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The Current Economic Crisis: History and Outlook February 19, 2009 By Dr. Matt Will
Copyright © 2009 by Dr. Matthew Will. All rights reserved Overview The Status – Loss of Confidence The Solutions: Bailout(s), Stimulus, Mortgage The Source – CDOs The Outlook
Copyright © 2009 by Dr. Matthew Will. All rights reserved Intermediaries Depositors (1) Funding comes from depositors (1) (2) Cash invested (2) (3) Payments are made by borrower or Assets Sold (3) (4) Proceeds repaid to depositors & reinvested (4) 1. Source of Credit Crisis Investments Banks Investment Banks Insurance Cos. CDOs / MBS Sub-Prime Others – No problem Institutional Corp. Other
Copyright © 2009 by Dr. Matthew Will. All rights reserved Intermediaries (1) Funding comes from depositors (1) (2) Cash invested (2) (3) Payments are made by borrower or Assets Sold (3) (4) Proceeds repaid to depositors & reinvested (4) 1. Source of Credit Crisis Investments Banks Investment Banks Insurance Cos. CDOs / MBS Sub-Prime Others – No problem
Copyright © 2009 by Dr. Matthew Will. All rights reserved 1. Source of Credit Crisis Corp. Developers New Business Consumers etc. Intermediaries Depositors Investments Banks Investment Banks Insurance Cos. GSE Mutual Funds… Institutional Corp. Intl. Consumer
Copyright © 2009 by Dr. Matthew Will. All rights reserved 2. Status = Loss of Confidence Impact Depositors Capital Markets Cash / Money Markets / Intl. / etc. ? What Happens To The Economy?
Copyright © 2009 by Dr. Matthew Will. All rights reserved How to Restore Depositor / Investor Confidence? 2. Status = Loss of Confidence
Copyright © 2009 by Dr. Matthew Will. All rights reserved The Issues The Status – Loss of Confidence The Solutions: Bailout(s), Stimulus, Mortgage Subsidies, Alternatives The Source – CDOs Agreement
Copyright © 2009 by Dr. Matthew Will. All rights reserved 3. Solutions Banks PROBLEM FIRMS Insurance Companies Investment Banks Intermediaries
Copyright © 2009 by Dr. Matthew Will. All rights reserved Send Cash (borrowed by Govt.) Sell Bad Mortgages to Government 3. Solutions: Paulson/Geitner/Bernanke (TARP) Government Owned Assets Government Owned Assets Rehabilitated Banks (restores confidence) Bad Banks (no confidence)
Copyright © 2009 by Dr. Matthew Will. All rights reserved Myth 1: The plan will restore confidence (BB GB) Fact: Only 20% to 30% of depositors will return Myth 2: There is no private market for mortgages Fact: False – See Lehman, Washington Mutual, etc. Myth 3: The government will make a profit Fact: Banks will sell worst mortgages Myth 4: We know which mortgages are bad and their value Fact: Mortgages are hidden in S.I.V.s - no market price Myth 5: The government is better at loan workout than banks Fact: Banks do this for a living 3. Solutions: Paulson/Geitner/Bernanke (TARP)
Copyright © 2009 by Dr. Matthew Will. All rights reserved Emergency Economic Stabilization Act of 2008 –Paulson = 4 pages ($700 bil) –Final bill = 451 pages ($850 bil) Highlights - TARP Troubled Asset = any other financial instrument that the Secretary … determines the purchase of which is necessary to promote financial market stability. Lack of Support Opposed by over 100 university economists in a signed letter 3. Solutions: Paulson/Geitner/Bernanke (TARP)
Copyright © 2009 by Dr. Matthew Will. All rights reserved HR 1424 – The Xmas Tree Energy Improvement and Extension Act of 2008 Tax Extenders and Alternative Minimum Tax Relief Act of 2008 Paul Wellstone and Pete Domenici Mental Health Parity and Addiction Equity Act of 2008 Heartland Disaster Tax Relief Act of 2008 "Certain wooden arrows designed for use by children" (Sec. 503) Wool research (Sec. 325) Film and television productions (Sec. 502) Virgin Island and Puerto Rican rum (Sec. 308) Auto racing tracks (Sec. 317)
Copyright © 2009 by Dr. Matthew Will. All rights reserved 3. Solutions: Stimulus $787 bil Recovery and Reinvestment Act of 2009 $400 tax credit per worker…phase out at $75,000 $2,500 tax credit for hiring workers $61 bil for DOT projects ** $20 bil for food stamps $2.5 bil for internet for farmers $7,500 credit, for low income first-time homebuyers
Copyright © 2009 by Dr. Matthew Will. All rights reserved 3. Solutions: Stimulus Impact Recovery and Reinvestment Act of 2009 Adds $35 bil per year in interest to federal budget Exacerbates root cause (unqualified homebuyers) –American Dream Downpayment Act (2003) –$7,500 for low income home buyers Tax credits are temporary (not tax cuts) Spending distribution –Social spending dominates plan –Infrastructure spending limited Credits new baseline for entitlement spending Magnifies credit crisis –Crowds out private borrowing
Copyright © 2009 by Dr. Matthew Will. All rights reserved 3. Solutions: Stimulus Impact Myth: New Deal Stopped Depression Cost of New Deal ($2009) = $550 bil Length of Depression AFTER New Deal = 8 years
Copyright © 2009 by Dr. Matthew Will. All rights reserved 3. Solutions: Mortgage Subsidies Total Cost = $275 bil $200 bil for Fannie Mae & Freddie Mac $75 bil direct payments to homeowners Low income qualification requirement Targeted assistance Details to follow
Copyright © 2009 by Dr. Matthew Will. All rights reserved US Govt. Financial Commitments Federal Government Financial Commitments from December 2007 thru February 2009. Excludes Federal Reserve injections via FOMC Disbursements to date = $ 2.546 trillion Government Borrowing Crowds Out Private Capital Formation
Copyright © 2009 by Dr. Matthew Will. All rights reserved 3. Solutions: Total Impact 2/19/09 national debt = $ 10.8 trillion Natl. Debt + Current Stimuli = $12.1 trillion –Assumes balanced budget –ALL Loans / Investments are repaid fully ($8.6 tril) Annual interest expense = $545 billion Per person –Debt = $40,333 –Annual interest = $1,817 2012 Forecast debt = $18.1 trillion 2012 Forecast annual interest = $815 billion
Copyright © 2009 by Dr. Matthew Will. All rights reserved 3. Solutions: Credit Market Thaw January 2009 China Private Bond issues = $237 bil (record) US Non-Govt Guaranteed Loan Volume as of 2/6/09 Reprint from 2/20/09 Wall Street Journal
Copyright © 2009 by Dr. Matthew Will. All rights reserved Status of Financial Market Clean Up Financial Market Realignment Only 1 qualified bidder for bailout RFP (Allianz) Cannot unwind CDOs Asset purchases not working (AIG, etc.) Everyone wants a bailout Only 1 qualified bidder for bailout RFP (Allianz) Cannot unwind CDOs Asset purchases not working (AIG, etc.) Everyone wants a bailout Market Solution Govt. Solution
Copyright © 2009 by Dr. Matthew Will. All rights reserved Solution 1.Fix the original problem Make predatory lending practices illegal Require overhaul of rating agencies and approve all derivatives Repeal Community Reinvestment Act of 1977 Repeal American Dream Downpayment Acts of 2003 and 2009 Regulate / Eliminate Credit Default Swaps *** 2.Market value all assets by banks & eliminate off balance sheet holdings 3.Orderly market realignment and/or liquidation of financial institutions Wachovia, Was Mu, Goldman, Morgan, Lehman, Merrill Lynch, etc. Expand TARP/CPP to include financing acquisitions 4.Avoid more bailouts (ala AIG, GM, etc.) 3. Solutions – An Alternative
Copyright © 2009 by Dr. Matthew Will. All rights reserved Result of Alternative Solution RESTORE CONFIDENCE Clean out poor institutions Increase quality of loan portfolios
Copyright © 2009 by Dr. Matthew Will. All rights reserved Summary Solution must… … address root causes … not be political or reactionary Bailouts… … delay recovery … make recession worse …do not fix fundamental problems …drain money from capital markets Economy will recover
Copyright © 2009 by Dr. Matthew Will. All rights reserved Questions
Copyright © 2009 by Dr. Matthew Will. All rights reserved Three Important Secrets 1. Credit Default Swaps (CDSs) 2. Structured Investment Vehicles (SIVs) 3. Rating Agency Game
Copyright © 2009 by Dr. Matthew Will. All rights reserved White House Aid Package Government appointed Czar Government to finance turnaround Required Targets Convert 2/3 of debt to equity Fund ½ of VEBA with Stock Eliminate Jobs Bank Convert UAW work rules to Transplant rules Convert UAW wages to Transplant wages Restructuring = CompetitiveIssues Can this be done outside of bankruptcy? Will Obama enforce targets? 3. Solutions – Auto Industry
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