THE SUBPRIME CRISIS What (the Hell) Happened and Why Presented by: Ken Roberts Foster Pepper, LLP Alphabet Soap ABS Alt-A ARS BHC CDO CDS CP CRA(2) CSE EESA FDIC FHFA FHLMC FNMA FRB FVA GDP GSE Hedge Funds LIBOR MBS Moral Hazard Naked Short Ninja OCC OTTI Prime Risk-Based Assets RPF Securitization Shorts SIV Subprime TARP Teaser TED Tier 1 Traunches “_______* makes the world go ‘round” *(Perry Como – 1958) *(Bernanke – 2008) The Numbers US GDP: $14.0 Trillion Us Mortgage Debt (most held in MBS) $12.0 Trillion US Federal Debt: $10.6 Trillion US Debt Held by the Public $5.0+ Trillion US Federal Obligations $60.0 Trillion ($560,000 per household) The Numbers (continued) US Commercial Paper $1.5 Trillion Money Market Funds $3.4 Trillion Collateralized Debt Obligations $3.0 Trillion Credit Default Swaps $58.0 Trillion How To Sell Big Ticket Items? “No One Cares what the Price is, They Only Want to Know what the _________ is.” Why Did it Happen? Interest Rates at Historic Lows Dot.com Bubble Bust and 9/11 Fed Funds Rate drops to 1% in 2003 Prime Rate at 4% in 2003 Why Did it Happen? Government Policy Promoting Home Ownership CRA Freddie Mac & Fannie Mae Mandated to: Lower credit standards Increase ownership of mortgages to subprime borrowers Capital ratios lowered SEC Adopts Consolidated Supervised Entity Why Did it Happen? Affordability ARMs Interest Only Teaser Rates Ninja Loans Why Did it Happen? Securitizations MBS GSE CDO SIV Credit Agencies CDS Why Did it Happen? Moral Hazard “Reducing Risk too much exposes people to the Hazard of Irresponsible Risk-taking” Mortgage Originators Securitization Credit Agencies CDO & SIV CDS Boom in the US Housing Market 1997-2006 124% price increase Price to median income moved from 3.0x to 4.6x Housing starts: 2.0 million annually The Bust Gravity Happens Excess Supply Speculators ARMs Reset Mortgage Debt 1190: 1908: 2008: First Reported Mortgage Standard Down Payment 50% US Single Family Mortgage Debt $12.0 Trillion (amount held by Freddie Mac and Fannie Mae: $6.0) Subprime & Alt-A Mortgage Debt $3.0 Trillion (virtually all securitized) Estimated Subprime Mortgage Losses $500 Billion – $1.0 Trillion The Effect 10.0 million homeowners underwater (12%) 10% Mortgage Loans Delinquent Huge Losses (aggravated by FAS 157) Job Losses Mounting Retail Sales – Big Ticket Items, down sharply The Names Barney Frank: Ranking Democrate on House Financial Services Committee (2000-2008) Alan Greenspan: Fed Chairman (1987-2006) Mark Brickell: Managing Director JP Morgan (1994) Henry Cisneros: Secretary of HUD (1993-1997) William Donaldson: SEC Chairman (2003-2005) Richard Fuld, Jr.: CEO of Lehman Brothers (19942008) Ben Bernanke: Current Fed Chairman Henry Paulsen: Current Secretary of the Treasury The Investment Banking Meltdown Bear Stearns June 2007: Bailed out Two Highly leveraged CDO Funds. July 2007: Two of it’s Subprime Hedge Funds lost nearly 100% of their value March 2008: FRB Loans $29.0 Billion backed solely by certain pledged assets; JP Morgan Purchases Bear Sterns The Investment Banking Meltdown July 17, 2008: IndyMac Bank closed by FDIC (largest failed bank to date) The Investment Banking Meltdown September 7, 2008: Fannie Mae & Freddie Mac Nationalized ($6.0+ Trillion). The Investment Banking Meltdown Lehman Brothers Born: 1844 Bankruptcy: September 15, 2008 ($600 Billion) The Investment Banking Meltdown Reserve Primary Fund September 16, 2008: Broke a Buck ($65.0 Billion) The Investment Banking Meltdown September 16, 2008: AIG (essentially) Nationalized The Investment Banking Meltdown September 22, 2008: Morgan Stanley and Goldman Sachs become Bank Holding Companies; increased access to the Fed Window The Investment Banking Meltdown September 30, 2008: $25.0 Billion in US Loans available to US auto makers FASB Statement No. 157 reinterpreted IRS revised NOL rules for Bank mergers The Investment Banking Meltdown October 3, 2008: EESA passes both Houses (includes $700 Billion for TARPs) FDIC increases deposit insurance The Investment Banking Meltdown October 14, 2008: 30 Day T-bill rate drops to all time low of 5bp Treasury reserves $250 Billion of TARPs for investment in banks and other financial institutions The Investment Banking Meltdown October 21, 2008: Fed commits $540 Billion to buy commercial paper adding liquidity to money market funds. The Great Depression Unemployment: 25% Stock Market Dropped 90% First Mortgages in Default 44% “I would have lost more but that was all the money I had.” Groucho Marx, 1929 AND THIS TOO SHALL PASS