PowerPitch Presentation

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mruszczy NEED LOGOS!!
GLOBAL CREDIT CRUNCH
The Credit Crisis
August 2007 - Present
Western Investment Club Created by Andy Krystal
and Matt Hall, January 30, 2008
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Origins of the Crisis

• The Fed continuously cut interest rates as a
  result of the Tech Bubble bursting (c. 2000) and
  the ensuing recession
• Foreign investors begin buying US debt
• Cheap debt rising home prices speculative
  bubble
• Consumer believes prices can increase perpetually
  (rent to home price ratio)
• Worst areas Florida, Southern and Central
  California, New Jersey

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Subprime Loans Predatory Lending

• Because of cheap debt and excess liquidity,
  sub-prime loans extended to high-risk debtors
• Loans extended with little or no money down
  re-financing current mortgage common
• Incentivized mortgage brokers committed fraud
  (illegally extending loans to unqualified
  customers)
• Predatory lending extension of loans to recent
  immigrants teaser rates and complex products to
  least informed consumer

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Fall of Interest Rates (2001 2004)
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Applying the Example to a Loan

• Low interest rates - Rob and Sue buy a house in
  January 2004
• House Costs 500,000
• Rob and Susan have 100,000
• Need Loan from bank
• Bank 1 will Lend 200,000 (1st Mortgage 3
  Variable Interest Rate)
• Bank 2 will Lend 150,000 (2nd Mortgage 4.5
  Variable Interest Rate)
• Bank 3 will Lend 50,000 (Sub-Prime Mortgage
  6.0 interest)
• Both employed, can manage to pay interest at a
  rate of 15,750/year

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Rise of Interest Rates (2004 2007)
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How Did the Problem Manifest?

• Interest Rates Begin to rise, and so does Rob
  and Sues Mortgage Rates

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Rob and Sue Have a Problem!

• March 2007 ? Cant afford their mortgage payment
  Bank Foreclosure
• Same problem happens to their neighbours
• Who will buy their house?
• Try Selling it for 550,000 No Buyers
• Try Selling it for 450,000 No Buyers
• Try Selling it for 325,000 SOLD!
• Net Loss on their House purchase 175,000

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The Banks

• Banks Divide up the 325,000
• Bank 1 (1st Mortgage) - 170,000 (100)
• Bank 2 (2nd Mortgage) - 127,500 (100)
• Bank 3 (Sub prime) - 27,500 (65)
• Rob and Susan - 0 (0)
• Bank 3 who held the sub-prime mortgage took the
  hitor did they?
• Two Options were available to bank 3
• Hold onto Rob and Susans Debt
• Sell Rob and Susans Debt to somebody else

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The Banks (Contd)

• Option 1 Hold onto Rob and Susans Debt
• Bank would have lost about 14,800 on the loan
• Must Write Down 15k per equivalent loan
  (thousands on the balance sheet)
• Maybe bank had insurance? If so, no need to write
  down (yet)
• Strategy allows banks to receive future cash
  flows, but keeps risk on the balance sheet

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The Acronyms

• Option 2 - Banks pooled loans to move risk off
  balance sheet
• Structured products to artificially reduce risk
  (CDOs, MDOs, etc)
• 1st Tranche first call on cash flows from pool
  (least risky)
• () 14th Tranche last call on cash flows from
  pool (most risky)
• Top tranches considered low enough risk to be
  purchased by institutional investors (mutual
  funds, pension funds)
• Bottom tranches appealing to Hedge Funds (junk
  bond quality high cash flows, high risk)

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What Goes Up Must Come Down

• Once prices start decreasing, crisis becomes
  self-perpetuating
• Banks foreclose on home forced to sell at
  deflated price (vs. assumed value of collateral)
• Opposite of bubble credit begins tightening
• Markets overreact in good and bad times
• AAA Tranches fell from 100 to 70 (junk bond
  grade)

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The Problem

• Answer Nobody Knows, and as a Result

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The Fed and the Economy

• Fed consistently slashing FF rate since Aug. to
  increase liquidity (FIs remain solvent, markets
  work out problems)
• Liquidity major concern in turbulent financial
  markets(Run on the Bank)
• Domestic Economy housing prices fall, credit
  tightens, consumer spending down, economy slows

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Historical Context

• Not many appropriate historical comparisons
• 1987, 2000 primarily paper losses (artificial
  wealth creation, artificial wealth loss)
• See Long Term Capital Management (c. 1998)
• Similar circumstances
• More unknown exposure across financial markets
  (Riskier)

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What it all means

• Huge proportion of US wealth in home equity
• Losses not just on paper
• Huge implications on Main Street, not just Wall
  Street
• Unknown exposure among major US FIs

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Companies Affected
Only to name a few