The Evolving Global Economy

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Lisa M. Lynch Dean Heller School for Social
Policy and Management
Bruce R. Magid Dean Brandeis International
Business School
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Origins of the problem
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Average Percentage of Subprime over Housing Units
2004-2006Data from Paul Milstein Center for Real
Estate, Columbia Business School
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Case-Shiller index peaks in April 2006 Most
recently declines 15.4 in 2nd quarter 2008
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Brandeis UniversityThe Heller School for Social
Policy and Management
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Brandeis UniversityThe Heller School for Social
Policy and Management
Timeline of the Crisis

• The early signs
• February-March 2007 - HSBC experiences
  significant losses in its holdings of US 2nd-lien
  mortgage loan losses
• March shares in subprime mortgage lenders drop
  sharply
• April New Century Financial in Chapter 11
• May Goldman Sachs cites concerns about Bear
  Stearns heavy exposure to mortgage securitization
  market

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Brandeis UniversityThe Heller School for Social
Policy and Management

• The situation deteriorates
• June 2007 Bear Stearns reports 10 earnings
  declines in mortgage securities area
• July Bear Stearns informs investors in its two
  struggling hedge funds that the funds have little
  value
• Defaults on subprime loans reach highest rate
  since 2002
• July 30 IKB Deutsche Industriebank, a German
  bank says earnings would be hurt by losses on
  United States subprime loans
• July 31 American Home mortgages shares drop
  90 - they are an Alt-A lender
• August 6 American Home mortgage files for
  bankruptcy

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Brandeis UniversityThe Heller School for Social
Policy and Management

• The Crisis Begins
• August 8 German fund invested in US
  mortgage-backed securities stops payouts
• August 9 BNP Paribas halts withdrawals from 3
  investments funds Fed and ECB inject liquidity
  into the financial system
• August 14 Goldman struggles with three of its
  hedge funds
• August 15 Merrill Lynch predicts Countrywide
  Financial could go bankrupt
• August 17 Fed cuts discount rate 50 bps, keeps
  federal funds rate at 5.25, extends to 30 days
  the lending period
• September 18 cuts federal funds rate 50 bps at
  regular FOMC meeting

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Brandeis UniversityThe Heller School for Social
Policy and Management

• Interventions by the Fed September 2007 August
  2008
• 5 cuts in the federal funds rate from 5.25 to
  2 by March 2008
• Decrease in the gap between the discount rate
  and federal funds rate from 100 bps to 25bps
• Creation and growth of the Term Auction Facility
• Extension of credit to other centrals banks --
  ECB and the Swiss National Bank
• Term Securities Lending Facility
• Primary Dealer Credit Facility
• Loan to JPMorgan Chase to purchase Bear Stearns

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Bear Stearns Share price
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• Current Round The week of September 15, 2008

• September 15 Lehman Files for Bankruptcy
• September 15 Bank of America to Acquire Merrill
  Lynch
• September 16 Fed to lend 85 billion to AIG,
  take 80 percent stake
• First indications of run on money market funds
  we see first examples of break the buck
• September 19 Treasury announces 50 billion
  insurance fund for money markets Fed announces
  new program for commercial banks through the
  Boston Fed discount window to purchase asset
  backed commercial paper from money market funds
• September 21 (SUNDAY) Fed announces that Goldman
  and Morgan Stanley will become bank holding
  companies provides additional funds to help
  this transition

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Tool Box

• Monetary Policy
• Rate setting - Federal Funds and Discount
• Changes in the composition of Feds assets (TAF
  and TLSF)
• Changes in who can borrow using Article 13.3
  (PCDF)
• Fiscal Policy
• 150 billion tax rebate rebates received spring
  2008
• Increase in the size of mortgages purchased by
  Fannie Mae and Freddie Mac
• 50 billion insurance guarantee for money market
  accounts
• Sept 7, 2008 Fannie Mae and Freddie Mac taken
  over by the Federal Housing Finance Authority
  with Treasury support
• Regulation - SEC and UK Financial Services
  Authority halt short selling September 19, 2008
  on 799 companies

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Brandeis UniversityThe Heller School for Social
Policy and Management
Consequences for the Real Economy
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Growth of real consumer spending
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Brandeis UniversityThe Heller School for Social
Policy and Management
Additional Policy Responses in Play
Treasury Authority to buy troubled assets -- 700
billion Extension of unemployment
insurance Loans to the auto industry (Range
7-25 billion) Stimulus aid package to
states Additional mortgage relief to homeowners

• Knowledge Advancing Social Justice

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Brandeis UniversityThe Heller School for Social
Policy and Management
What Next or What Keeps Me Awake at Night?

• Immediate Concerns
• The Labor Market
• Net Exports
• Business Investment
• Longer Term
• Nature of Regulatory Reform/Social Contract
• Investments in Human Capital - Financial
  Literacy
• Consequences for my own workplace

• Knowledge Advancing Social Justice

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Financial Crisis at Home and AbroadLessons
Learned and the Way Forward
September 23/24, 2008
B. Magid Dean Brandeis IBS
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The Evolving Global Economy

• United States Economic Stress
• Assumption that home prices would continue to
  soar
• Lax supervision and regulation of banking
  industry

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Bursting of U.S. Housing Market

• Bursting of home price bubble
• Home prices dropped foreclosures increased
• Financial companies lost billions on bad mortgage
  loans
• Firms cut back on all lending

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During Wall Street financial crisis, the hyenas
pick off the weakest first
U.S. ? Insurance Companies
?U.S. Banks
?U.S. Intervention
?Market Forces
Hedge Funds?
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• Government as Lender of Last Resort

• Who pays when the U.S. government intervenes?

• Moral hazard Government rescue of risk takers

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Current U.S. Financial System
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Financial Tsunami

• Greed, fear and uncertainty create the perfect
  storm

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Systemic Approach to a Systemic Crisis

• For months, one-off/ad hoc decision making
• Worst financial crisis since the Depression
• Necessitated action new federal agency to
  purchase toxic assets

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Future U.S. Financial System

• Massive reconsolidation
• Fewer Entities Fewer Bankers
• Investment banks will disappear
• More regulations to manage market
• New government entities

Bank Of America Merril Lynch
Bank of America
Merril Lynch
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Impact of emergency measures on U.S. Economy
Sinking or Swimming

• Fragile Financial System
• High fiscal deficit
• High current account deficit
• Dependence on imported fuel
• Dependence on foreign capital

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Thinking the Unthinkable

• What happens if foreign nations lose their
  appetite for U.S. dollars?

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Is World Growth at Risk?

• U.S. consumer no longer the engine of global
  growth

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Emerging Markets

• Contagion from U.S. economic ills
• Engines of world growth
• Commodity price outlook
• Political stability to support growth?

Shanghai, China
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Globalization At Risk?

• More protectionism
• Anti free trade
• Global financial market regulation

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Can a Weaker U.S. Lead?
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U.S. Ability to Finance Global Cop Role

• U.S. defense budget
• 4.17 of GDP
• 570 billion
• Russian defense budget
• 33 billion
• Chinese defense budget
• 47 billion

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Rising Geopolitical Tension
Deteriorating relations between Russia and the
West
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Venezuelas Chavez Anti U.S. and Fanning
Regional Instability

• Venezuela-Colombia relations
• Bolivia political crisis
• Ecuador political strife

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Keys to U.S. Economic Future

• 1) Education commitment to excellence
• 2) Rebuild an aging infrastructure
• 3) Increase investments in clean energy and life
  sciences
• 4) Regain moral compass

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The New Global Environment

• U.S. will remain first among equals
• China, India, Brazil, Russia will continue to
  gain economic power
• Russia Iran Venezuela
• Dependence on hostile oil exporters

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The 21st Century Global Imperative

• Improve standard of living of the global
  disenfranchised