Transcript The New Hard Times

The New Hard Times
Recession or depression?
OR
Depression 2.0
Where are we?
Depression / depression /
recession?
Recession
•
A general economic
decline; specifically, a
decline in GDP for two or
more consecutive
quarters.
– GDP – the measuring
stick to tell us how
much the economy is
growing or shrinking.
– Business quarter =
three months.
What kind of growth has the US
economy had?
• Usually “good” growth is
3% per year.
Symptoms of a recession?
• Higher unemployment –
– July 2009 – 9.7%
Another symptom of recession
• Less consumer spending!
– Personal Income is
down.
• -1.8%
– Personal Consumption
Expenditures are UP.
• .4%
• RECESSION:
People HAVE
money, but they
don’t feel safe
enough to spend it.
So where is the recession?
Where is the recession in the
US?
http://www.msnbc.msn.com/id/30991972
Current Unemployment
http://www.nytimes.com/interactive/2009/07/15/business/economy/20090715leonhardt-graphic.html
So, why isn’t this a depression?
Definition of Depression
• a depression is a
sustained, long downturn
in one or more
economies. It is more
severe than a recession,
which is seen as a normal
downturn in the business
cycle.
Definition of a depression
• Considered a rare and
extreme form of recession, a
depression is characterized
by abnormal increases in
unemployment, restriction of
credit, shrinking output and
investment, numerous
bankruptcies, reduced
amounts of trade and
commerce, as well as highly
volatile relative currency
value fluctuations, mostly
devaluations. Price deflation
or hyperinflation are also
common elements of a
depression
The New Hard Times
Recession or depression?
OR
Depression 2.0
Where are we?
Bankers: Plains Economy in Bad
Shape • OMAHA -- A monthly survey of rural bankers suggests
the economy in 11 Midwest and Plains states is still in
bad shape, with real estate, retail sales and hiring still
below levels needed for growth.
• The Rural Mainstreet Index dipped to 32.0 in August from
32.6 in July and 34.0 in June. It is, however, significantly
higher than the index's record low of 16.9 in February.
• The index ranges from 0 to 100. A score below 50
suggests the economy will contract in the next three to
six months, while a score above 50 indicates the
economy will expand.
• 10th-straight month of contraction.
• Lincoln Journal Star, Friday August 22, 2009
BUT: New state unemployment
numbers came out!
• 17 states reported
DECREASES in
unemployment.
– Nebraska went from
5% to 4.9%
• 26 States reported
INCREASES!
– August 22, 2009
BUT: Sales of existing homes increased
for the first time in 2 Years!
• The U.S. housing market
is a buyer's market and
they are buying.
• The National Association
of Realtors reports sales
of existing homes
nationwide jumped 7.2
percent in July, the
biggest monthly increase
since it began keeping
track in 1999.
– BizJournal, August 23,
2009
Is the economy on the “cusp of
recovery”?
• Fed Chairman Ben Bernanke
said today that the U.S.
economy is on the verge of
recovery after having
endured the worst financial
crisis since the Great
Depression.
• "After contracting sharply
over the past year, economic
activity appears to be
leveling out, both in the
United States and abroad,
and the prospects for growth
in the near term appear
good," Bernanke said during
a speech in Jackson Hole,
Wyo.
– August 21, 2009
BUT:
• Though much progress in
stabilizing the markets
worldwide has been made,
Bernanke cautioned that the
economy is not back to
normal and more steps will
have to be taken toward
long-term stability in the
financial system.
• "Although we have avoided
the worst, difficult
challenges still lie
ahead," he said.
– Bernanke’s speech on
August 21.
So how did this recession start?
• In one word?
– DELEVERAGING
Leverage – a Financial Term
• he use of various financial
instruments or borrowed
capital, such as margin, to
increase the potential return
of an investment.
2. The amount of debt used
to finance a firm's assets. A
firm with significantly more
debt than equity is
considered to be highly
leveraged.
Leverage is most commonly
used in real estate
transactions through the use
of mortgages to purchase a
home .
So, what is Deleverage mean?
•
The best way for a
company or individual to
delever is to immediately
pay off any existing
debt on its balance sheet.
If it is unable to do this,
the company or individual
will be in significant risk
of defaulting.
Deleverage
• Companies or individuals
will often take on excessive
amounts of debt to initiate
growth. However, using
leverage substantially
increases the riskiness of
the firm or individual.
• If leverage does not further
growth as planned, the risk
can become too much for
the company to bear. In
these situations, all the firm
can do is delever by paying
off debt.
Two ways that most consumers
accrue debt
• Spending too much!
• Over investing in homes.
How do you get into financial
trouble?
Study the four scenarios
from FINANCING YOUR
FUTURE – and in your
group answer the
following:
Is this person / family
creating wealth?
What are they doing
wrong or right?
The fact of debt
• 1980: Household debt
was 50% of GDP.
• 2006: Household debt
was 100% of GDP.
– In other words,
households now owe
as much as the
ENTIRE US economy
can produce in a year!
• The Ascent of Money:
A Financial History of
the World – Niall
Ferguson
How did this happen?
• Much of this increase in
debt was used to invest in
real estate.
– Some markets saw the
prices of US Housing
rise 20% per year!
– A BUBBLE was
formed.
Bubble?
• Trade in products or
assets with inflated
values.
– Prices are higher than
the product is worth!
– Bubbles BURST
Step 1 to the Recession
• The Real Estate Bubble
burst.
• More Supply than
demand.
A new factor: The Subprime
Borrower
• People that were “credit
risks” getting loans.
• Were they maybe
“encouraged” by some
banks / loan companies to
overleverage themselves?
Subprimes find their interest
rates up BUT
• Their homes are worth
less than their mortgages.
– UNDERWATER
• DEFAULTS rise, sending
prices further south.
• The downward spiral
begins.
Step 2: Run on CDOs
• Collateralized Debt
Obligations (CDOs)
• The basic principle of CDO
is that corporations hold
assets as COLLATERAL.
• The financial institutions
then packaged groups of
CDOs and sold them to
people as “cash flow
investments.”
• Pools of mortgages
– AAA / AA rating on a lot!
• Now called TOXIC
ASSETS
Step 3: Leverage LOVES
Company!
• Firms borrow to load up
on CDOs and other real
estate.
• Lehman Brothers was
leveraged more than 30 to
1.
– OWED $30 for every $1
they made.
Step 4: The Mortgage Collapse
• Defaults begin to hit big
lenders like Washington
Mutual and Countrywide
Financial.
Step 5: Finance Takes the Next
Hit
• CDOs lose values.
Investment banks must
raise capital.
• Can’t raise the capital
needed to cover their
leverage.
• Bear Sterns / Lehman
Brothers / Citi Group
The stock market reacts!
• No one wants to invest in
companies that are going
DOWN!
• Stock prices CRATER!
• Companies don’t have
money to operate.
– Close?
– Get a loan?
– Cut costs?
– Sell assets?
– Ask the federal
government for help?
How bad is it?
• June 4 (Reuters) - Top U.S. and European banks have lost
more than $900 billion on toxic assets and from bad
loans since the start of 2007.
• Deleveraging assets soared in 2008 as a global financial
crisis deepened. Losses on souring corporate and home
loans are rising as economies worsen.
• Losses by banks between 2007 and 2010 are expected to
reach almost $2.5 trillion, roughly split between losses on
securities and bad debts on loans, according to
International Monetary Fund forecasts. U.S. banks will
take a $1.6 trillion hit and European bank losses will
reach $737 billion, the IMF said.
Step 6: Begin the Bailout
• Government loan
programs like Fannie Mae
and Freddie Mac have to
be made “wards” to try to
stop the crisis.
– A LOT of toxic assets!
Step 6: Begin the Bailout
• Then the Feds step in and
save AIG.
– $135-billion.
• The Proposal was made
in September that $700
Billion would be needed
to bail out the financial
institutions.
Step 7: The Freeze
• With questions IF the bailout
would be passed and IF it
was enough – credit markets
seized up.
– CDOs were rated as
“junk”
– Big banks were reluctant
to loan to ANYONE.
– Small banks didn’t want
to loan.
– Businesses couldn’t get
money for operation.
• Raise prices?
• Cut costs?
• Go out of business?
How does the credit crunch
affect mortgages
• Mortgage rates are low –
but the trick is GETTING
APPROVED.
– More of a down
payment
• 5% to 15% down!
– Higher credit scores.
• At LEAST a 680
How does the credit crunch
affect credit cards?
• Credit card offers in your
mailbox have dropped
35%!
• If you live in an area hit by
house-price deterioration,
credit limits are cut 10%
• More background credit
checks before approval!
How does the credit crunch
affect auto loans?
• 0% financing exists – BUT
YOU AREN’T GOING TO
GET IT unless your credit
score is OVER 700.
• Approval rates for people
with good credit have
gone down 30% since
2008.
How will the credit crunch affect
student loans?
• 137 lenders have stopped
funding federal student
loans.
• 33 lenders have dropped
private programs.
• Loans approvals taken
by parents are down 29%
• Education Dept. are
spending $5 billion
buying loans in an effort
to reignite private lending.
Step 8: The Market Gets Volatile
• Volatility is NEVER good
in the stock market.
Step 8: The Stock Market Gets
Volatile
• Investors head to the
sidelines, willing to park
their money until it is safe
to come out again.
Step 9: The Deleveraging Death
Spiral
• Banks under stress
(Washington Mutual and
Wachovia) need to set
aside more capital against
potential losses.
• How do you do that?
– Sell assets.
Step 9: The deleveraging death
spiral • Asset prices go even
lower – which requires
more capital.
Step 10: From Wall Street to
Main Street
• As lending tightens, short
term loans on about
everything become less
available.
Step 10: From Wall Street to
Main Street
• Commerce gets stuck.
• Growth slows
• Layoffs follow as
companies trim costs.
Are there signs of life for the
economy?
• The “Clunker” programs
are getting people out.
• People are responding to
the “big” sales.
• Other ideas?
What is the cost?
• www.brillig.com/debt_clo
ck