstanding Commercial Sav ings banks: total institutions: residential real total estate assets residential real estate assets Sources: Freddie Mac, Fannie Mae, FDIC, Milken Institute. 88

89 Fannie Mae and Freddie Mac: Too big with too little capital? US$ billions 3,000 2,500 Fannie Mae 2,278 Freddie Mac 2,000 1,778 1,500 1,000 1,022 1, , , Q Q Total assets Total MBS outstanding Sources: Freddie Mac, Fannie Mae, Milken Institute. 89

90 Fannie Mae and Freddie Mac are highly leveraged Mortgage book of business over capital measures Fannie Mae 185x Sources: Freddie Mac, Fannie Mae, FDIC, Milken Institute. Freddie Mac 203x 81x 60x 60x 64x 56x 58x 48x 52x 56x 55x 57x 167x Core capital Fair value Core capital Fair value -66x -52x Q

91 Freddie Mac s and Fannie Mae's retained private-label portfolios Subprime Alt-A All others Fannie Mae, Q Fannie Mae, 2007 Fannie Mae, 2006 Fannie Mae, 2005 Freddie Mac, Q Freddie Mac, 2007 Freddie Mac, 2006 Sources: Freddie Mac, Fannie Mae, FDIC, Milken Institute. $85.7 billion 30.3% 33.4% 36.4% $94.8 billion 33.8% 34.3% 32.0% $97.3 billion 46.4% 36.1% 17.5% $86.9 billion 32.1% 37.4% 30.5% 41.7% 24.0% 34.3% 46.3% 23.4% 30.3% 54.4% 25.0% 20.6% $191.5 billion $218.9 billion $224.6 billion 91

92 Leverage ratios of different types of financial firms (June 2008) Leverage ratio, total assets/common equtity Freddie Mac 67.9 Fannie Mae Federal Home Loan Banks Brokers/hedge funds 31.6 Savings institutions Commercial banks Credit unions Sources: Federal Deposit Insurance Corporation, Office of Federal Housing Enterprise Oversight, National Credit Union Administration, Bloomberg, Google Finance, Milken Institute. 92

93 28 27 Too much dependence on debt? Leverage ratios at biggest investment banks Total assets/total shareholder equity Sept n.a June 2008 Bear Stearns Merrill Lynch Morgan Stanley Lehman Brothers Goldman Sachs Sources: Bloomberg, Milken Institute. 93

94 Debt dependence Leverage ratios at bank holding companies Total assets/total shareholder equity Sept Sources: Bloomberg, Milken Institute. Citigroup Bank of America JP Morgan Chase 94

95 Fitch long term issuer default rating AAA 24 AA+ 23 AA22 AA- 21 A+ 20 A 19 A-18 Bank of America JP Morgan Sources: Bloomberg, Milken Institute. Leverage vs. issuer rating Citigroup Merrill Lynch Merrill Lynch Goldman Sachs Morgan Stanley Morgan Stanley Total assets/total equity capital Lehman Brothers Merrill Lynch Bear Stearns 95

96 Leverage vs. issuer rating Total assets/ total shareholder equity Fitch long term issuer default rating Bear Stearns A+ A+ A+ Merrill Lynch AA AA- A+ Morgan Stanley AA AA- AA- Lehman Brothers A A+ AA- Goldman Sachs AA- AA- AA- Citigroup AA AA+ AA Bank of America AA- AA- AA JP Morgan Chase AA- A+ AA- Sources: Bloomberg, Milken Institute. 96

97 CDS premiums vs. issuer rating Fitch long term issuer default rating AAA AA+ AA Bank of America Citigroup Morgan Stanley Merrill Lynch Lehman Brothers AA- A+ JPMorgan Goldman Sachs Merrill Lynch A A- Lehman Brothers Av erage CDS premium, basis points Sources: Datastream, Milken Institute. Bear Stearns 97

98 Credit default swap premiums basis points Bear Stearns Merrill Lynch Morgan Stanley Lehman Brothers Goldman Sachs Citigroup Bank of America JP Morgan Chase Sources:Datastream, Milken Institute. 98

99 Average CDS premium, basis points Leverage vs. CDS premiums Bear Stearns 80 Lehman Brothers Merrill Lynch 60 Goldman Sachs JP Morgan Morgan Stanley 40 Morgan Stanley 20 0 Bank of America Sources: Datastream, Bloomberg, Milken Institute. Merrill Lynch Citigroup Lehman Brothers Total assets/total equity capital Bear Stearns

100 Leverage vs. CDS premium Total assets/ total shareholder equity Average CDS premium basis points Bear Stearns Merrill Lynch Morgan Stanley Lehman Brothers Goldman Sachs Citigroup Bank of America JP Morgan Chase Sources: Datastream, Bloomberg, Milken Institute.

101 Credit default swap premiums for large banks Credit default swap premium, basis points JP Morgan Chase Wells Fargo Bank of America Citigroup / / / / / / / / / /2008 Sources: Datastream, Milken Institute. 101

102 Standard & Poor s ratings New 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 Sources: Bloomberg, Milken Institute. Non-investment-grade securities BB+ 238 BB 313 BB- 331 B+ 339 B 330 B- 1,189 CCC+ 293 CCC 214 CCC- 104 CC 36 C 11 D

103 56 percent of MBS issued from 2005 to 2007 were eventually downgraded S&P Total Downgraded Downgraded as a percentage of total AAA 1, % AA(+/-) 3,495 1, % A(+/-) 2,983 1, % BBB(+/-) 2,954 2, % BB(+/-) % B(+/-) % Total 11,261 6, % Sources: Inside Mortgage Finance, Milken Institute. Note: A bond is considered investment grade if its credit rating is BBB- or higher by S&P. 103

104 Subprime mortgage-backed securities downgrades issuance Percent downgraded S&P Moody s Fitch AAA AA(+/-) A(+/-) BBB(+/-) Sources: S&P, Datastream, Milken Institute. Investment grade S&P 500 companies credit ratings and associated CDS spreads S&P Rating Number of companies CDS spread Highest Lowest Average AAA AA AA AA A+ 17 2, A 36 1, A- 34 2, BBB+ 43 1, BBB 41 1, BBB- 17 1, Note: As of October 17,

105 Credit ratings of selected S&P 500 companies and associated CDS spreads as of October 17, 2008 S&P's Investment grade Number of companies Speculative grade CDS spreads (basis points) Number of CDS spreads (basis points) S&P's Highest Lowest Average companies Highest Lowest Average AAA BB AA BB AA BB- 8 1, AA B+ 4 3, ,612 A+ 17 2, B 3 2, ,523 A 36 1, B- 2 4,718 3,701 4,209 A- 34 2, BBB+ 43 1, BBB 41 1, BBB- 17 1, 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. 105

106 When is a AAA not a AAA? Multilayered mortgage products Origination of mortgage 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-squared BB-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% Sources: International Monetary Fund, Milken Institute. 106

107 50 40 Mortgage loan fraud surges Number of cases reported, thousands US$ millions 1,200 1, Dollar losses in reported cases of mortgage fraud 1, Sources: Financial Crimes Enforcement Network, Federal Bureau of Investigation, Milken Institute. 107

108 Is adequate information disclosed to consumers? Percent of respondents who could not correctly identify various loan costs using current disclosure forms Prepayment penalty amount Total up-front cost amount Property tax and homeowner s insurance cost amount Reason why the interest rate and APR sometimes differ Presence of charges for optional credit insurance Presence of prepayment penalty for refinance in two years Loan amount Which loan was less expensive Whether loan amount included finances settlement charges Interest rate amount Balloon payment (presence and amount) Settlement charges amount Monthly payment (including whether it includes taxes and insurance) Cash due at closing amount APR amount Sources: Federal Trade Commission, Milken Institute. 108

109 Detroit Drivers of foreclosures: Strong appreciation or weak economies? Foreclosures per 1,000 homes Warren Weak economies Cleveland Akron National average Toledo Dayton Denver Atlanta Memphis Columbus Indianapolis Sacramento Oakland Stockton San Diego Tampa Housing bubbles Las Vegas Fort Lauderdale Phoenix Riverside Five-year price gain, Q Q (percent) Orlando Palm Beach Fresno Bakersfield Miami Sources: U.S. Treasury Department, RealtyTrac, Office of Federal Housing Enterprise Oversight, Milken Institute. 109

110 After housing bubble burst in 2007: Foreclosures highest for areas with biggest price declines Foreclosures per 1,000 homes Stockton Collaping housing bubbles Riverside Las Vegas Fort Lauderdale Bakersfield Oakland Sacramento Phoenix Fresno San Diego Palm Beach Sources: RealtyTrac, Office of Federal Housing Enterprise Oversight, Milken Institute. Detroit National average Tampa W arren Miami Orlando Weak economies strengthen Denver Price change, 2007 June 2008 (percent, annualized) Toledo Cleveland Dayton Columbus Akron Atlanta Memphis Indianapolis 110

111 XIII. Policy lessons from the current crisis and proposals for reform in regulatory oversight 111

112 Percent Equity capital-toasset ratio (right axis) Balance sheet information on FDIC-insured institutions Deposits-to-asset ratio (right axis) Cash-to-asset ratio (left axis) Borrowed funds-toasset ratio (left axis) Insured deposits-toasset ratio (right axis) Percent Q Sources: FDIC, Milken Institute. 112

113 U.S. regulatory capital requirements and prompt corrective action categories Tier 1 leverage Tier 1 riskbased Well capitalized >= 5% and >= 6% and >= 10% Adequately capitalized >= 4% and >= 4% and >= 8% Undercapitalized < 4% or < 4% or < 8% Total risk-based Significantly undercapitalized Critically undercapitalized < 3% or < 3% or < 6% Tangible equity capital ratio that is <= 2% Source: FDIC. 113

114 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, Citigroup 1, Bank of America 1, Wells Fargo 1, US Bancorp SunTrust Banks BB&T Corp Regions Financial Fifth Third Bancorp KeyCorp Sources: Bloomberg, Milken Institute. 114

115 Selected information for U.S. banks December 31, 2008 Regulatory capital ratios Alternative capital adequacy assessment Name Total riskbased capital ratio Tier 1 riskbased 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 Aa3 A+ Citigroup N.A. A Bank of America A1 A+ Wells Fargo n.a Aa3 AA US Bancorp Aa2 AA SunTrust Banks A1 A BB&T Corp Aa3 A+ Regions Financial n.a. n.a. n.a A2 A Fifth Third Bancorp A2 A- KeyCorp A2 A- Sources: Bloomberg, Milken Institute. 115

116 25 Equity capital-asset ratio for commercial banks Equity capital/asset ratio, percent : 28.1% : 16.2% Q3 2008: 9.7% Average, Q3 2008: 10.9% : 5.5% 1979: 5.8% Sources: Historical Statistics of the United States, FDIC, Milken Institute. 116

117 Leverage ratio for commercial banks Asset/equity capital ratio : 3.6x 1932: 6.2x 1945: 18.2x 1979: 17.4x Average, Q3 2008: 11.0x Q3 2008: 10.3x Sources: Historical Statistics of the United States, FDIC, Milken Institute. Note: The leverage ratio is the reciprocal of the capital-asset ratio. 117

118 US$ billions Loan-loss reserves (left axis) Noncurrent loans (left axis) Reserve coverage ratio of all FDIC-insured institutions Coverage ratio (right axis) 03/ / / / / / / /2008 Percent Sources: Quarterly Banking Profile, FDIC, Milken Institute.

119 The U.S. regulatory regime: In need of reform? Justice Department Assesses effects of mergers and acquisitions on competition Financial, bank and thrift holding companies Fed OTS Fannie Mae, Freddie Mac, and Federal Home Loan Banks Federal Housing Finance Agency Federal courts Ultimate decider of banking, securities, and insurance products Fed is the umbrella or consolidated regulator Primary/ secondary functional regulator National banks OCC FDIC Federal branch OCC Host county regulator State commercial Federal savings and savings banks banks State bank regulators FDIC Fed--state member commerical banks Foreign branch Fed Host county regulator Sources: Financial Services Roundtable (2007), Milken Institute. OTS FDIC Limited foreign branch OTS Host county regulator Insurance companies 50 State insurance regulators plus District of Columbia and Puerto Rico Securities brokers/dealers FINRA SEC CFTC State securities regulators Other financial companies, including mortgage companies and brokers Fed State licensing (if needed) U.S. Treasury for some products Notes: Justice Department: Assesses effects of mergers and acquisitions on competition Federal Courts: Ultimate decider of banking, securities, and insurance products CFTC: Commodity Futures Trading Commission FDIC: Federal Deposit Insurance Corporation Fed: Federal Reserve FINRA: Financial Industry Regulatory Authority GSEs: Government Sponsored Enterprises OCC: Comptroller of the Currency OTS: Office of Thrift Supervision SEC: Securities and Exchange Commission 119

120 Countries with the Central Bank as a supervisory authority Income level High income Upper middle income Lower middle income Low income Central bank only (75 countries) Anguilla Estonia Israel Montserrat Slovenia Netherlands Antigua and Barbuda Germany Italy New Zealand Spain Central bank among multiple supervisors (7 countries) Saudi Arabia South Korea United States Central bank not a supervisory authority (52 countries) Australia Denmark Isle of Man Norway Bahrain Finland Japan Sweden Austria Greece Kuwait Portugal Taiwan, China Belgium France Luxembourg Switzerland Hong Kong, Trinidad & United Cyprus Liechtenstein Singapore Canada Iceland Macau, China China Tobago Kingdom 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 St. Vincent Slovak Equatorial and the Republic Guinea Grenadines Kazakhstan Mexico Brazil Grenada Romania South Africa Uruguay 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 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 Ethiopia Kenya Mozambique Central African Republic Guinea- Bissau 120

121 Countries with single vs. multiple supervisory authorities Income level High income Upper middle income Lower middle income Low income 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 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 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 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 Central African Republic Guinea-Bissau Mozambique 121

122 Income level High income Upper middle income Lower middle income Low income Scope of supervisory authority for countries 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 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 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, Bosnia and Syrian FYR Herzegovina Guatemala Maldives Bolivia El Salvador Moldova Thailand Cameroon Guyana Morocco 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 Chad Kenya Pakistan Zimbabwe 122

123 Conservatorship of Fannie Mae and Freddie Mac

124 Bailing out AIG

125 Capital Purchase Program under the TARP

126 Automotive Industry Financing Program

127 Targeted Investment Program and Asset Guaranty Program

128 And Still