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Karl Smith

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Banks will be forced to cut lending ... Tranches allowed banks to create safe debt out of risky mortgages (or so they thought) ... – PowerPoint PPT presentation

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Title: Karl Smith


1
Credit Crisis and Recession
  • Karl Smith
  • School of Government
  • Jan 2008

2
Crisis Overview
  • The Origins of the Crisis
  • Housing
  • Credit
  • Current State of Financial Markets
  • General Crisis
  • Municipal Bond Markets
  • Real Economy
  • Job Losses
  • Unemployment
  • Revenue Outlook

3
Problem
  • Economy is in a unprecedented condition
  • Financial Crisis Reminiscent of Great Depression
    or Japanese Depression
  • Extremely Responsive Government Action
  • Resilient Real Economy Until Recently
  • Rapidly Deteriorating Real Economy Now
  • Take a Brief Look at the Fundamentals of the
    Crisis

4
Housing Bubble
  • Usual Chart
  • Steady Climb
  • Sharp Fall
  • Housing Bubble!
  • However, all Cities did not experience the same
    phenomenon

5
Housing Bubble
  • North Carolina did not have the same run-up
  • Will not have the same crash
  • Will suffer the effects of the financial collapse
    nonetheless

6
Credit vs. Housing
  • General Credit Bubble
  • There will be weakness across all credit products
  • Consumer Credit
  • Auto Loans
  • Commercial Real Estate
  • Corporate Bonds
  • Banks will be forced to cut lending
  • Consumers and Business will find it harder to get
    loans and lines of credit

7
Financial Innovation
  • Fed Policy and Foreign Reserve Building played a
    role
  • Even more important is the role of financial
    innovation
  • Traditionally mortgages were funded by banks and
    held as assets
  • GSEs Fannie Mae, Freddie Mac
  • Started 1930s
  • Exploded late 1980
  • However not everyone could qualify for a GSE
  • LTV, Credit, Amortizing

8
Financial Innovation
  • In the early part of this decade investment banks
    expanded more heavily into securitization using
    structured debt (CDOs)
  • Structured debt involves breaking an obligation
    into tranches
  • Tranches allowed banks to create safe debt out of
    risky mortgages (or so they thought)
  • This allowed the investment banks to fund
    mortgages from risky borrowers

9
Housing Boom
  • This combination of
  • Low Fed Funds Rate
  • Easy credit because of financial innovation
  • Created an environment where anyone could buy a
    home
  • NINJA loans became common place (No Income No Job
    or Assets)
  • With so many buyers out there housing prices in
    tight markets skyrocketed

10
Ted Spread Stress on Banks
  • One measure of the panic is known as the TED
    spread
  • The difference between what the government pays
    to borrow money and what banks pay other banks to
    borrow money

11
Commercial Paper Spread Stress on Business
  • A second measure is the difference between
    commercial paper from highly secure companies and
    riskier entities

12
Municipal Bond Stress on Government
  • Municipal bonds spreads are still rising
  • More and more expensive to issue debt
  • Fed is acting to open market Goal mid 2009

13
The Real Economy
  • The current economic situation may seem bad but
    many economists feared that it would be much
    worse than it currently is
  • The same forces that are at work today, large
    scale credit contractions, are the same that
    caused the Great Depression
  • Our hope is that we have learned from previous
    mistakes
  • So how is the real economy doing?

14
Unemployment
  • Definitive Marker
  • Characteristic Pattern

15
Job Creation
  • Also year over year job creation is consistent
    with recession

16
The Future
  • The level of uncertainty is high and there are at
    least four possible scenarios each with a
    different likely result for government revenue
  • Weak growth through 2009
  • Hard Recession late in 2008 with recovery late
    2009 early 2010
  • Japanese style depression

17
Hard Landing
  • Worldwide slowdown means US exports will fall
  • Credit Crisis means sharp slowdown in lending as
    financial institutions reduce their debt to
    capital ratios
  • Recession larger than 2001 or 1990
  • On par with early 1980s

18
Japanese Style Depression
  • We cannot rule this out
  • Sept 18th was close Commercial Paper market was
    frozen
  • Corporations and Banks depend on short term loans
    (CP)
  • Many loans ultimately come from MMMF
  • MMMF accounts were drawn down
  • Revenue Effects large and unpredictable

19
Statewide Taxes
20
Statewide Trends Sales Tax
21
  • Unprecedented Collapse in Spending on Goods

22
Property Tax in Previous Recession
  • Declines in the property tax base are
    unprecedented
  • Conceivable if foreclosures rise to record levels

23
Caveats
  • Much depends on how well the Federal Government
    can respond
  • Stimulus Package to States
  • Efforts to get Muni, Mortgage and Corporate Bonds
    rates down
  • Keep Financial System Intact
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