The Financial Crisis
of 2008
“The road to hell is paved with good
intentions”
And a lot of greed
© Gaylen K. Bunker, 2008, All Rights
Reserved
Clinton Administration
1. The Gramm-Leach-Bliley Act of 1999:
–De-regulated the banking industry (competition)
–Sub-prime mortgages (help the poor)
–Complex derivatives (mortgage backed
securities – more options and insurance)
2. The "dot-com bubble“ of the 1990s burst
climaxing in Aug of 2000 when the
S & P 500 peaking above 1500
3. Enron exposed manipulation of accounting--(Sarbanes-Oxley: Fannie and Freddie Excluded)
© Gaylen K. Bunker, 2008, All Rights
Reserved
Distribution of Income: 2006
The poorest 20% of the population makes 3.4% of the income
3.4
8.6
14.5
Lowest Fifth
Second Fifth
50.5
Third Fifth
Fourth Fifth
Highest Fifth
22.9
The richest 20% of the population makes 50.5% of the income
© Gaylen K. Bunker, 2008, All Rights
Reserved
S & P 500 Industrials
1800
1600
1400
1200
1000
800
600
400
200
0
© Gaylen K. Bunker, 2008, All Rights
Reserved
Push for lowering credit standards
In the Winter 2000 edition of the City Journal Howard
Husock reported how Bill Clinton's Administration
forced banks to loan large sums of money to high risk
projects in inner cities. The Democrats in Congress and
the White House forced banks to lower their
investment standards in order to…help poor people.
http://www.parapundit.com/archives/005558.html
© Gaylen K. Bunker, 2008, All Rights
Reserved
Alan Greenspan
Fed Res Chair 1987 to 2006
Greenspan said as chairman at the Federal Reserve System's
Fourth Annual Community Affairs Research Conference,
Washington, D.C. April 8, 2005.
“Innovation has brought about a multitude of new
products, such as subprime loans… Such
developments are representative of the market
responses that have driven the financial services
industry throughout the history of our country. With
these advances in technology, lenders have taken
advantage of credit-scoring models and other
techniques for efficiently extending credit to a broader
spectrum of consumers.”
© Gaylen K. Bunker, 2008, All Rights
Reserved
Alan Greenspan (con’t)
“It was our job to unfreeze the American
banking system if we wanted the economy
to function. This required keeping interest
rates modestly low,”
© Gaylen K. Bunker, 2008, All Rights
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Alan Greenspan (con’t)
“The development of a broad-based secondary
market for mortgage loans also greatly expanded
consumer access to credit. By reducing the risk of
making long-term, fixed-rate loans and ensuring
liquidity for mortgage lenders, the secondary
market helped stimulate widespread competition
in the mortgage business.”
© Gaylen K. Bunker, 2008, All Rights
Reserved
Alan Greenspan (con’t)
“The mortgage-backed security helped
create a national and even an international
market for mortgages, and market support
for a wider variety of home mortgage loan
products became commonplace,”
© Gaylen K. Bunker, 2008, All Rights
Reserved
Fannie Mae (10K) Dec 31, 2007
The following diagram illustrates the basic process by which we create a typical Fannie Mae MBS
in the case where a lender chooses to sell the Fannie Mae MBS to a third-party investor.
Trying to add liquidity
to the market
© Gaylen K. Bunker, 2008, All Rights
Reserved
Credit Default Swaps
A credit default swap (CDS) is a contract in which
the buyer makes a series of payments to the seller
and, in exchange, receives a payoff if a credit
instrument goes into default. Credit insurance
Credit Default Swaps can be bought by any
investor; it isn’t necessary for the buyer to own the
underlying credit instrument.
© Gaylen K. Bunker, 2008, All Rights
Reserved
The System and AIG
© Gaylen K. Bunker, 2008, All Rights
Reserved
Mortgage Rate History
Interest rates
began a long
decline early in
2001
http://mortgage-x.com/general/historical_rates.asp
© Gaylen K. Bunker, 2008, All Rights
Reserved
Home sales
reached their peak
in 2005
© Gaylen K. Bunker, 2008, All Rights
http://calculatedrisk.blogspot.com/2008/06/existing-home-sales-not-seasonally.html
Reserved
Speculators & Flippers
"Historically, roughly 3 percent of all houses
nationally are bought for investment purposes.
During the 2004-06 period, as much as 25-35
percent of houses in hot real estate markets -such as southern Florida, Las Vegas, and
California -- were bought by investors and
speculators."
Robert F. Wescott, Ph.D.
President, Keybridge Research LLC
© Gaylen K. Bunker, 2008, All Rights
Reserved
© Gaylen K. Bunker, 2008, All Rights
http://mysite.verizon.net/vzeqrguz/housingbubble/
Reserved
Oct 2004
House hearing on Fannie Mae
Ruben Hinojosa: “Over the last 4 years, the United States
has suffered from immense job loss; an increase in the
number of people living in poverty; an incredible and
unsupportable switch from federal budget surplus to an
ever-growing budget deficit; [and] a tremendous increase in
the national debt.
“However, there is one sector of our economy that
has been performing well consistently, and that is the
housing market. It has served as the foundation of the U.S.
economy since the stock market declined. We need to
nurture it [and] ensure that nothing we do…harms it.”
© Gaylen K. Bunker, 2008, All Rights
Reserved
Oct 2004
House hearing on Fannie Mae
Barney Frank: “We have a subset of issues involving
affordable housing, and those are very important to many
of us. What derailed the [regulatory] legislation was an
insistence by the Bush administration on going beyond
safety and soundness and…not do these new products.
“There was an article by Gretchen Morgenson in the
New York Times on Sunday that said the problem is that
they have done too much to bring housing to people who
really cannot afford it and they have overextended by
lending money to people who were below the economic
level that should be there.
© Gaylen K. Bunker, 2008, All Rights
Reserved
William H. Donaldson
SEC Chairman (2003-2005)
“SEC decision allowed [five] firms
to legally violate existing net
capital rules that, in the past 30
years, had limited broker dealers
debt-to-net capital ratio to 12-to1. Instead, the 2004 exemption
allowed them to lever up 30 and
even 40 to 1. "
© Gaylen K. Bunker, 2008, All Rights
Reserved
1959: founded
Donaldson, Lufkin
& Jenrette.
Investment Bank
Grease the
wheels of credit
and growth.
Consumer Debt (pink) and Financial Profits (blue)
as a Percentage of GDP (John Watkins)
Drop Page Fields Here
140.00%
4.50%
4.00%
120.00%
3.50%
100.00%
3.00%
80.00%
2.50%
Data
2.00%
60.00%
1.50%
40.00%
1.00%
20.00%
0.50%
0.00%
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
0.00%
© Gaylen K. Bunker, 2008, All Rights
Year orReserved
quarter
0.00%
1959.
1960.
1961.
1962.
1963.
1964.
1965.
1966.
1967.
1968.
1969.
1970.
1971.
1972.
1973.
1974.
1975.
1976.
1977.
1978.
1979.
1980.
1981.
1982.
1983.
1984.
1985.
1986.
1987.
1988.
1989.
1990.
1991.
1992.
1993.
1994.
1995.
1996.
1997.
1998.
1999.
2000.
2001.
2002.
2003.
2004.
2005.
2006.
2007:III
Financial Profits as a Percentage of GDP
(John
Drop Watkins)
Page Fields Here
4.50%
4.00%
3.50%
3.00%
2.50%
Data
Sum of Other Financial/GDP
2.00%
Sum of Fed Res Banks/GDP
1.50%
1.00%
0.50%
© Gaylen
K. Bunker, 2008, All Rights
Year or quarter
Reserved
Mortgage Rate History
http://mortgage-x.com/general/historical_rates.asp
© Gaylen K. Bunker, 2008, All Rights
Reserved
Hurricane Katrina
Hurricane Katrina was the costliest hurricane, as
well as one of the five deadliest, in the history of the United
States. It formed over the Bahamas on August 23, 2005,
and crossed southern Florida. The most severe loss of life
and property damage occurred in New Orleans, Louisiana.
At least 1,836 people lost their lives in the actual
hurricane and in the subsequent floods.
The storm is estimated to have been responsible for
$81.2 billion (2005 U.S. dollars) in damage, making it the
costliest tropical cyclone in U.S. history.
© Gaylen K. Bunker, 2008, All Rights
Reserved
A decline in building permits was caused by:
1. Mortgage rates have risen steadily over the last
10 weeks, [and] Higher rates tend to depress
demand for housing.
2. In addition, prices for lumber, concrete and other
building materials have jumped in the wake of
Hurricane Katrina.
3. The steady rise in new home prices in recent
years has also helped put the brakes on building.
Prices create their own drag on the market.
http://money.cnn.com/2005/11/17/news/economy/housingstarts/index.htm
© Gaylen K. Bunker, 2008, All Rights
Reserved
Housing Starts
© Gaylen K. Bunker, 2008, All Rights
Reserved
Warren Buffett
"It's only when the tide goes out that
you learn who's been swimming
naked."
© Gaylen K. Bunker, 2008, All Rights
Reserved
Mort Zuckerman
Publisher/owner of the New York Daily News since 1993 and
Editor-in-Chief of U.S. News & World Report since 2007.
“The single greatest contributor to the housing
bubble was Fannie and Freddie. Everybody
knew these were two government sponsored
institutions out of control. They made over 600
billion dollar investment in sub-prime
mortgages in the first six years of this century.
Paulsen, when he said the core of the problem
was the collapse of housing---that’s where it all
started in the sub-prime field.”
McLaughlin Group Sep, 21, 2008
© Gaylen K. Bunker, 2008, All Rights
Reserved
Mort Zuckerman (con’t)
Publisher/owner of the New York Daily News since 1993 and
Editor-in-Chief of U.S. News & World Report since 2007.
Cox, the SEC commissioner was the man who
sat there while they doubled and even tripled
the ability of financial houses to use leverage.
They went from a maximum of twelve to one to
as high as forty to one. This is what happened
on the other side---the over uses of leverage
that compounded the problem in the housing
world and vice versa.”
McLaughlin Group Sep, 21, 2008
© Gaylen K. Bunker, 2008, All Rights
Reserved
© Gaylen K. Bunker, 2008, All Rights
http://mysite.verizon.net/vzeqrguz/housingbubble/
Reserved
Morgan Stanley (10K) Dec 31, 2007
The Company recorded $9.4 billion in mortgagerelated writedowns in the fourth quarter of fiscal
2007 resulting from an unfavorable subprime
mortgage-related trading strategy and the
continued deterioration and lack of market liquidity
for subprime and other mortgage-related
instruments. Included in the $9.4 billion were
writedowns of $7.8 billion related to U.S. subprime
trading positions, principally super senior
derivative positions in CDOs.
© Gaylen K. Bunker, 2008, All Rights
Reserved
S & P 500 Industrials
1800
1600
1400
1200
1000
800
600
400
200
0
© Gaylen K. Bunker, 2008, All Rights
Reserved
Unemployment Rate Nov ‘07 to Nov ’08
(in thousands)
Emp’d
11/07
Occupation
Emp’d
11/08
UnEm
11/07
UnEm
11/08
%
11/07
%
11/08
Total
Chng
% of
Total
Mgmt, Prof & related occupations
52348
53274
963
1786
1.8%
3.4%
823
27.1%
Service occupations
23763
24595
1651
1898
6.9%
7.7%
247
8.1%
Sales and Office occupations
36260
35205
1579
2304
4.4%
6.5%
725
23.9%
Nat'l res, constr & maint. occupations
16011
14480
955
1587
6.0%
11.0%
632
20.8%
Prod'n, transp. & Mat'l occupations
18636
17055
1117
1726
6.0%
10.1%
609
20.1%
147018 144609
6265
9301
4.3%
6.4%
Total
http://www.bls.gov/news.release/empsit.t10.htm
© Gaylen K. Bunker, 2008, All Rights
Reserved
3036 100.0%
The distribution of millionaires in the main regions of the world:
•North America - 2.9 million
•Europe - 2.8 million
•Asia-Pacific - 2.4 million
•Latin America- 0.3 million
•Middle East - 0.3 million
•Africa - 0.1 million
“If all the
national of
the world
are in debt,
where did
the money
go?”
Reader’s Digest,
Jan. ‘09
http://ww-success.com/blog/index.php/2006/10/16/millionaires-in-the-world/
© Gaylen K. Bunker, 2008, All Rights
Reserved
Remedy
“We do not need much more regulation
other than to put a ceiling on leverage by
investment banks and to impose, and
enforce, market-based regulations. Marketbased regulations will do away with
bureaucrats riding a turtle while trying to
catch up to a race horse.”
VALERIANO F. GARCIA (executive director of the World
Bank from 1998 to 2000)
© Gaylen K. Bunker, 2008, All Rights
Reserved
Ludwig von Mises
“Business cycle result from central-bank
generated loose money and cheap credit, and
the cycle can only be made worse by
intervention.
The Causes of the Economic Crisis: And
Other Essays Before and After the Great
Depression, 1931
© Gaylen K. Bunker, 2008, All Rights
Reserved
http://www.opensecrets.org/news/2008/09/update-fannie-mae-and-freddie.html
© Gaylen K. Bunker, 2008, All Rights
Reserved
Lynn E. Turner
We began the decade with names such as
1. Enron and Worldcom,
2. followed by the revelations regarding Wall Street
analysts misleading investors,
3. then on to the mutual fund late trading and market
timing scandal,
4. then the stock option back dating at companies such
as United Health, and
5. now we find ourselves in the midst of the subprime
fiasco.
© Gaylen K. Bunker, 2008, All Rights
Reserved
Lynn E. Turner (con’t)
The problem was:
Subprime loans: A high risk of not being repaid.
Executive Pay: hundreds times average employee.
Credit Rating Agencies compromised independence
Accounting Standards failed to provide transparency.
Due Diligence required of investment banks was
deficient.
“Cheap” debt fueled high levels of liquidity risks.
Regulation was “a turtle chasing a race horse.”
© Gaylen K. Bunker, 2008, All Rights
Reserved
Resets are coming
© Gaylen K. Bunker, 2008, All Rights
Reserved
Freedom versus Equality
“Nature smiles at the union of freedom and
equality in our utopias. For freedom and equality
are sworn and everlasting enemies, and when one
prevails the other dies. Leave men free, and their
natural inequalities will multiply almost
geometrically. Utopias of equality are biologically
doomed, and the best that the amiable philosopher
can hope for is an approximate equality of legal
justice and educational opportunity.”
Will and Ariel Durant, The Lessons of History, pg 20
© Gaylen K. Bunker, 2008, All Rights
Reserved
2006 Data (billions)
Gross Domestic Product:
$13,195
National Health Expenditures 2,105
Private 53% of NHE
1,135
Public 46% of NHE
970
Medicare (65+)
Medicaid (Poor)
VA and Military
Children 0-18
(27% of Population)
© Gaylen K. Bunker, 2008, All Rights
Reserved
100%
16%
The Bunker Curve
(an organic approach)
Vision, Innovation, Creativity
High demand valued service
Benefit greater than Cost
© Gaylen K. Bunker, 2008, All Rights
Reserved
Keep commitments
© Gaylen K. Bunker, 2008, All Rights
Reserved