1. Six Things You Need to Know to Understand the Nation’s Financial Crisis and What We Can Do to Survive It North Perimeter Chapter Georgia Society of CPA’s March 17, 2009 Bill McDermott
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3. Total Returns for Large Company Stocks: 1970-2008* S&P 500 was up 3.53% in 2007, but down 36.0% so far in 2008* Markets were up in 2007 for the 5 th consecutive year before the crash of 2008 Source: Ibbotson Associates, Insurance Information Institute. *Through October 17, 2008.
5. The housing industry… More of the Same The Housing Crash Collapse of the Home Price Bubble
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7. Home Price History: Anatomy of a Bubble Jan. 1988 Early stages of S&L fallout; Credit tightens post-Oct. 1987 crash Aug. 1990 Price decline begins. Gulf War, Energy price spike, Recession April 1991 Max pace of decline. S&L bank shakeout; Recession, Gulf War, Energy price spike March 1996 House price recovery begins after 6 years of falling or flat prices. Feb. 2002 Home price increases slow post 9/11 and tech bubble collapse; recession ends late 2001. Stock markets down; Lowest interest rates in 40 years begin to fuel massive real estate and credit bubble Jul. 2004 Peak annual increase reached: 20.5%; Credit standards deteriorate rapidly; Explosion in subprime loans, MBS, CDS Jan. 2007 Home prices begin to fall Jul. 2008 Home prices plunge 17.5% vs. July 2007 Source: Standardandpoors.com (CSXR series); Insurance Info. Institute
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9. Total Private Employment* Grew by 25½ Million Workers from 1991 to 2008 The US economy added 25.5 million jobs between 1991 and 2008, but job growth has recently stagnated, impacted payrolls and the workers comp exposure base *seasonally adjusted at mid-year Source: U.S. Bureau of Labor Statistics, at http://data.bls.gov/cgi-bin/surveymost
10. Average Weekly Real Earnings in Private Employment Were Flat from 1999 to 2008 Virtually all of the real wage growth occurred between 1995 and 1999 and has now stagnated Sources: U.S. Bureau of Labor Statistics; I.I.I.
11. Percent Change in Debt Growth (Quarterly since 2004:Q1, at Annualized Rate) Deflation of housing bubble is very evident Consumer desperation? Corporate deleveraging
13. Ratio of Debt Service Payments to Disposable Income, 1980 – 2008:Q2 Long-term ratio of debt service to income is 12.1%, well below where it is today HOUSEHOLD DELEVERAGING In Q2 2008 13.85% of disposable personal income went to service mortgage and consumer debt, down from a peak of 14.42% in Q4 2006, % of Disposable Personal Income
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15. Real Annual GDP Growth, 2000-2009F March 2001-November 2001 recession Recession is likely second half 2008 into first half 2009
16. Real GDP Growth* *Yellow bars are Estimates/Forecasts from Blue Chip Economic Indicators. Source: US Department of Commerce, Blue Economic Indicators 10/08; Insurance Information Institute. Recession likely began Q2:08. Economic toll of credit crunch, housing slump, labor market contraction and high energy prices is growing
21. Unemployment Rate: On the Rise Previous Peak: 6.3% in June 2003 Average unemployment rate since 2000 is 5.0% August 2008 unemployment jumped to 6.1%, its highest level since Sept. 2003 Trough: 4.4% in March 2007 Source: US Bureau of Labor Statistics; Insurance Information Institute.
22. U.S. Unemployment Rate, ( 2007:Q1 to 2009:Q4F)* Rising unemployment will erode payrolls and workers comp’s exposure base. Unemployment is expected to peak at about 7% in the second half of 2009. * Blue bars are actual; Yellow bars are forecasts Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (10/08); Insurance Info. Inst.
23. Monthly Change Employment* (Thousands) Job losses now total 760,000 (from January through September 2008)
33. Credit Default Swaps: Notional Value Outstanding, 2002:H2 – 2008:H1* At year end 2007, the notional value of CDS’s outstanding was $62.2 trillion or 4.5 times US GDP, up nearly 40 fold from 2002. The 12% decline in 08:H1 was the first since 2001. (End of calendar half (H1 = June 30, H2 = December 31).
Good evening. Thank you for having me tonight. Back in October 2008, Charlie Rose interviewed Warren Buffet as the financial rescue package was being signed. Mr. Buffet said that a great athlete (The US economy) was on the floor in cardiac arrest. Many of us in the financial markets didn’t see this coming or if we saw it coming it certainly didn’t think it would be this bad. It has caused me to go back and try to understand what was going in the economy to create this financial crisis. What I hope to convey is an understand that there was somewhat of a perfect storm of circumstances some of which have been going for some time, that led to our current crisis
As we can see from this slide, total returns for large company stocks have only decreased 9 years in the last 38. However, after 5 years of consecutive increases ending in 2007, the market returns peaked in 2004 and have steadily declined since that time. As of October 2008, the market was down 36% for the year and has continued to drop steadily probably another 30%. Not shown on this chart the the Dow hit bottom at about 6500 and recently increased to right around 7200 Friday. While it’s probably way too early to tell, the market may be showing signs of improvement
1967 - 1982: Bear market. Traders deal with a stagnant economy in an inflationary monetary environment. The Dow enters two long downturns in 1970 and 1974; during the latter, it falls nearly 45% to the bottom of a 20-year range. 1982 - 2000: Bull market. The Dow experiences its most spectacular rise in history. From a meager 777 on August 12 , 1982 , the index grows more than 1,500% to close at 11,722.98 by January 14 , 2000 , with the exception of a brief but severe downturn in the late 1980s. 2000 - present: Bear market. The index meanders and then plunges to a closing low of 7,286.27 on October 9 , 2002 . A cyclical bull peak above the 14,000 level, reached exactly five years later, does not substantially surpass the inflation-adjusted 2000 high. A renewed bear is recognized in summer 2008 and multiple volatility records are set that autumn. Another acute phase in early 2009 brings the index to new 12-1/2 year lows around 6,600, for a total loss of 53% in less than 18 months.
t is fashionable in some circles to fume and fuss that the current financial crisis was born out of greed. It wasn’t. This mess was born out of the best of intentions, which is dangerous enough in Washington. Greed came later. It began with the well-intentioned goal of helping more working-class renters become homeowners. Many did. The numbers of minority and other first-time homeowners climbed. The housing market prospered. Congress, the lending industry and the Clinton and Bush administrations each took credit for the boom, all ignoring experts who called the housing boom a “bubble.” But as more and more money chased fewer and fewer qualified home buyers, the needy were elbowed aside by the greedy. Thousands of home buyers were lured by loan officers into no-money-down, interest-only and other tantalizing loans for higher amounts than the mortgage applicants could afford. Housing prices soared. The boom became a bubble that now has burst. Now, the finger-pointing begins as to who let it happen.
In 1999, for example, Fannie Mae, the nation’s biggest underwriter of home mortgages, announced it was easing the credit requirements on loans that it would purchase from banks and other lenders. The purpose was to help increase home ownership among minorities and others whose incomes, credit ratings and savings were too low to qualify for conventional loans. Of course, Fannie Mae was taking on more risk. But Fannie Mae also was being pressured by the Clinton administration to help working-class home buyers. And the entire lending industry was being pressured to ease up on its consideration of income, credit history, down payment and closing costs in determining the creditworthiness of customers. Conservatives now want to place blame for today’s Wall Street collapse in former President Bill Clinton’s lap. Yet President George Bush also embraced the expansion of higher-risk home loans and in 2003 called for “the entire housing industry to help at least 5.5 million minority families become homeowners by the end of this decade.”
In the late 80’s the Resolution Trust Corp was formed to sell the loans they inherited from the savings and loan industry. Starting in 1990, prices are relatively flat, we have the Gulf War, a spike in energy prices and a recession. Starting in 1996 housing prices begin to recover, the combination of the Clinton administration focus on home ownership along with the same focus in the Bush administration in 2003 housing prices really began to climb. When Fannie Mae announced in 1999, that they had eased lending requirements that accelerated the process. Interest rates were fairly low in 2002 and in 2004 the sub prime loan market kicked in along with the use of mortgage backed securities and credit default swaps. Housing prices began to fall in early 2007 and have continued to fall. There is not much improvement for the housing industry in the foreseeable future. We still have a lot of inventory at certain price points to absorb and it will take time
Many peopl
The economy added significant jobs in the past 17 years. But job growth has stagnated in the past few years. February's employment report is nothing to worry about, even though the addition of 97,000 jobs marked the weakest monthly performance since January 2005. The latest figure is heavily skewed by construction, which shed 62,000 positions—many of them likely the victims of February's bad weather. In addition, revisions to employment numbers for December and January added a combined 55,000 jobs to those months' already-strong performances. The bottom line: Companies continue to hire at a healthy pace, particularly in the service sector, which is 80% of the job market. Services added an impressive 168,000 jobs in February, accelerating from 120,000 in January. Overall, we expect the economy to generate a net 1.5 million jobs this year, averaging out to 125,000 per month. That isn't a spectacular pace in historical terms, but it's enough to support consumer confidence, keep people shopping and prevent the economy from slumping.
As you can see from this slide, wage growth occurred from 1995 to 1999, but has been virtually flat since 1999.
With stagnant wage growth, consumers and businesses used debt to supplement the lack of growth in income. ince 1975, total household debt in the US has grown by a factor of 41/2 when adjusted for inflation. Household debt from mortgages over that same period has similarly grown by a factor of 51/2. In fact, total household debt in the US increased every single year from 1982 to 2007, even when factoring in inflation, except in the recession year of 1991. Through good times or bad, while incomes have risen or fallen, and when interest rates have been high or low, consumer debt in the U.S. has climbed ever skyward. But while consumer debt levels have consistently risen over the past 30 years, the rate of debt growth has increased dramatically since 2000. Between 2000 and 2007, the total debt taken on by households nearly doubled in a period when consumer prices increased less than 20 percent. Experts point to a variety of reasons why debt levels have soared. For many Americans, the cost of medical care and health insurance has outpaced income and earnings growth. Interest rates have been kept low, and home prices skyrocketed until 2007, leading to a substantial increase in home loan borrowing. Mortgages traditionally represent the largest proportion of consumer debt. An oft-repeated statistic holds that the average American now owes more than he or she makes annually. Factoring in mortgages, total household debt stood at $13.9 trillion in 2008
The volatility in housing markets and expansion of mortgage credit since 2000 - and the subsequent rise in delinquencies and foreclosures - undoubtedly explains a significant portion of the total rise in consumer debt. Home mortgages accounted for 69 percent of total household debt in 2000; at the start of 2009, the figure has risen to 76 percent. It would be impossible to completely extricate housing debt from the debt equation that American consumers are facing today. But even if we discount the great expansion of mortgage debt since 2000, the growth of non-mortgage consumer debt over the same period has still outpaced the growth of inflation, as well as the growth in consumer prices for food, housing, energy, and medical expenses. Credit card debt is at a historic high. Payday loan operations are flourishing. Students are acquiring high levels of debt well before they face the prospect of owning a house.
Due to the rise in consumer debt with no real wage growth, consumer households are faced with an increasing percentage of their income going to debt repayment, this leaves a smaller portion to handle rising health care and educational costs. Changes in debt-to-income ratios are not a passive phenomenon only responding to changes in price. The psychology of buyers reflected in debt-to-income ratio is the facilitator of price action. In market rallies people put larger and larger percentages of their income toward purchasing houses because they are appreciating assets. People are not passively responding to market prices, they are actively choosing to bid prices higher out of greed and the desire to capture the appreciation their buying activity is creating. This will go on as long as there are sufficient buyers to push prices higher. The Great Housing Bubble proved that as long as credit is available there is no rational price level where people choose not to buy due to prices that are perceived to be expensive. No price is too high as long as they are ever increasing.
As you can see, we have had a real decline in GDP for the past four years. Fourth quarter GDP was revised down significantly as the Commerce Department's first revision to fourth quarter GDP knocked the quarter's growth rate down to a 6.2 percent decline from the initial estimate of a 3.8 percent drop. The latest number was below the market forecast for a 5.4 percent decrease. The downward revision was primarily due a sharply lower estimate for inventories and for exports. Also, personal consumption, nonresidential fixed investment, and government purchases were revised down modestly. These were partially offset by a less weak decline in residential investment. The fourth quarter fall in GDP followed a 0.5 percent dip the prior quarter. The positive news in the report was that inventories are now seen as falling $19.9 billion instead of rising $6.2 billion. This leaves less inventory overhang to work off even though the downward revision pulled down Q4.
The initial estimate for fourth quarter GDP showed the recession is worsening with a sizeable 3.8 percent decline, following a 0.5 percent contraction the prior quarter. The economic decline was spread throughout the economy. The all important consumer spending component dropped 3.5 percent annualized. We also saw sharp declines in residential investment and business investment in equipment & software. Nonresidential structures investment dipped slightly and even exports declined. We likely will see a downward revision to the fourth quarter. But pay specific attention to final sales-which indicate how strong demand is. Markets did not pay much attention to it, but final sales fell an annualized 5.1 percent in the fourth quarter. How this figure winds up will play a key role in how first quarter growth ends up.
The index of industrial production measures the physical output of the nation's factories, mines and utilities. The industrial sector accounts for less than one-fifth of the economy but for most of its cyclical variation. Industrial production in December plunged on lower auto assemblies plus broad-based weakness. Overall industrial production in December dropped 2.0 percent, following a 1.3 percent decline the month before. The December fall was far worse than expected - the market had projected a 1.0 percent decrease. The all-important manufacturing component fell 2.3 percent after a 2.2 percent decline in November. For the other major components in December, utilities slipped 0.1 percent while mining output decreased 1.6 percent. A key part of manufacturing weakness was in motor vehicle assemblies which dropped to an annualized pace of 6.64 million units in December from 7.60 million in November - a 12.6 percent fall. But weakness was widespread. Durables output fell 2.6 percent in December while nondurables dropped 2.1 percent. You have to go deep into the detail to find any positive at all for December - which was in aerospace & miscellaneous transportation equipment (i.e., Boeing production). On a year-on-year basis, industrial production in December slipped to down 7.8 percent from down 5.9 percent in November. Today's industrial production report paints a bleak picture for manufacturing. Not much is supporting economic growth and more sectors are pulling growth down further as manufacturing and housing are both very negative. Today's numbers should be a negative for equities although a government bailout (another one) for Bank of America has equities up.
The capacity utilization rate reflects the usage of available resources among factories, utilities and mines. A high and rising operating rate may signal that resources are being utilized to their fullest capacity -- a warning sign of inflationary pressures. Overall capacity utilization in December fell to 73.6 percent from 75.2 percent in November and came in below the consensus forecast for 74.6 percent. Overall capacity utilization in November dropped to 75.4 percent from 76.0 percent in October and came in lower than the consensus forecast for 75.7 percent. Looking ahead, manufacturing output is likely to be ugly in January as manufacturing production hours plummeted a monthly 2.4 percent for the month, according to the employment situation report.
U.S. industrial production fell in January for the sixth time in seven months and more than forecast as companies reduced manufacturing amid a worldwide slowdown in demand. Output at factories, mines and utilities dropped 1.8 percent, after a revised decrease of 2.4 percent in December that was more than previously reported, the Federal Reserve said today in Washington. Car and truck assemblies fell to a record. Manufacturers are cutting back on production as consumers retrench and companies are unable to get credit to fund capital investments. President Barack Obama yesterday signed into law a $787 billion stimulus packaged that will boost government spending and provide more tax cuts to families and businesses. “ The continued disaster in the auto sector was the biggest driving force,” Ian Shepherdson , chief U.S. economist at High Frequency Economics Ltd. in Valhalla, New York, said in a note to clients. He accurately forecast the decline in production. “Industry continues to contract, with no chance of a near-term recovery,” he said. Economists forecast industrial production would drop 1.5 percent, according to the median projection in a Bloomberg News survey of 75 economists. Estimates ranged from a decline of 3.1 percent to a gain of 0.5 percent. Capacity utilization, or the proportion of plants in use, fell to 72 percent, the lowest since February 1983, from 73.3 percent in December. Economists had forecast that figure would fall to 72.4 percent, according to a separate Bloomberg survey. Housing Crisis U.S. builders broke ground in January on the fewest houses on record as housing starts plunged 17 percent to an annual rate of 466,000, lower than projected, according to figures from the Commerce Department today in Washington. Building permits, a sign of future construction, also decreased. U.S. stocks declined, with the Standard & Poor’s 500 Index falling 1 percent to 781.06 as of 10:11 a.m. in New York. Treasury securities fell. Factory output, which accounts for about four-fifths of industrial production, decreased 2.5 percent, led by automakers. A regional report yesterday showed manufacturers continuing to struggle in the first quarter of the year. The Federal Reserve Bank of New York’s Empire manufacturing report fell to minus 34.7 this month. Readings below zero signal that the industry is shrinking. Vehicle Production Motor vehicle and parts production in today’s report plummeted 23.4 percent in January following an 8.1 percent drop a month earlier, the report said. Vehicles alone had a 40 percent drop after a 12.6 percent decline the month before. Automakers assembled cars and light trucks at an annual rate of 3.9 million during the month, the lowest since record-keeping began in 1967.
In 2000, the average unemployment was 5%, it rose to 6.3% in 2003 falling again to 4.4% in March 2007 and reached 6.1% in August 2008. The February report came out and our unemployment rate is now 8.1%. Unemployment in the US surged to a 26-year high of 8.1% as struggling employers reacted to a deepening recession by slashing 651,000 jobs last month. Jobs were lost in almost every category of employment, ranging from construction to retail, financial services and factories. Adding to the gloom, the US department of labour revised its employment figures sharply lower for two preceding months. The figures mean that the US economy has lost 4.4m jobs since it plunged into a tailspin in December 2007. Economists said that the cumulative loss over the past three months is the worst since troops were demobilised at the end of the second world war.
The forecast released in October by the US Bureau of Labor since the projection shows unemployment to peak at 7% in the second half of 2009 and is already at 8.1 in February. Worst-hit employment sectors in February include factories, which axed 168,000 jobs, and the construction industry, where 104,000 were lost. Professional services shed 180,000 jobs, retailers cut 40,000 and financial companies reduced their payrolls by 44,000. The only areas showing a modest rise in employment were health, education and the government. Most US commentators expect a deepening slump in gross domestic product in the first half of the year, with stabilization unlikely until the final quarter at the earliest. "Companies are reducing workers and output in order to bring inventories into line with weak sales," said Greg Thayer, senior economist at Wachovia Securities in St Louis.
Jobs were lost in almost every category of employment, ranging from construction to retail, financial services and factories. Adding to the gloom, the US department of labour revised its employment figures sharply lower for two preceding months. The figures mean that the US economy has lost 4.4m jobs since it plunged into a tailspin in December 2007. Economists said that the cumulative loss over the past three months is the worst since troops were demobilised at the end of the second world war. "We're in freefall at the moment and you can't see any sign of improvement here," said Nigel Gault, senior US economist at IHS Global Insight. "These declines are unprecedented. The last time we had three months in a row of job losses over 600,000 was in 1945.“Unemployment will probably get worse through 2009. As of January 2009, the Congressional Budget Office ( CBO ) predicted the unemployment rate will rise to 8.3% in 2009, and 9% in 2010. Christina Romer, chairman of the Council of Economic Advisers , said
These are the biggest holders of US securities by country. This is from the Treasury department as of Friday. China is now officially the US government's largest foreign creditor after overtaking Japan, in a development that signals Washington's increasing reliance on Beijing to save its economy. China became the largest foreign holder of US Treasuries, as of September, 2008 according to US Treasury Department figures. But, analysts warned Wednesday, neither country should be celebrating the development, which underlines serious imbalances in the global economy. "China's GDP per capita ranks around 100th in the world but it is actually subsidizing the world's richest country," said Zhang Ming, an economist with the Chinese Academy of Social Sciences, a government think-tank in Beijing. Zhang argued that becoming the largest foreign holder of US Treasuries is only an illustration of how serious the imbalances are in China's overly export-driven economy, rather than an indicator of its strength. "What China is doing involves high risks," he said. "When the debts become massive, there are always more risks for the creditor -- that's by no means symmetrical."
The ChangeWave survey of 2,715 U.S. consumers was conducted December 2 - 9, 2008. the December survey does show the rate of decline stabilizing. Nonetheless, the 90-day outlook remains the worst on record in a ChangeWave survey. Signs of the consumer retreat include record numbers saying they’re spending less because they’re trying to save more money and to reduce debt. Consumer sentiment has also taken a direct hit since November, with two-in-three respondents now believing the overall direction of the U.S. economy is going to worsen over the next 90 days – 9-pts more than a month ago.
Saving More Money (39%; up 6-pts) and Reducing Debt (33%; up 2-pt) are still dominant reasons given by consumers for why they’re spending less. Reduced Income (37%; up 4-pts) also remains a top reason – up for the third consecutive survey and a clear sign that the recession is continuing to take an enormous toll on the spending power of consumers. Consumer spending rose in January after falling for a record six straight months, pushed higher by purchases of food and other nondurable items. But the increase is expected to be fleeting given all the problems facing the U.S. economy. A batch of fresh reports Monday showed little signs of an economic rebound, with nonresidential construction spending falling to its lowest level in more than a decade and manufacturing activity contracting for a 13th straight month. The personal savings rate surged to 5 percent, the highest level since 1995 as consumers continued to sock away more of their incomes amid the deepening recession. The goverment calculates the savings rate as a percentage of after-tax incomes. The growth from from 3.9 percent in December partly reflected that while overall incomes rose 0.4 percent, after-tax incomes shot up 1.7 percent, providing potentially more money for savings. The 0.6 percent rise in spending followed a record six straight declines, including a 1 percent drop in December when retailers endured their worst holiday shopping season in at least four decades.
For example…
This slide shows you that the notional value increased to 62 trillion in credit default swaps by year end 2007, that’s 4.5 times GDP. by far the largest portion of AIG’s losses has come in the $50 trillion credit default swap market, which was instituted only in 1995. Other Wall Street products have caused huge losses, but have spent decades growing before they did so, producing sober profits for many years before blowing up. [Just last week , in fact, U.S. Federal Reserve Chairman Ben S. Bernanke verbally ripped AIG - saying the insurer operated like a hedge fund, while stating that having to rescue the insurer made him "more angry" than any other episode during the financial crisis - because of how its mishandling of credit default swaps led to the company's implosion.] A subsidiary of AIG wrote insurance in the form of credit default swaps, meaning it offered buyers insurance protection against losses on debts and loans of borrowers, to the tune of $447 billion . But the mix was toxic. They also sold insurance on esoteric asset-backed security pools – securities like collateralized debt obligations (CDOs), pools of subprime mortgages , pools of Alt-A mortgages , prime mortgage pools and collateralized loan obligations. The subsidiary collected a lot of premium income and its earnings were robust. When the housing market collapsed, imploding home prices resulted in precipitously rising foreclosures. The mortgage pools AIG insured began to fall in value. Additionally, the credit crisis began to take its toll on leveraged loans and it saw mounting losses on the loan pools it had insured.
Back in 2004, The SEC allowed five firms — the three that have collapsed plus Goldman Sachs and Morgan Stanley — to more than double the leverage they were allowed to keep on their balance sheets and remove discounts that had been applied to the assets they had been required to keep to protect them from defaults. As you can see, when an investment bank is allowed to have a leverage ratio that is double or triple what a commercial bank keeps. That model is not sustainable forever. Leverage works when times are good.
Leverage works extremely well when things are going good. But, it can have the opposite effect when things aren’t.. As you can see my return on cash in the non leveraged is 10% assuming my share of stock goes up $10. If I put up $10 and borrow $90, my return is 100% assuming my stock goes up to $110. If my stock goes down, I will probably lose my $10 investment and I’m still on the hook for the $90 I borrowed. As I pointed this arithmetic works equally unpleasantly the other way
The predecessor of Fannie Mae actually started in 1938. Freddie Mac was started in 1970. This act also allowed Fannie Mae to buy conventional mortgages in addition to FHA and VA. There are many reasons for mortgage originators to finance their activities by issuing mortgage-backed securities. Mortgage-backed securities transform relatively illiquid , individual financial assets into liquid and tradable capital market instruments. allow mortgage originators to replenish their funds, which can then be used for additional origination activities. can be used by Wall Street banks to monetize the credit spread between the origination of an underlying mortgage (private market transaction) and the yield demanded by bond investors through bond issuance (typically, a public market transaction). are frequently a more efficient and lower cost source of financing in comparison with other bank and capital markets financing alternatives. allow issuers to diversify their financing sources, by offering alternatives to more traditional forms of debt and equity financing. allow issuers to remove assets from their balance sheet, which can help to improve various financial ratios, utilise capital more efficiently and achieve compliance with risk-based capital standards.
To summarize,
So, how are we going to survive this… first I’m going to talk about what the federal government is going to do. Then I’m going to spend some time talking about you and I can do. The government first looked at a solution to provide liquidity into the banking, buying troubled assets, but the value of those was assets was unknown because real estate prices were falling. They didn’t want it to be a bad deal for the seller or the buyer. In addition, the banking industry was really leveraged and the powers to be recognized that the banks need some capital to bolster their balance sheets. That gave the birth to what has become knows as The Financial Services Rescue Package. What follows are some of the fine points of the program and how they were originally conceived.
The Emergency Economic Stabilization Act of 2008 , commonly referred to as a bailout of the U.S. financial system , is a law enacted in response to the global financial crisis of 2008 authorizing the United States Secretary of the Treasury to spend up to US$ 700 billion to purchase distressed assets, especially mortgage-backed securities , and make capital injections into banks. [1] [2] Both foreign and domestic banks are included in the bailout. The Federal Reserve also extended help to American Express , whose bank-holding application it recently approved. [3] The Act was proposed by Treasury Secretary Henry Paulson during the global financial crisis of 2008. The original proposal was three pages, as submitted to the United States House of Representatives . The purpose of the plan was to purchase bad assets, reduce uncertainty regarding the worth of the remaining assets, and restore confidence in the credit markets . The text of the proposed law was expanded to 110 pages and was put forward as an amendment to H.R. 3997. [4] The amendment was rejected via a vote of the House of Representatives on September 29, 2008, by a margin of 228-205. [5] On October 1, 2008, the Senate debated and voted on an amendment to H.R. 1424 , which substituted a newly revised version of the Emergency Economic Stabilization Act of 2008 for the language of H.R. 1424. [6] [7] The Senate accepted the amendment and passed the entire amended bill by a vote of 74-25. [8] Additional unrelated provisions added an estimated $150 billion to the cost of the package and increased the size of the bill to 451 pages. [9] [10] See Public Law 110-343 for details on the added provisions. The amended version of H.R. 1424 was sent to the House for consideration, and on October 3, the House voted 263-171 to enact the bill into law. [6] [11] [12] President Bush signed the bill into law within hours of its enactment, creating a $700 billion Troubled Assets Relief Program to purchase failing bank assets. [13]
As you recall, the credit markets seized up, major financial institutions want to de leverage and there has to be somebody there to buy the debt. This created a tidal wave of financial circumstances. The only force that can leverage up while the bankiing system wants to deleverage is the US Treasury. The economy needs plenty of money toied to market prices and the US has unlimited borrowing power, low borrowing costs and plenty of staying power. The goal here was for the US government to take an equity stake in some of the major banks in the US to bolster their capital and liquidity. In addition, The FDIC wanted to restore confidence in the banking system so that bank credit would be paid back no matter what happens to the bank.
Additional insurance coverage on bank deposits allowed all banks to offer coverage rather than just large banks. The Fed also agreed to be a purchaser of commercial to fund short term operating expenses of many of the large corporations and financial institutions in the US
The purchase of troubled assets will hopefully remove these assets from the bank’s balance sheets and banks should be able to attract capital and begin lending again
So, immediately after being signed in to law, The Treasury Secretary, took these positions in some of largest banks and investment banks in the country. About $125 billion in these 9 banks with another $125 billion in regional and local banks. The purpose of this was to try to get these banks back in the lending business.
Since October, banks, investment banks and auto manufacturers have been recipients of the Troubled Asset Relief program. In February, The Treasury Departmen t released the first monthly bank lending survey, which showed that 20 major financial institutions that received TARP funds had fallen in mortgage origination across the board in December since the TARP began distributing bailout funds through the Capital Purchase Program in October. Many of the institutions reported increases in originations in the month-over-month period from November to December, “fueled by falling mortgage interest rates,” according to the Treasury. However, those gains in origination were erased by the initial declines in origination activity reported by many of the institutions in the October-to-November period. The Treasury media statement announcing the survey downplayed the weaker originations since TARP began by pointing out that unemployment rose to 7.2 percent from 6.5 percent and 1.5 million jobs were shed as real GDP fell 3.8 percent during that same time period. “Despite the negative effects of the economic downturn and unprecedented financial markets crisis, the first survey of the top 20 recipients of government investment through the Capital Purchase Program (CPP) found that banks continued to originate, refinance and renew loans from the beginning of the program in October through December 2008,” Treasury officials said in the statement.
The components of the package included establishement of a Financial Oversight Board to regulate the activities of the Treasury Dept. Congress asked Fannie and Freddie to step up their buying of mortgage backed securities in the open market and the FDIC increased the insurance limits on deposits from $100,000 to $250,000. Given the declines in the market, they also order the halt of short selling of financial stocks.
Going forward there will be more oversight and regulation to eliminate the high leverage model, more monitoring of derivatives and the underlying reserves to pay claims and additional requirements for capital and liquidity going forward.
The federal government has tried to solve two issues in the market, one of liquidity and one of solvency. While it appears that these two terms are similar, they really are different. liquidity problems occur when an entity owes money but doesn't have readily available cash to pay off those debts. They may have other assets, and generally speaking, if they're facing a liquidity problem, they're likely to try to sell off those assets, potentially below cost, just to get the money they need to pay off their debts. But much of the problem in the financial world over the past few weeks hasn't been a lack of liquidity but an unwillingness to lend. That is, the banks have a ton of cash on hand, but they're afraid to give it out to anyone, because they don't know if whoever they lend it to will still exist when it comes time to repay. So, instead of lending it out, they're dumping it into the safest of safe investment vehicles: US gov't treasury bonds, even though they pay almost no interest. Basically, many of the banks have liquidity (cash), but are so afraid that the others they lend to are insolvent (unable to pay back loans) that they won't loan.
there's plenty of money in many of these banks, suggesting that they're not so worried about liquidity, but the solvency of everyone else they deal with. Of course, the two things overlap a bit. A bank that doesn't have liquidity may then be considered insolvent as well. On the good side, it looks like the federal government is finally recognizing the difference between liquidity and solvency and is trying to deal with the solvency issue by effectively agreeing to buy up commercial paper from money market funds . Basically, the issue here is that the commercial paper market has been standing still. That said the real problems touch on both liquidity and solvency, so the real solution needs to deal with both. If we don't deal with the worries over solvency, then we'll have a much bigger liquidity problem across the economy. Because the banks are afraid to lend money out, lots of companies are unable to then get the money they need for daily operations -- and then they become insolvent, creating a disastrous domino effect. Those with money are afraid to lend it, because they're afraid they won't get it back -- and their unwillingness to lend is making it so that others really can't meet their obligations. So, while there's some argument about solvency vs. liquidity, a solvency problem at one part of the chain can create a liquidity problem elsewhere, which in turn leads to solvency problems. This is why it is rather important to get those with money to get it moving again, or it very much is like an engine running out of oil. Just dumping money into the market can help somewhat, but until recently, it was mostly going to banks who already had cash, but weren't lending it.
Last month, Treasury Secretary Timothy Geithner unveiled the Obama administration's second front in its battle for economic recovery — a plan aimed at soaking up $500 billion in toxic loans to jump-start stalled bank lending. In an announcement, Geithner said the plan was designed to raise private funds, as well as use government money, to encourage investors to buy the assets. The action is a departure from the Bush administration's initial response to the financial meltdown, which Geithner praised while saying that it did not go far enough and suffered from a lack of transparency. Americans "have lost faith in the leaders of some of our financial institutions," he said, while they are "skeptical that their government has used taxpayers' money in ways that will benefit them." The White House under both Presidents Bush and Obama has come under fire for failing to provide a detailed accounting of how previous installments of the TARP money have been spent. "This has to change. To get credit flowing again, to restore confidence in our markets and to restore the faith of the American people, we are going to fundamentally reshape our program to repair the financial system," Geithner said. The plan represented one of "two fronts" — along with the more than $800 billion stimulus plan — in the "battle for economic recovery," he said.
Certainly, there will be oversight established on a global basis to deal with risk management issues, capital and liquidity requirements, the accounting rules will be reviewed to discuss accounting and reserve requirements for structured finance and complex derivative products.
Many questions remain as to how this oversight will be implemented. It’s unknown whether there will be a massive wide sweeping reform or if will be left to limited legislation at a federal or state level. Also, will oversight for financial institutions be consolidated under one organization. Effectively eliminating, state banking departments or consolidating the Office of the Comptroller with the State Banking Departments. Only time will tell.
Have your CPA or bookkeeper prepare a thorough analysis of each account on your balance sheet. More often than not there will be some significant blances that need adjustment. Its very dangerous to be making business decisions about things like AR and inventory when the account balances you are looking are wrong.
Get with your industry associations and find out what kind of financial benchmarks and statistics they provide. One of the best way to evaluate your financial performance is to compare your results against other companies in your industry. This could be critical information that you may not be performing as well as you could. This may be the wake up call you and your team need to get focused on making your business more profitable
The process of creating a budget forces you and your team to really think about your business plan and what is most likely to happen next year. It helps you determine what has to happen inorder to achieve your financial objectives. It creates accountability. You need to budget down to the detailed account level so you can enter that budget in your accounting system. Then every month you can review you income statement with the budget numbers by account. This will make your monthly review of the numbers fast and easy
Your budget projects specific revenue and expense categories and arrives at budgeted net income. Your collection of AR, purchase of inventory, loan payments, capital expenditures, accounts payable and other items that affect your cash flow also
To summarize,
Based largely on broad proposals made by President Obama, the Act is intended to provide a stimulus to the U.S. economy in the wake of the economic downturn brought about by the subprime mortgage crisis and the resulting credit crunch. The Act includes federal tax cuts, expansion of unemployment benefits and other social welfare provisions, and domestic spending in education, health care, and infrastructure, including the energy sector. The Act also includes numerous non-economic recovery related items that were either part of longer-term plans (e.g. a study of the effectiveness of medical treatments) or desired by Congress ( e.g. a limitation on executive compensation in federally aided banks added by Senator Dodd and Rep. Frank). The government action is much larger than the Economic Stimulus Act of 2008, which consisted primarily of tax rebate checks.
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