The Economic Crisis and You

1. The Economic Crisis and You Skip Victor November 4, 2010

2. The Economy

3. The Point “I have learned in my life as a composer chiefly through my mistakes and pursuits of false assumptions, not by my exposure to founts of wisdom and knowledge.” Igor Stravinsky

4. Experience With False Assumptions

8. My Background

9. Resume • 1956 Born in Detroit, Michigan • 1974 Cranbrook High School • 1978 Cornell University, A.B. in Economics • 1981 Bankers Trust Company • 1983 UCLA Anderson, MBA in Strategy & Policy • 1984 Drexel Burnham Lambert • 1990 Chanin Capital Partners • 2005 Balmoral Advisors • 2006 Duff & Phelps / Chanin Capital Partners

16. Observations • Assumptions • Questions • Listen • Synthesize • Mistakes and Failures and Rejections • Luck and Serendipity

17. Economic Crisis

18. What Happened • Severe Decline in Stock and Bond Markets • Record Foreclosures • High and Persistent Unemployment • (Near) Collapse of the Financial System • Decline of American Pre-eminence

19. Implicit Assumptions. . . • Home Ownership • Low Interest Rates • Financial Innovation • Globalization / New Prosperity • Ratings Agencies • Optimism

20. Housing In 2004 the George W. Bush administration urged Congress to pass the American Dream Downpayment Act. Federal Housing Commissioner John Weicher said, “the White House doesn’t think those who can afford the monthly payment but have been unable to save for a down payment should be deprived from owning a home.” He added, “We do not anticipate any costs to taxpayers.”

21. Housing “These two entities Fannie May and Freddie Mac are not facing any kind of financial crisis. . .” “I want to roll the dice a little bit more in this situation towards subsidized housing. . . “ Rep. Barney Frank House Financial Services Comm. September 2003

22. Housing “Improvements in lending practices driven by information technology have enabled lenders to reach households with previous unrecognized borrowing capacities.“ Alan Greenspan October 2004

24. Financial Innovation “Derivatives have permitted the unbundling of financial risks.” Alan Greenspan May 2005

25. Financial Innovation “Derivatives are financial weapons of mass destruction.” Warren Buffett

26. Risk “As long as the music is playing, you’ve got to get up and dance.” “We’re still dancing.” Charles Prince, July 2007 CEO of Citibank

27. The Day “The Music” Died. . . Citigroup’s stock market value dropped from $244 billion to $6 billion, 75,000 in employee layoffs, and approximately $45 billion in TARP/government assistance.

28. Lessons • Policy Confusion about Home Ownership • Home Values Don’t Always Increase • Spending Beyond Your Means Usually Doesn’t Last • Financial Economy vs. Real Economy: Volatility • Global Interdependence • Faulty Assumptions and Reliance on Ratings Agencies • Severe Under-pricing of Risk • Most of the Experts Missed It • Lessons Likely to Be Forgotten

29. Lessons What Economic Crisis Doesn’t Mean • Never Buy a House • Never Use Leverage • Don’t Buy Derivatives • Restrict Globalization • Prosperity is Over • Will Never Be Another Bubble / Crisis

30. Lessons What Economic Crisis Means For You • Tough Job Market • Lower Housing Prices • Harder to Obtain Financing • “Less” • Less Optimism, More Pessimism • Less Confidence, More Anxiety

31. Human Nature “ . . . Human beings assume that the existing state of affairs will continue indefinitely, except in so far as we have specific reasons to expect change.” John Maynard Keynes

32. Perspective • 9-11 • Savings & Loan Crisis • Long Term Capital Management • Internet Bubble • “Flash Crash” – May 6, 2010 • Recovery in Financial Markets in 2010

33. Dow Jones Industrial Average: January 1973 to December 6, 1974

34. Dow Jones Industrial Average: January 1970 to Present

35. Possible Next Crises • Pensions – Public and Private • Medical Care • Government Debt • Social Security • Environmental • Political • Terrorism

36. Future Economic Crisis:Underfunded State Pensions Costs to Taxpayers $124.6 Billion $109-127 Billion $389 Billion $3 Trillion Savings and Loan Crisis Troubled Asset Relief Program(“TARP”) Fannie May / Freddie Mac Underfunded State Pensions Source: Taxpayers for Wilson

37. Pensions Defined Contribution vs. Defined Benefit • Difference between setting aside a fixed amount of money each year and promising to pay a fixed amount in the future for an unknown amount of time • All about risk allocation

38. Pensions Predictions: • Move to defined contribution and away from defined benefit • Some promises will be broken

39. Greek Response to “Pension Reform”

40. Government Debt • Federal and state deficits and debt loads skyrocketing • History is littered with ruins of empires and kingdoms that have taken on debt they couldn’t repay

43. “The Federal Reserve can make a difference, but it doesn’t have a magic bullet. It can’t take a weak economy facing a lot of major challenges and rapidly turn it into a strong economy.” Donald Kohn Former Federal Reserve Vice Chairman

44. “Consumption when brought forward must be financed, and that financing is a two way bargain between borrower and creditor. When debt levels become too high lenders balk and even lenders of last-resort sovereigns, central bankers and supernatural agencies – approach limits beyond which private enterprises productivity itself is threatened.” Bill Gross PIMCO July 2010

45. Conclusions • Good News / Bad News • Humility, Curiosity, Flexibility • Mentor(s) • Think Independently • Read The Fine Print • Move up the Problem Hierarchy: • Cause • Identify • Solve • Assumptions Drive Behavior