The New Hard TimesRecession 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/20090715-leonhardt-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 TimesRecession 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_clock