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The Crash of 2008 and Its Aftermath

The Crash of 2008 and Its Aftermath. August 2010. Jack Marco Chairman/ Sr Consultant Marco Consulting Group. Outline. Part 1: 2008 Year in Review Part 2: 2009 Year in Review Part 3: 2010 First Half Year in Review Part 4: 2010 What Lies Ahead Part 5: How Pension Funds Suffered After 2008.

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The Crash of 2008 and Its Aftermath

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  1. The Crash of 2008 and Its Aftermath August 2010 Jack Marco Chairman/ Sr Consultant Marco Consulting Group

  2. Outline • Part 1: 2008 Year in Review • Part 2: 2009 Year in Review • Part 3: 2010 First Half Year in Review • Part 4: 2010 What Lies Ahead • Part 5: How Pension Funds Suffered After 2008

  3. 2008 Year in Review

  4. Jump on the Housing Bandwagon S&P/Case-Shiller United States Home Price Index 350 300 250 200 150 100 50 0 Mar-06 Mar-07 Mar-08 Mar-94 Mar-95 Mar-96 Mar-97 Mar-98 Mar-99 Mar-00 Mar-01 Mar-02 Mar-05 Mar-87 Mar-88 Mar-89 Mar-90 Mar-91 Mar-92 Mar-93 Mar-03 Mar-04 +206% (3-87 to 9-06) -21% (9-06 to 9-08) Source: Bloomberg, 1987 index level set to 100

  5. Homeowners… …took on too much debt Household Debt Debt $ Debt % 16,000 20 14,000 19 12,000 10,000 18 Total Debt Outstanding ($B) Debt Payments as % of Income 8,000 17 6,000 4,000 16 2,000 - 15 1980 Q1 1983 Q3 1987 Q1 1990 Q3 1994 Q1 1997 Q3 2001 Q1 2004 Q3 2008 Q1 Source: Federal Reserve

  6. Mortgage Lenders… Types of Mortgages Issued Agency Jumbo Alt-A Subprime Other 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 …issued risky mortgages and quickly sold them Source: PIMCO, UBS (2000-2007), JPMorgan (2008)

  7. Credit Freeze • First Half of 2008 • Overall lending slows • Lending frozen in risky areas (e.g., subprime, leveraged loans) • Belief that government will step in (Bear Stearns) • Second Half of 2008 • Lehman bankruptcy • Paralyzed by headlines • Lending frozen across the board (prime mortgages, corporate bonds, commercial paper, interbank lending)

  8. Headlines #1: Bankruptcy • Bankruptcy or similar failure • Lehman Brothers • FDIC seized 25 failed banks (IndyMac, Washington Mutual) • Retailers (Linens n’ Things, Sharper Image) • Others (ATA Airlines, Icelandic banks) • Reaction: Stocks ↓. Bonds ↓.

  9. Headlines #2: Government Assistance • Temporary government protection • Bear Stearns: JPM purchase with Fed $30 billion guarantee • Fannie Mae, Freddie Mac: conservatorship • AIG: $152 billion rescue package (loans and investments) • Dozens of major banks: accept $250 billion in government capital in exchange for preferred shares • Reaction: Stocks ↓. Bonds stabilize or ↑.

  10. Headlines #3: Private Assistance • Acquired or re-capitalized • Countrywide: acquired by Bank of America • Merrill Lynch: acquired by Bank of America • Morgan Stanley: $9 billion investment from Mitsubishi UFJ • Goldman Sachs: $5 billion investment from Buffet/Berkshire • GE: $3 billion investment from Buffet, $12 billion from others • Wachovia: acquired by Wells Fargo • National City: acquired by PNC Financial • Reaction: Stocks ↑. Bonds ↑.

  11. Headlines #4: Bank Holding Companies • Applied for federal bank charter • Morgan Stanley • Goldman Sachs • American Express • GMAC • Benefits: collect retail deposits, FDIC guarantee on bank debt, access to Fed’s discount window • Trade-Offs: bank regulators, higher capital requirements

  12. Massive Sell-Offs Cumulative Returns in 2008 US Large Cap US Small Cap Intl Equity Emrg Mkt Equity Aggregate Bond High Yield Bond Commodities 40% 20% 5.2% 0% Cumulative Return -20% -26.2% -33.8% -35.6% -40% -37.0% -43.4% -53.3% -60% -80% Jul-08 Oct-08 Jun-08 Jan-08 Mar-08 Apr-08 Dec-08 Aug-08 May-08 Nov-08 Feb-08 Sep-08 Source: Bloomberg

  13. Record Highs for Volatility VIX Volatility Index 90 80 70 60 50 Expected 30-day volatility - S&P 500 40 30 20 10 0 Jan-06 Jan-07 Jan-08 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-04 Jan-05 Credit Crunch Enron/Worldcom Russia/LTCM Sept 11, 2001 Tech Bubble Source: CBOE

  14. Flight to Quality Safety in U.S. Government assets • U.S. dollar • U.S. Treasuries Risk assets • Sell anything with any level of risk • Higher correlations across the board Technical reaction, not fundamental

  15. Strength of U.S. Dollar Nominal Dollar Broad Index 140 130 120 110 Index Level 100 90 80 70 Jul-03 Jul-04 Jul-05 Jul-07 Jul-08 Jul-02 Jul-00 Jul-01 Jul-06 Jan-08 Jan-03 Jan-04 Jan-05 Jan-06 Jan-00 Jan-01 Jan-02 Jan-07 Source: Federal Reserve’s trade-weighted US dollar index

  16. Treasury Yields Pushed to Zero 3M LIBOR Fed Funds Target 3M TBILL 6% 5% 4% 3% 2% 1.43% 1% 0.25% 0% 0.08% Jul-08 Oct-08 Apr-08 Nov-08 Jun-08 Jan-08 Mar-08 Dec-08 Aug-08 Sep-08 May-08 Feb-08 Source: Bloomberg

  17. Demand Higher Yields from Risky Bonds 2500 2000 1500 1000 500 0 Jul-08 Jul-08 Jul-08 Apr-08 Apr-08 Jun-08 Jun-08 Jan-08 Jan-08 Jan-08 Mar-08 Mar-08 Nov-08 Nov-08 Aug-08 Aug-08 May-08 May-08 Oct-08 Feb-08 Feb-08 Oct-08 Sep-08 Sep-08 Dec-08 Dec-08 Dec-08 Excess yield over Treasuries (basis points) Source: Option-adjusted spreads on Merrill Lynch indexes through 12-31-08

  18. Imagine a World Where… • People can’t get mortgages • People can’t get car or student loans • Companies can’t raise funds for new factories or new products • Companies have to stash more cash to cover payroll or operating costs • Banks don’t want to lend to each other

  19. Government Intervention • Buyer of last resort • Lender of last resort • U.S. Treasury • U.S. Federal Reserve • Foreign governments • Foreign central banks

  20. U.S. Bail-Out: TARP • $700 billion Troubled Asset Relief Program (TARP) • Run by the U.S. Treasury • Waiting for Congress to release second installment of $350 billion

  21. U.S. Bail-Out: Other Actions

  22. U.S. Bail-Out: Other Actions

  23. U.S. Bail-Out: Other Actions

  24. Central Banks Drop Rates Central Bank Interbank Lending Rates US England Canada Australia Europe Japan 8 7 6 5 4 3 2 1 0 Jul-07 Jul-08 Jan-07 Jan-08 Jun-08 Jun-07 Apr-07 Oct-07 Apr-08 Oct-08 Mar-07 Mar-08 May-07 May-08 Aug-07 Aug-08 Sep-08 Sep-07 Nov-07 Dec-07 Nov-08 Dec-08 Feb-07 Feb-08 Source: Bloomberg

  25. Concern 1: Housing Median Price Months Supply $300,000 12 11.2 $229,000 $250,000 10 $181,300 $200,000 8 Months Supply Median Price $150,000 6 $100,000 4 $50,000 2 $- 0 2005 2006 Jul-07 Jul-08 Oct-08 Apr-08 Oct-07 Apr-07 Jan-08 Jun-07 Mar-08 Jun-08 Sep-08 Nov-08 Feb-08 Aug-08 Mar-07 Aug-07 Sep-07 Nov-07 Feb-07 Dec-07 May-08 May-07 Home Sales Source: National Association of Realtors

  26. Concern 2: Economy and Unemployment 300 8.0 Change in Nonfarm Payrolls Unemployment Rate 7.2 177 200 162 7.0 140 126 107 81 100 74 60 57 46 41 6.0 25 0 5.0 -47 -67 -67 -100 -76 -83 -88 -100 -127 -200 4.0 Unemployment Rate Change in Nonfarm Payrolls (000s) -300 3.0 -400 -403 2.0 -423 -500 -524 1.0 -600 -584 -700 0.0 Jul-07 Jul-08 Apr-08 Oct-08 Apr-07 Oct-07 Jan-08 Jun-08 Jan-07 Jun-07 Mar-08 Nov-08 Mar-07 Nov-07 Feb-08 Dec-08 Feb-07 Dec-07 Aug-07 Sep-07 Aug-08 Sep-08 May-08 May-07 Source: Bureau of Economic Analysis

  27. Hopeful Sign 1: Historical Recessions Source: NBER

  28. Hopeful Sign 2: Average Drawdowns S&P 500 Index Returns • Average return for the 3 months following the bottom of a cycle: +13.9% • Average return for the 12 months following the bottom of cycle: +34.9% • Return from 11/20/08 to 12/31/08: +20.5% Source: Attalus Capital, Morningstar

  29. Hopeful Sign 3: Forecast MSNBC Year-End Economic Roundtable Source: MSNBC.com

  30. Hopeful Sign 4: Government Actions Hooray! More jobs More infrastructure More stimulus checks More tax breaks Easier mortgages Challenges Higher taxes later or spending cuts elsewhere Infrastructure projects take time to get running Mortgage modifications can hurt bond investors Government spending can lead to: weaker dollar higher inflation being more indebted to other nations

  31. 2009 Year in Review

  32. 2009: a Tale of Two Markets In early 2009, investors were still shell-shocked from 2008 Credit markets still frozen Fear prevailed as investors kept money on the sidelines “Green shoots” of economic recovery Investors begin risk-seeking typical of recoveries and market normalization Bargain-hunting activity increase as investors see oversold areas of market Q1 Q2 to Q4

  33. Early 2009 Headlines...

  34. In January, Things Were Still Unraveling... Asset Prices Investments Consumption Spending Savings Profits Employment Characterized by: • Market uncertainty: indicated by high volatility; search for market bottom • Declining consumer spending and business investment • Home prices in free fall • Rising unemployment The Downward Economic Spiral Dire negative expectations and lack of credit availability prevent a reset of the system despite much lower asset prices Source: PIMCO

  35. Equity Markets Continued Heading South… 1/1/09-3/9/09 decline = -24.6% 0% 2008 decline = -37.0% -10% -20% 10/9/07-3/9/09 total decline from the market peak to the market trough: -54.9% -30% -40% -50% -60% 10/07 12/07 02/08 04/08 06/08 08/08 10/08 12/08 02/09 04/09 06/09 08/09 10/09 12/09 Cumulative Returns 10/9/2007 - 12/31/2009

  36. Consumer Confidence Went With the Markets Consumer Confidence Index 160 140 Monthly Average 7/31/2000 – 2/28/09 = 94.7 120 100 80 60 40 2/28/09 level = 25.3 20 0 Jul-00 Sep-01 Nov-02 Jan-04 Mar-05 May-06 Jul-07 Sep-08 Dec-09 • Consumer confidence bottomed in February Source: The Conference Board (via Bloomberg). Consumer Confident Index through 2/28/2009.

  37. Government Intervention in 2009 • February 17: $787 billion government stimulus package enacted • February 18: Obama announces plan to aid homeowners with mortgage payments • March 18: Federal Reserve announces it will increase its balance sheet to purchase additional securities for the purpose of increasing liquidity in credit markets • March 23: Treasury details Public Private Investment Program • June 24: Bill with Cash for Clunkers provision signed into law

  38. “Green Shoots” Appeared in Late Q1 “Green shoots” is a term used colloquially to indicate signs of economic recovery during an economic downturn. Federal Reserve Chairman, Ben Bernanke, made the first public use of the phrase by a Fed official in a March 15, 2009 interview with 60 Minutes BusinessWeek cover, April 13, 2009. Bernanke photo from www.federalreserve.gov

  39. March 9th Market Turnaround 0% -10% -20% -30% -40% -50% -60% 10/07 12/07 02/08 04/08 06/08 08/08 10/08 12/08 02/09 04/09 06/09 08/09 10/09 12/09 Cumulative Returns 10/9/2007 - 12/31/2009 Source: Bloomberg, through 12/09

  40. S&P 500 Rebounded 66% Since March Bottom 0% -10% -20% -30% -40% -50% -60% 10/07 12/07 02/08 04/08 06/08 08/08 10/08 12/08 02/09 04/09 06/09 08/09 10/09 12/09 Cumulative Returns 10/9/2007 - 12/31/2009 66.1% rally since March 9 Source: Bloomberg, through 12/09

  41. Consumer Confidence Turned Up in March Consumer Confidence Index 160 140 Monthly Average 7/31/2000 – 12/31/2009 = 90.5 120 100 80 60 40 20 Current level = 52.9 0 Jul-00 Feb-02 Sep-03 Apr-05 Nov-06 Jun-08 Dec-09 • Consumer confidence rebounded March through May; flat in the third quarter • Still well-below average Source: The Conference Board (via Bloomberg). Consumer Confident Index through 9/30/2009.

  42. End of the Recession • Economists indicate recession officially over in mid-year 2009 • Bernanke: “From a technical perspective the recession is likely over” • Former Fed staffer: “June was mostly likely the trough” • 41 of 51 economists surveyed by WSJ believe recession is over • But things are still tentative… • Unemployment • Consumer spending • Credit creation • Housing prices • Government programs • Where are we today and where are we going?

  43. Yield Curve Steepening Process Began Treasury Yield Curve 12/31/2008 12/31/2009 6.0 5.5 4.64 5.0 4.5 3.84 4.0 3.5 2.68 2.68 Yield to Maturity (%) 3.0 2.21 2.5 1.55 2.0 1.5 1.0 0.44 0.5 0.34 0.0 1 yr 10 yrs 30 yrs 5 yrs 3 mos Time to Maturity • Beginning of Year and End of Year Difference

  44. In the U.S., GDP Growth Was Positive in Second Half but Negative for Full Year U.S. GDP Growth 10 Real GDP Growth, % change q/q at an annualized rate 7.5 8 6.4 5.7 6 4.8 4.8 4.8 3.8 3.6 3.5 3.5 4 3 3 2.8 2.7 2.7 2.6 2.7 2.5 2.4 2.2 2.1 2.2 1.6 1.5 1.3 2 1.2 1.2 1.0 0.9 0.8 Percent Change from Prior Quarter 0.2 0.1 0 -0.2 -0.5 -0.5 -0.5 -1.0 -1.4 -2 -4 -6 -6.1 -6.3 -8 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Full year 2009 GDP declined by 2.4% Source: Morgan Stanley

  45. Potential Shapes of the Economic Recovery • Economic Alphabet Soup • V Shaped Recovery • U Shaped Recovery • W Shaped Recovery • L Shaped Recovery

  46. V-Shaped Recovery Example GDP Growth 1952-1955 15% 10% 5% 0% -5% -10% 1952 1953 1954 1955 • U.S. Recession of 1953 • GDP growth for this recession forms a classic v-shape

  47. U-Shaped Recovery Example S&P 500 Index 1973-1976 GDP Growth 1973-1975 140 12% 10% 120 8% 100 6% 80 4% 2% 60 0% 40 -2% 20 -4% -6% 0 1973 1974 1975 1976 1973 1974 1975 1976 • U.S. Recession of 1973-1975 • Recession is longer than a V-shaped recession with a less clearly-defined trough • GDP may shrink for several quarters and only slowly return to trend growth

  48. W-Shaped Recovery Example 8 6 4 2 0 -2 -4 1978 1979 1980 1981 1982 1983 1984 GDP Growth 1978-1983 • Early 1980s Recession in the U.S. • Also called a “Double Dip” recession

  49. L-Shaped Recovery Example 45000 40000 35000 30000 25000 20000 15000 10000 5000 0 85 87 89 91 93 95 97 99 01 03 05 07 09 NIKKEI 225 (1984-2009) • Asset Price Bubble in Japan 1980s-1990s Source: finance.yahoo.com. Penn World Tables

  50. Key Themes in 2009 Unemployment Consumer Spending Government Actions Housing Credit Creation

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