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THE LIGHTS IN THE GLOOM Presented by Andrew Hill Disclaimer: The information contained in this presentation is a collection of information sourced from.

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Presentation on theme: "THE LIGHTS IN THE GLOOM Presented by Andrew Hill Disclaimer: The information contained in this presentation is a collection of information sourced from."— Presentation transcript:

1 THE LIGHTS IN THE GLOOM Presented by Andrew Hill Disclaimer: The information contained in this presentation is a collection of information sourced from a wide variety of sources. I didn’t directly participate in or contribute to the US Sub Prime Crisis but I have read as much on the topic as I could since it became a reality in 2007. No aspect of this presentation should be considered advice (financial or otherwise) nor should any decision to invest or divest be made as a result of the content of this presentation. Thanks to: Ryan Barnes – Author – “The Fuel that Fed the Subprime Meltdown” Karina Barrymore – Herald Sun 02 Feb 09 – “Lights in the Gloom”

2  What was the catalyst that created our current economic decline? How has this economic decline affected us? Explanation of what the Government is doing to attempt to stem the economic downturn. What are the personal & business opportunities in our current economic situation?

3 What was the catalyst that created our current economic decline? November 19, 2008 The cost for the Federal Reserve and US Government for the recent bailout mania has already gone past 4 trillion dollars according to CNBC - the 700 billion TARP programme is just the tip of the iceberg. That’s more than the cost of World War II, inflation adjusted. The Troubled Asset Relief Program (TARP) is a program of the United States Government to purchase assets and equity from financial institutions in order to strengthen its financial sector. It is the largest component of the government’s measures in 2008 to address the subprime mortgage crisis.

4 What does a subprime loan mean? A type of loan that is offered at a rate above prime to individuals who do not qualify for prime rates What does Residential Mortgage-Backed Security (RMBS) mean? A type of security whose cash flows come from residential debt such as mortgages. Home Equity Loans and Subprime Mortgages. This is a type of MBS that focuses on Residential instead of Commercial debt.

5 THE PATH TO A CRISIS Was this the case of one group or one company falling asleep at the wheel? In 2001 the US Federal Reserve began cutting rates dramatically, and the fed funds rate arrived at 1% in 2003. The goal of a low federal funds rate is to expand the money supply and encourage borrowing, which should spur spending and investing. REAL ESTATE BEGINS TO LOOK ATTRACTIVE As lower interest rates worked their way into the economy, the real estate market began to work itself into a frenzy as the number of homes sold – and the prices they sold for - increased dramatically in 2002.

6 INVESTMENT BANKS, AND THE ASSET BACKED SECURITY If the housing market had only been dealt a decent hand – say, one with low interest rates and rising demand – any problems would have been fairly contained. Unfortunately, it was dealt a fantastic hand, thanks to new financial products being spun on Wall Street. A SIMPLE IDEA LEADS TO BIG PROBLEMS Take a bunch of assets that have predictable and similar cash flows, bundle them into one managed package that collects all of the individual payments, and use the money to pay investors.

7 WIDENING THE MARGINS Thanks to an exploding real estate market, an updated form of the Asset Backed Security (ABS) was also being created, only these ABSs were being stuffed with subprime mortgage loans. Subprime loans, along with their much higher default risks, were placed into different risk classes, or tranches. All of a sudden, even the subprime mortgage lenders had an avenue to sell their risky debt, which in turn enabled them to market this debt even more aggressively. As a result of this activity, it became very profitable to originate mortgages – even risky ones.

8 COLLATERALISED DEBT JOINS THE FRAY The ability to borrow more prompted banks and other large investors to create “collateralised debt obligations” (CDO), which essentially scooped up equity and “mezzanine” tranches from Mortgage Backed Securities and repackaged them yet again, this time into mezzanine CDOs. By using the same “trickle down” payment scheme, most of the mezzanine CDO’s could gain an ‘AAA’ credit rating, landing it in the hands of hedge funds, pension funds, commercial banks and other institutional investors.

9 TEASER RATES AND THE ADJUSTABLE RATE MORTGAGE Teaser Rates – three, five or seven years. The Real Estate Market pushed to its peak in 2005 and 2006. What borrowers didn't take into account in the booming housing market, however, was that any decrease in home value would leave the borrower with an untenable combination of a balloon payment and a much higher mortgage payment. Over the space of five years, home prices in many areas had literally doubled. New homes couldn't be built fast enough, and homebuilders' stocks soared. The CDO market (secured mainly with subprime debt) ballooned to more than $600 billion in issuance during 2006 alone - more than 10-times the amount issued just a decade earlier.

10 CRACKS BEGIN TO APPEAR New home sales stalled, and median sale prices halted their climb. Interest rates - while still low historically - were on the rise, with inflation fears threatening to raise them higher. All of the easy-to-underwrite mortgages and refinances had already been done, and written 12 to 24 months earlier, were beginning to reset.

11 THE CRUNCH OF EASY CREDIT Scores of mortgage lenders - with no more eager secondary markets or investment banks to sell their loans into - were cut off from what had become a main funding source and were forced to shut down operations. As a result, CDOs went from illiquid to unmarketable. Flight to quality, three-month Treasury bills became the new "must-have" fixed- income product and yields fell a shocking 1.5% in a matter of days. Many institutional funds were faced with margin and collateral calls from nervous banks, which forced them to sell other assets, such as stocks and bonds, to raise cash. To help stem the impact of the crunch, the central banks of the U.S., Japan and Europe, through cash injections of several hundred billion dollars, helped banks with their liquidity issues and helped to stabilise the financial markets.

12 How has this economic decline affected us? 9 Apr 2009... The jobless rate in March climbed to 5.7%, seasonally adjusted, from 5.2% in February, the most since December of 2003. Interest Rates are at the lowest they have been in 30 years. A number of Mortgage Backed Investment Funds have been frozen. The Financial Institutions have changed dramatically: Financial Institutions have changed their appetite for risk. Financial Institutions have either disappeared from the market or have been bailed out by other Financial Institutions. Many small & medium size businesses have had to close their doors. Many large size businesses have downsized or restructured.

13 What is the Australian Government doing? First Home Owners Boost Free ceiling insulation for around 2.7 million Australian homes. Building or upgrading a building in every one of Australia’s 9,540 schools Building more than 20,000 new social and defence homes Introduced the Household Stimulus Package Tax Bonus for Working Australians of up to $900 for eligible taxpayers, depending on income thresholds Single-Income Family bonus of $900 to provide additional assistance for families that have one main income earner. Farmer’s Hardship Bonus of $950. Training and Learning Bonus of $950. Back to School Bonus of $950. Significantly increased funding for local community infrastructure and local road projects. Introduced a temporary business investment tax break for small businesses.

14 What are the personal & business opportunities in our current economic situation? Looming recession or not there are winners and losers in every investment cycle and this one is no different. Anyone cashed up and debt free is already on a potential winning streak. On the other hand, businesses facing downturns, households faceing job losses, businesses with heavy debt or households with heavy debt are most at risk. The financial crisis is takeing its toll on our economy, businesses and households. However, there are still some shining lights of opportunity if you know where to look. The first place to look is within. Most advisers and financial experts say confidence is the biggest deciding factor in any investment, personal or business finance decision, even more important than how much money you have. Overconfidence often means too much risk, while not enough can see you miss out on rare opportunities. It's easy to do nothing in uncertain times, however this is exactly when the professional investors make their move.

15 PROPERTY With interest rates at the lowest they have been in 30 Years, this is the best time for those with equity and stable businesses and/or jobs to purchase investment properties. With the Governement funded First Home Owners Boost it is an ideal time for First Home Owners to enter the market. SHARES Heavily discounted share prices are always the green light for counter- cyclical investors. Many of Australia's blue chip investment stocks are at historically low levels and therefore a good buy. SMALL BUSINESS AND GENERAL TAX BREAK PAYG INSTALMENT REDUCTION

16 How do we survive the current situation? Review your financial position regularly both personal & business. Invest if your financial position is strong enough, after seeking professional advice. Ensure you take advantage of the personal & business initiatives that the governement introduces. Review your business regularly and consider alliances or partnerships, to help share expenses or strenghen your business. Support small businesses where possible to ensure their survival.

17 “In the business world, the rearview mirror is always clearer than the windshield.” Warren Buffett

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