December 11, 27 Authorized for Public Release 127 of 138 Appendix 1: Materials used by Mr. Dudley
Class II FOMC Restricted FR Page 1 of 8 9. 8. 7. 6. 5. 4. 3. 2. 1.. December 11, 27 Authorized for Public Release 128 of 138 of Total Loans (1) Subprime Mortgage Performance Continues to Worsen January 1998 September 27 6+ Days Delinquent Entered Foreclosure 1998 1999 2 21 22 23 24 25 26 27 Source: Mortgage Bankers Association and Economy.com of Total Loans 9. 8. 7. 6. 5. 4. 3. 2. 1.. of Total 24 2 16 12 (2) Subprime 6 Day+ Delinquency Rate by Vintage ABX 6.2 ABX 7.1 Average 2-25 ARMs of Total 24 ABX 6.1 2 16 12 8 4 ABX 7.2 8 4 1.2 1..8 5 6 7 8 9 1 11 12 13 14 15 16 17 18 19 2 21 22 23 24 25 26 27 28 Source: Merrill Lynch, Intex Loan Age in Month of Total Loans 6+ Days Delinquent Entered Foreclosure (3) Prime Mortgage Performance Also Worsens January 1998 September 27 of Total Loans 1.2 1..8.6.4.2. 1998 1999 2 21 22 23 24 25 26 27 Source: Mortgage Bankers Association and Economy.com.6.4.2.
Class II FOMC Restricted FR Page 2 of 8 1 8 6 4 2 December 11, 27 Authorized for Public Release 129 of 138 (4) Average Loss Estimates for 26/7 ABS CDOs Based on Underlying Mortgage Loan Losses Base Case Loan Losses 15% X Base Case Mezzanine ABS CDO High Grade ABS CDO Mezz CDO: Super Senior HG CDO: Super Senior Source: UBS Tranche Tranche # Bonds 1 8 (5) Estimated Losses for the Super Senior Tranches of 26/7 Mezzanine ABS CDOs Base Case Loan Losses 15% X Base Case 6 4 2 % -1% 11-2% 21-3% 31-4% 41-5% >=51% Source: UBS (6) Financial Guarantors CDS Spreads and Equity Prices Dollars 1 January 1, 27 December 7, 27 8 8 6 6 4 2 Ambac Equity (LHS) MBIA Equity (LHS) Ambac CDS (RHS) MBIA CDS (RHS) 1/1/7 2/1/7 3/1/7 4/1/7 5/1/7 6/1/7 7/1/7 8/1/7 9/1/7 1/1/7 11/1/7 12/1/7 Source: Markit 4 2
Class II FOMC Restricted FR Page 3 of 8 $ Billions 12 115 11 15 1 95 9 85 8 Jan-7 Feb-7 Mar-7 Apr-7 May-7 Jun-7 Aug-7 Sep-7 Oct-7 Nov-7 Source: Federal Reserve Board (8) Fannie Mae and Freddie Mac s CDS Spreads and Equity Prices Dollars January 1, 27 December 7, 27 8 7 6 5 4 3 2 1 Dollars 7 6 5 4 3 2 1 December 11, 27 Authorized for Public Release 13 of 138 (7) Outstanding ABCP Volume Contraction Accelerates Again January 1, 27 December 5, 27 Total Outstanding Volume (LHS) Average 3-Day Rate (RHS) Average Overnight Rate (RHS) Fannie Mae Equity (LHS) Freddie Mac Equity (LHS) Fannie Mae CDS (RHS) Freddie Mac CDS (RHS) FOMC Rate Cut: 9/18 FOMC Rate Cut: 1/ 3 1 1/1/7 2/1/7 3/1/7 4/1/7 5/1/7 6/1/7 7/1/7 8/1/7 9/1/7 1/1/7 11/1/7 12/1/7 Source: Markit (9) Mortgage Insurers CDS Spreads and Equity Prices January 1, 27 December 7, 27 MGIC Inv. Group Equity (LHS) PMI Gp Inc Equity (LHS) Radian Equity (LHS) MGIC Inv. Group CDS (RHS) PMI Gp Inc CDS (RHS) Radian CDS (RHS) 1/1/7 2/1/7 3/1/7 4/1/7 5/1/7 6/1/7 7/1/7 8/1/7 9/1/7 1/1/7 11/1/7 12/1/7 Source: Markit 6.5 6.25 6. 5.75 5.5 5.25 5. 4.5 7 6 5 4 3 2 1 14 12 1 8 6 4 2
Class II FOMC Restricted FR Page 4 of 8 225 2 175 December 11, 27 Authorized for Public Release 131 of 138 Investment Grade (LHS) High-Yield (RHS) (1) Corporate Credit Spreads Widen January 1, 27 December 7, 27 7 6 5 15 125 1 75 1/1/7 3/1/7 5/1/7 7/1/7 9/1/7 11/1/7 8 7 6 5 4 3 2 1 (11) Probabilities for Policy Rate Outcomes for December FOMC Meeting November 1, 27 December 7, 27 4. Target Rate 4.25 Target Rate 4.5 Target Rate 11/1/27 11/8/27 11/16/27 11/26/27 12/3/27 4 3 2 1 8 7 6 5 4 3 2 1 4.5 4.25 4. 3.75 Source: Cleveland Fed (12) Fed Funds Futures Rate Expectations Fall 9/17/27 1/3/27 12/7/27 4.5 4.25 4. 3.75 3.5 Dec-7 Jan-8 Feb-8 Mar-8 Apr-8 May-8 Jun-8 Fed Funds Futures Contracts 3.5
Class II FOMC Restricted FR Page 5 of 8 5. 4.5 4.25 4. 3.75 3.5 3.25 6. 5.5 5. 4.5 4. 3.5 3. 2.5 2. 6. 5.5 5. 4.5 4. 3.5 3. 2.5 2. December 11, 27 Authorized for Public Release 132 of 138 (13) Eurodollar Futures Curve Shifts Lower 9/17/27 1/3/27 12/7/27 Dec-7 Mar-8 Jun-8 Sep-8 Dec-8 Eurodollar Futures Contracts (14) Distribution of Expected Policy Target Among Primary Dealers Prior to December 11 FOMC Meeting Survey Response -size indicates freq December Average Forecast Market Rates as of 12/3 Q4 27 Q1 28 Q2 28 Q3 28 Q4 28 Source: Dealer Policy Survey (15) Distribution of Expected Policy Target Among Primary Dealers Prior to October 31 FOMC Meeting Survey Response -size indicates freq October Average Forecast Market Rates as of 1/23 Q4 27 Q1 28 Q2 28 Q3 28 Q4 28 Source: Dealer Policy Survey 5. 4.5 4.25 4. 3.75 3.5 3.25
December 11, 27 Authorized for Public Release 133 of 138 Class II FOMC Restricted FR Page 6 of 8 3. 2.8 Barclays Federal Reserve Board (16) TIPS Implied Inflation: 5-1 Year Horizon June 1, 26 December 7, 27 Cut: 9/18 3. 2.8 2.6 2.6 2.4 2.2 4.7 Cut: 1/31 6/1/6 9/1/6 12/1/6 3/1/7 6/1/7 9/1/7 12/1/7 Source: Federal Reserve Board and Barclays Capital (17) While Day-to Day Effective Rate Remain Volatile, But Cumulatively Close to Target Rate November 1, 27 December 7, 27 2.4 2.2 4.7 4.6 4.5 4.4 4.3 4.2 4.1 Rolling Cumulative Effective Rate Since 11/1 Target Fed Funds Rate Effective Fed Funds Rate 11/1/7 11/8/7 11/15/7 11/22/7 11/29/7 12/6/7 Source: Federal Reserve Bank of New York 4.6 4.5 4.4 4.3 4.2 4.1
Class II FOMC Restricted FR Skew.16.14.12.1.8.6.4.2. December 11, 27 Authorized for Public Release 134 of 138 APPENDIX: Reference Exhibits (18) Demand for Downside Protection on S&P 5 January 1, 27 December 7, 27 Put - Call Equity Risk Reversal 1/1/7 2/1/7 3/1/7 4/1/7 5/1/7 6/1/7 7/1/7 8/1/7 9/1/7 1/1/7 11/1/7 12/1/7 Source: OptionMetrics Page 7 of 8 Skew.16.14.12.1.8.6.4.2. Index to 1 on 1/1 12 115 11 15 1 S&P 5 Nasdaq Russell 2 (19) U.S. Equity Indices Partially Reverse Sharp Decline January 1, 27 December 7, 27 Cut: 9/18 Index to 1 on 1/1 12 115 11 15 1 95 9 14 12 1 8 6 4 2 Cut: 1/31 1/1/7 2/1/7 3/1/7 4/1/7 5/1/7 6/1/7 7/1/7 8/1/7 9/1/7 1/1/7 11/1/7 12/1/7 16 S&P 5: Bottom-Up Equity Analyst Forecasts for 27 (2) Equity Earnings Expectations January 1, 27 November 3, 27 S&P 5: Bottom-Up Equity Analyst Forecasts for 28 1/1/7 2/1/7 3/1/7 4/1/7 5/1/7 6/1/7 7/1/7 8/1/7 9/1/7 1/1/7 11/1/7 Source: Thompson Financial 95 9 16 14 12 1 8 6 4 2
December 11, 27 Authorized for Public Release 135 of 138 Class II FOMC Restricted FR 6 5 4 3 ITRAXX Crossover Series 7 LCDX (21) Global Credit Default Swap Spreads March 1, 27 December 7, 27 Cut: 9/18 Page 8 of 8 6 5 4 3 2 1 3/1/7 4/1/7 5/1/7 6/1/7 7/1/7 8/1/7 9/1/7 1/1/7 11/1/7 12/1/7 14 12 1 8 6 4 2 4.5 4.25 4. 3.75 3.5 3.25 3. 2.75 (22) Implied Volatility Stays High January 1, 27 December 7, 27 SMOVE (LHS) 1-Month Dollar-Yen Vol (RHS) VIX (RHS) 1-Month Euro-Dollar Vol (RHS) Cut: 9/18 Cut: 1/31 35 1/1/7 2/1/7 3/1/7 4/1/7 5/1/7 6/1/7 7/1/7 8/1/7 9/1/7 1/1/7 11/1/7 12/1/7 Cut: 1/31 (23) Treasury Yield Curve Shifts Lower and Continues to Steepen 9/17/27 1/3/27 12/7/27 1-Year 2-Year 3-Year 5-Year 7-Year 1-Year Years to Maturity 2 1 3 25 2 15 1 5 4.5 4.25 4. 3.75 3.5 3.25 3. 2.75
December 11, 27 Authorized for Public Release 136 of 138 Appendix 2: Materials used by Mr. Madigan
December 11, 27 Authorized for Public Release 137 of 138 Class I FOMC Restricted Controlled (FR) Material for FOMC Briefing on Monetary Policy Alternatives Brian Madigan December 11, 27
December 11, 27 Authorized for Public Release 138 of 138 Class I FOMC Restricted Controlled (FR) Table 1: Alternative Language for the December 27 FOMC Announcement Bluebook version: December 6, 27 Policy Decision October FOMC Alternative A Alternative B Alternative C 1. The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 4-1/2 percent. The Federal Open Market Committee decided today to lower its target for the federal funds rate 5 basis points to 4 percent. The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 4-1/4 percent. The Federal Open Market Committee decided today to keep its target for the federal funds rate at 4-1/2 percent. Rationale 2. Economic growth was solid in the third quarter, and strains in financial markets have eased somewhat on balance. However, the pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction. Today s action, combined with the policy action taken in September, should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and promote moderate growth over time. 3. Readings on core inflation have improved modestly this year, but recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully. 4. The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth. Incoming information suggests that the housing correction has intensified and that growth in business and consumer spending is softening. Moreover, strains in financial markets have increased in recent weeks. Overall, the outlook for the economy has weakened somewhat, and downside risks to growth have increased. Today s action, combined with the policy actions taken earlier, should help promote moderate growth over time. Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending. Moreover, strains in financial markets have increased in recent weeks. Today s action, combined with the policy actions taken earlier, should help promote moderate growth over time. As the Committee had anticipated, economic growth appears to be slowing, partly reflecting the intensification of the housing correction. Although strains in financial markets have increased in recent weeks and now pose greater downside risks to growth, the monetary policy actions taken earlier are expected to help promote moderate growth over time. Readings on core inflation have improved modestly this year, but elevated energy and commodity prices, among other factors, may put upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully. Readings on core inflation have improved modestly this year, but elevated energy and commodity prices, among other factors, may put upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully. Readings on core inflation have improved modestly this year, but elevated energy and commodity prices, among other factors, may put upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully. Assessment of Risk The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth. Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth. The Committee views the downside risks to growth as the predominant policy concern. Future policy adjustments will depend on the outlook for both inflation and economic growth, as implied by incoming information.