The Financial Crisis of 2007-2009: Causes, Consequences and Cures

Graduate School of Banking at Colorado Timothy W. Koch University of South Carolina

Who Said It?

Borrowing from the Federal Reserve is a sign of strength.
Tim Geithner, President NY Fed, August 17, 2007

IndyMac could face failure if prescriptive measures are not taken quickly. Letter released June 27, 2008 Citing the letter IndyMacs hometown papers headline was

IndyMac Appears Close to Collapse

Charles Schumer, Senator from New York

Fannie Mae and Freddie Mac are not facing any kind of financial crisis .. The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.
Barney Frank, Sept. 11, 2003

How Much (%) of Each of the Following Does the U.S. Government Own?
Citigroup AIG Fannie Mae Freddie Mac GM Chrysler 34% 80+% 100%* 100%* 61% (post bankruptcy) 8% (post bankruptcy)

* To be independent, both firms must repay government investments plus interest; they are not close to profitability and it will likely take 75 + years after profits appear

Key Events: 2007 - 2009

2007 April: New Century Financial files for bankruptcy June: Bear Stearns suspends redemptions on two hedge funds that invested in mortgage-backed securities Nov.: Bank of England nationalizes Northern Rock 2008 Feb.: Municipal auction-rate securities market shuts down March: Bear Stearns fails acquired by JPMorgan Chase June: B of A acquires Countrywide Financial July: IndyMac fails FDIC operates it as a bridge bank

2008 cont. July: SEC prohibits naked short-selling in financial stocks Sept: Fannie Mae and Freddie Mac are placed in conservatorship while Treasury eliminates dividends on their preferred stock - Lehman Brothers fails - Reserve Fund (MMMF) breaks the buck - B of A announces acquisition of Merrill Lynch - SEC banks short selling - Goldman Sachs and Morgan Stanley convert to BHCs - WAMU fails assets acquired by JPMorgan Chase - FED lends AIG $85 billion; effectively in conservatorship

2008 cont. Oct.: Wells Fargo acquires Wachovia - Treasury allows firms to issue FDIC-insured debt - Treasury under TARP mandates sale of preferred stock by 9 large institutions; PNC acquires Nat City using TARP $ Nov: Federal agencies announced mortgage modification plans Dec.: Treasury authorizes loans for GM and Chrysler 2009 Jan.: FHLBs of San Francisco and Seattle suspend dividends Feb.: Treasury creates PPIP; stimulus bill is signed into law - Federal agencies will conduct stress tests on 19 large inst.s

Feb.: FDIC announces a 20 basis point deposit ins. assessment Mar.: Gov.t assistance to AIG totals around $180 billion - Treasury grants $5 billion in financing for auto industry April: FASB eases mark-to-market accounting rules May: Gov.t releases stress test results - Silverton Bank (former bankers bank) fails - FDIC deposit insurance increases to $250,000 through 2014 - GMAC is authorized to issue $7.4 billion in FDIC-insured debt June: GM files for bankruptcy - 10 large institutions repay $68 billion in TARP funds - Obama Adm. announces Financial Regulatory Reform Plan

How Did We Get Where We Are Today?

Low interest rates Excessive financial leverage Complexity of financial products Lack of effective risk management at large institutions Inadequate appreciation/regulation of derivatives risk Conflicts of interest at rating agencies Mark-to-market accounting Lack of access to liquidity Poor corporate governance practices

Seeking Alpha online; June 30, 2009

Change in House Prices: Recent Month & Past Year Through April 2009
Mar. 09 Apr. 09 Atlanta Boston Charlotte Chicago Cleveland Dallas Denver Detroit - 0.4% - 0.4% - 1.2% - 0.02% 0.3% 0.7% 0.7% - 1.2% 1-Year* -14.8% - 7.7% -10.0% -18.7% -10.5% - 5.0% - 4.9% -25.4%

Change in House Prices: Recent Month & Past Year Through April 2009
Mar. 09-Apr. 09 Las Vegas - 3.7% Los Angeles - 1.2% Miami - 1.9% Minneapolis - 0.9% New York - 1.5% Phoenix - 2.8% San Diego - 0.8% San Francisco - 0.5% Washington, D.C. 0.1% Composite - 0.9% 1-Year* -32.2% -21.2% -27.3% -22.0% -12.5% -35.3% -20.0% -28.0% -16.9% -18.1%

* May 1, 2008 April 30, 2009; S&P Case-Shiller Housing Indexes

Are We at the Bottom in Housing?

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WSJ, June 17, 2009

12% of Homes Had Negative Equity; 47% of Foreclosures

Liebowitz, Stan, New Evidence on the Foreclosure Crisis, WSJ, July 3, 2009

Capital Chronicle, May 28, 2009

How Did We Get Here?

Federal Reserve under Alan Greenspan (Easy Money) Fannie Mae, Freddie Mac & Congress: GSEs supporting affordable housing increased demand for subprime and Alt-A loans Borrowers at best were uninformed; at worse, lied about their financial condition Mortgage Brokers, Appraisers, Realtors: Overvalued properties and pushed borrowers into gimmick or complex mortgages Rating Agencies misrepresented security/asset values

How Did We Get Here? Cont.

Large Commercial and Investment Banks

demonstrated poor risk management practices Regulators (Banking & SEC) allowed excessive leverage and failed to criticize the large institutions business models; no regulation of derivatives Separation of Ownership from Origination: Securitization allowed loan originators to care less about the quality of the loans they originated Mark-to-Market Accounting forced unreasonable valuations of securities when there was no liquidity

Consequences
Firms and Individuals took on too much debt Too few understood complex financial products: what is an option ARM, CDO, CDS, SIV? Securitization process is flawed the Originate-toDistribute Model is broken Where were the regulators? CDSs at AIG?, etc. Rating agencies are paid only if deals are done; there is an inherent conflict of interest between the issuer and rating agency Mark-to-market doesnt work when markets collapse; what is a security worth when there are no bids?

Consequences

cont.

Why did Lehmans failure create market chaos? - Hedge funds couldnt access their funds so they withdrew funds from Morgan Stanley and Goldman Sachs - Fear of counterparty risk defaults on clearings/CDSs Today, who has easy, quick access to relatively low cost credit? - Thank you for all the government programs Too many Boards of Directors failed in their duties - Is there a link between compensation and risk tolerance? - People respond to incentives

NINJA Loans
No Income No Job No Assets

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NINJA Loans
No Income No Job No Assets

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NINJA Loans
No Income No Job No Assets

No Problem

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Has Financial Leverage Changed Recently?

Nonfinancial Corporations are Reducing Debt

Contrary Investor, February 1, 2009 at www.gold-eagle.com

The Paradox of Thrift

Thrift: Dont buy things you dont need. Dont

spend more than you make. Strategy: Save More .. Spend Less Paradox: If everyone reduces spending, total saving will decrease because less spending lowers income Implication: All of you should increase spending. Go out and shop! Shop! Shop!

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U.S. Savings Rate Jumps in 2009

6.9% in May

Lahart and Alini, WSJ, June 2, 2009

Fitch, Stephane, The Savings Bugbear, Forbes, April 27, 2009 28

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The Periodot Capitalist, April 7, 2009

June 17, 2009; Jacoby at www.gallup.com

Gallup Poll, June 17, 2009; Jacoby at www.gallup.com

Glick and Lansing, U.S. Household Deleveraging and Future Consumption Growth

Shrinking Household Wealth

Lahart & Izzo, Retail Sales Rise, but Caution Still Restrains Consumers, WSJ, June 12, 2009

Consumer Spending
In growth times, 70% of GDP reflects consumer spending Q4 2008: Visa reports that debit card purchases exceed credit card purchases (first time ever) Recession began 19 months ago Savings rate equaled 6.9% in May 2009; in 1980s it was around 9%

Catalysts for Increased Consumer Spending

Wealth effect: value of stock and bond portfolios and retirement accounts Home equity: liquidity reserve from equity in your home Job security: knowledge that you will be employed and the predictability of your income Prices: are we in a deflationary or inflationary environment? What is your forecast? Are there regional differences?
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National Unemployment rate for June equaled 9.5% (up 0.1% in month)

June 6, 2009

Future of Financial Regulation - Obama

Federal Reserve can specify requirements for capital, liquidity and leverage for any firm whose combination of size, leverage, and interconnectedness could pose a threat to financial stability if it failed.

If a large firm is failing, Treasury can appoint a conservator or receiver in lieu of bankruptcy

Implication is that such firms are TOO BIG TO FAIL or truly, TOO BIG TO SUCCEED INDEPENDENTLY

Originate-to-Distribute vs Eating Your Own Cooking

Source: Pathology of the U.S. Mortgage Crisis, Celente,

OTD Model
Lenders originate loans for the purpose of securitizing them revenues derive largely from origination fees Little concern about default risk because someone else would buy/own the loans (hence little due diligence) Underwriters earned fees for packaging/selling securities backed by the loans (little due diligence) To sell securities, underwriters had to get the rating agencies to sign-off on acceptable credit quality Rating agencies are paid their fees only if the deal is done [NOTE: structured finance deals dont exist without ratings]

Investors relied on ratings and reputations of the loan originators and pool creators; or originators used SIVs Given the extraordinary liquidity available, lenders originated increasingly risky (higher default risk) loans (Alt A, option ARM, subprime mortgages) As housing values fell, borrowers ability to repay deteriorated, defaults and foreclosures increased Lessons: - Lack of transparency about risks in OTD Model - Assumptions of rating agencies were seriously flawed - Improper incentives create problems

Structured Investment Vehicles (SIVs)

Off-balance sheep entities Sponsor finds equity investors; SIV issues commercial paper (short-term) and uses proceeds to buy securitized loans Assets MBSs CDOs CLOs Total 150 Liabilities + Equity Commercial Paper 100

Medium Term Notes 40 Equity Total 10 150

Sponsor provides a liquidity back-stop Spread = avg. yield on securitized loans avg. cost of debt

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March 4, 2009

What is the Solution?

The US Treasury is planning a sweeping overhaul of securitization markets with tough new rules designed to restore confidence by reducing the incentive for lenders to originate bad loans and flip them on to investors. The authorities plan to force lenders to retain part of the credit risk of the loans that are bundled into securities and to end the gain-on-sale accounting rules that helped spur the boom of the markets at the heart of the financial crisis.

What is the Role of Derivatives?

Derivatives (swaps, forwards, options) transfer risk to a counterparty; they do not reduce risk overall Derivatives link counterparties via valuations (bets) on the value of an underlying asset, index or contract Bear Stearns and AIG were not allowed to formally fail. Is it that they were Too Connected to Fail? - AIG sold $80 billion in CDSs on subprime mortgages - As defaults rose, counterparties demanded collateral At failure, Lehmans notional derivatives book was $730 billion (contrast with JPMorgans $85 trillion) representing 900,000 different contracts

Loomis, C., Derivatives: the risk that still wont go away, Fortune, June 24, 2009

Who Actively Trades Derivatives?

Loomis, Fortune, June 24, 2009

The Role of Credit Default Swaps

A credit default swap (CDS) is a contract between two entities labeled counterparties. The buyer of the swap makes periodic payments to the seller of the swap. If a specific default event occurs during the time horizon of the swap, the seller makes a payment (payoff) to the buyer. Spread is the amount (annual) paid by the CDS buyer as a percentage of the notional amount of protection purchased Default event is typically associated with a credit instrument, such as a bond or a loan Credit event may be a firm that files for bankruptcy, experiences a downgrade or pursues a restructuring Counterparties do not need to own the underlying instrument to be a buyer or seller
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CDS Example
Payoff with a Credit Event

AIG
CDS Seller
Periodic payments for Swap Credit event trigger

Hedges R Us CDS Buyer

Credit event trigger

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AIG is a risk buyer, or a protection seller Hedges is a risk seller, or a protection buyer

Lehman

In the event of a default by Lehman

Physical Settlement: Hedges R Us delivers the underlying Lehman bond in default to AIG for payment at par Cash Settlement: AIG pays Hedges R Us the difference between par value and the current market value of the Lehman bond

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Case: Hedges R Us bought $100 million of CDS protection from AIG for 4% over 2 years
Annual payment from Hedges R Us equals $4 million; payments are often made quarterly If Lehmans default risk is perceived to increase, the value of the CDS will increase in this case the spread will rise, e.g. to 9%; Hedges R Us may now sell $100 million of CDS protection for $9 million annually If Lehman defaults after 1 year, Hedges R Us will have paid $4 million, but will receive $100 million from AIG If Lehman does not default over 2 years, Hedges R Us 51 will have paid $8 million and will receive nothing

CDS Characteristics
CDS are like options that are based on a credit event CDS may appear to be insurance, but the counterparties rarely do the same type of actuarial analysis associated with insurance underwriting Problems with CDSs arise from: - CDS are not regulated but are sold via broker arrangements with commercial and investment banks as initial brokers - Commercial and investment banks had capital requirements based on counterparty risk; AIG did not have capital requirements based on its CDS exposure - CDSs were written against many high risk instruments (MBS, ABS, CDO, CLO, SIVs, etc.) It appears that we will have a central clearinghouse for CDSs in the future

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What are the Markets Telling Us?

Barr, C., Fears of Big Bank Problems Return, Fortune, June 24, 2009

Proposal to Regulate Derivatives

Standardized over-the-counter derivatives will be traded on regulated exchanges (which ones) Provides an indication of which parties own which derivatives Trades of customized derivatives not traded on an exchange must keep records and report on which parties own which derivatives Dealers with large positions will be subject to regulatory oversight due to systemic risk concerns

U.S. Gov.t is Controlling Shareholder in AIG

FRB NY owns $25 billion in two of AIGs foreign life insurers

Pleven & Lublin, WSJ, June 26, 2009

Global Impact of Large Institutions Actions

Lehman issued $35 billion in complex mortgagebacked securities via its small subsidiary in Amsterdam U.S. is the GLOBAL LENDER OF LAST RESORT In 2008, the U.S. government paid AIG $58 billion that went to creditors headquartered outside the U.S.

A Case Study in the Ratings Game

GSAMP Trust 2006 S3 (Goldman Sachs underwriter) $494 million pool of 8,274 second-mortgage loans originated by Fremont Investment, Long Beach Mort. > 1/3rd were in California; avg. rate paid = 10.51% Avg. equity in homes equaled 0.71% (LTV = 99.29%) 58% of loans were no-doc or low-doc; 98% said they were living in the homes full-time 13 tranches; first 3 rated AAA ($336 million); next 7 were rated AA to BBB- ($123 million)

How Quickly Performance Changes

GSAMP cannot foreclose unless 1st mortgage holder forecloses; no money set aside to pay off the 1st 10 months after issue, AAA ratings dropped to BBB GSAMP started defaulting 11 months after issue; 17 months after issue, 18% of loans were in default Source: Sloan, Junk Mortgages Under the Microscope, Fortune Magazine, October 16, 2007

Ratings Downgrades at FHLBs in 2008

Credit Default Swap Prices

www.subsidyscope.com , May 26, 2009

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Data are for Dec. 31, 2008 estimates from banks

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Stress Testing 19 Large Institutions

WSJ, April 25, 2009

WSJ, May 9, 2009

Mark-to-Market Changes: April 2009

Firms can use significant judgment in valuing assets Banks can effectively use internal models to value securities, such as detailed cash flow analysis Will likely reduce asset write-downs and increase earnings relative to the prior accounting requirements FAS 157 doesnt apply when there are no trades; it is impossible to get market prices, which does not mean that the value is zero Issue: Have we let accounting treatment determine solvency for large financial institutions?

Which of These Firms are Bank Holding Companies?

Goldman Sachs Morgan Stanley American Express GMAC CIT MetLife Lincoln National
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How Has CIT Performed Recently?

CIT has $76 billion in assets, $69 billion in liabilities and has received $2.3 billion in TARP funds. TLGP?

Look at All the Government Programs

TAF (collateralized borrowing from the FED) TSLF (loans to primary securities dealers) PDCF (loans to securities dealers) AMLF (loans to acquire money market sec.s (CP)) TARP (preferred stock) TLGP (FDIC-insured debt) MMIFF (finance purchase of assets from money market funds) PPIP (buys problem assets)

Banks Will Face Material Challenges Going Forward

Lengthy Recession: continued high unemployment,
low capital investment and consumer spending; gradual improvement in economic growth

Near-term economic growth (Q4 2009?): followed by rising inflation and rising interest rates

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The Regulatory Environment Will be Dramatically Different

Systemic risk regulator - Who is in charge? - What form? Increasing FDIC insurance - Penalty for volatile funding - Move to risk-based insurance premiums Mortgage forbearance / Cramdowns? - Mandatory? - Impact on MBS market & new lending?
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Factors Affecting Confidence and the Economic Climate

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Recession: Falling Output and Rising Unemployment Weak (But Improving) Consumer Confidence Real Estate Prices have not hit Bottom Many Institutions remain Undercapitalized Loan Losses will increase: Spillover Effects of Mortgage Problems on HELs, Commercial Real Estate, Credit Card Receivables and other AssetBacked Securities Rising Bank Failures States and Local Governments are in Trouble

Current Competitive Environment

Federal Reserve is committed to keeping interest rates

low The Treasury Yield curve will remain upsloping Competition for deposits will be fierce Loans will be better priced for credit risk and interest rate risk Floors on loan rates will be increasingly common

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What Are the Impacts?

In the aggregate, credit is less available. - The Shadow Banking system has closed down (The Originate-to-Distribute Model is broken such that securitizations have fallen sharply) - Many banks are cautious about lending due to uncertainty about asset quality, viability of commercial and real estate business, regulatory sanctions, and limited access to capital Everyone is de-leveraging (save more, reduce debt)
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Trends in Credit Availability*

59% said access to short-term credit was unchanged 27% said credit was less available (35% for non-investment grade firms) 67% anticipate no change in credit availability over next year 42% held larger cash and ST investment balances 93% have taken at least one action as a result of decline in credit availability - 70% decreased capital spending
- 69% reduced or froze hiring

67% will take additional actions if conditions dont improve

*Source: 2009 Association of Financial Professionals Liquidity Survey; May 2009 responses of 360 U.S. firms regarding activity over the past 6 months

News N Economics, February 4, 2009

Consider Credit Cards

Reddy, Credit Card Bill Makes Headway, WSJ, May 12, 2009

What Will Be the Impact of Budget Deficits?

Davis and Hilsenrath, WSJ, June 15, 2009 78

Budget Deficit Passes $1 trillion for FY 2009

Which Way are Interest Rates Headed?

Reddy and Smith, Fed on Hold as Slump Eases, WSJ, June 25, 2009

Most State Budgets are in Deficit

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McNichol and Lay, State Budget Troubles Worsen, Center on Budget & Policy Priorities, Jan. 29, 2009

Estimated Budget Shortfall: $230 Billion for 2009 - 2011

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Weisman, WSJ, June 15, 2009

How Does This Recession Compare?

WSJ Editorial, March 6, 2009 82

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Evans, WSJ, July 1, 2009

Cures?
Specific Bank Strategies
Make sure that you have sufficient capital Pursue insured core deposits aggressively Ensure liquidity even in extreme circumstances

Macro-Strategies for the Global Economy

Find a floor on housing values Clean-up the balance sheets of large institutions

What Does History Teach Us?

Governments remove problem assets from banks to allow banks to start lending again Governments temporarily guarantee bank borrowing to provide access to funds and lower borrowing costs Governments inject capital (replace capital lost from charge-off and asset write-downs)

HAVE ANY OF THESE OCCURRED?

Getting Rid of Toxic Assets ..

Reduces uncertainty about future losses embedded in balance sheet holdings Eliminates the distraction of problem assets when managements time and attention are focused on problem assets, normal business isnt the focus Allows management to make new loans with greater confidence that additional capital will not be needed to support existing assets If banks had sufficient capital, they would take losses on assets and move on

Economic Positives
Many individuals, businesses and markets still assume that the worst will happen Problems in housing are concentrated in specific markets Central banks have unleashed their weapons to - lower interest rates - provide liquidity - ensure capital adequacy for large institutions - unfreeze credit markets Oil prices are reasonable Businesses have reduced inventories There are great buys out there.
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Some New Capital Realities

Capital preservation is paramount More is better Be prepared to operate with more capital Is 12% risk-based capital the new standard Capital is difficult to get today - TARP - Private equity firms - Bank capital merger partners - Existing shareholders, directors, friends & family

Quick Critique of TARP Capital Purchase Program

Can obtain up to 3% of risk-weighted assets Preferred stock pays 5% dividend for 5 years; thereafter it

increases to 9% (non-voting stock) Treasury gets warrants up to 15% of funds committed as preferred stock
Negatives

- Government ownership; can change rules anytime - warrants represent common stock Positives - Use capital to make loans or expand operations - Be a buyer not a seller of branches and banks
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Who Has Received TARP Funds?

Sidel and Solomon, Banks to Repay Bailout Cash, WSJ, June 10, 2009 90

How Are Warrants to Be Handled?

Paletta & Solomon, Financial Firms Lobby to Cut Cost of TARP Exit, WSJ, April 22, 2009

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Governments Return on TARP for 10 Banks Approved to Repay TARP

Amt Invested Dividends Warrant Value ROI* $68.3 billion $2.24 bn $4.65 bn $0.53 bn $0.40 bn 10.1% 4.0% 14.2%

BB&T: $3.1 bn $0.10 bn AMEX: $3.4 bn $0.09 bn

* Annualized: 17.8%, 7.3% and 36.2%, respectively, through May 2009 Source: Hill-Townsend Capital, LLC, Gary Townsend

Do TARP Recipients Buy Failed Banks?

No. Bank Failures All = 53 6 Failed Bank Assets < 1 B Assets < 1 B 47 19 Acquirer Assets < 1 B Assets < 1 B 47 28 28% (md = 27%) 9 (32%) 31% (md = 30%) 16 (84%) 6 18% (md = 19%) Failed Bank Assets > 1 B Acquirer Assets > 1 B Cost to FDIC (% of Failed Bank Assets) TARP Y (% Failures) 30 (57%) 5 (83%)

Assets > 1 B

Data include 60 Failed Banks from Oct. 2008 July 10, 2009; 7 banks excluded w/o acquirer.
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Some Banks Have Stopped Paying TARP Dividends

WSJ, June 23, 2009

New Liquidity Realities

Liquidity risk is a principal concern of regulators Recent regulatory conclusions: - heavy reliance on volatile funding - too few liquid assets - too few backup funding sources that have not been tested periodically - failure to examine cash flow needs over various time intervals; insufficient stress testing - weak contingency funding plans Pay greater attention to liquidity risk concerns

New Liquidity Realities

Deposit insurance premiums will continue to increase Will pay penalty premiums for excessive brokered deposit financing and FHLB financing Collateral requirements will increase Government liquidity programs will eventually go away As rates increase and large institutions compete more aggressively, core deposits will be harder to get

Taxpayers Now Own GMAC

Berman, Dennis, Get Ready: You Will Own GMAC, Too, WSJ, May 12, 2009

GMAC Issues $4.25 Billion TLGP Debt

Authorized to issue $7.4 billion in FDIC-insured debt June 3 - issued $3.5 billion in fixed-rate notes (2.25% rate) maturing Dec. 2012 - issued $0.75 billion in floating rate notes (3-mth LIBOR at 0.64%) maturing Dec. 2012 - AAA rated by Fitch due to FDIC guarantee What will GMAC do with the proceeds?

Ally Bank (Ally.com)

2.25% Online Savings Account linked to customers

current checking account no minimum balance, no monthly fees [July 6: 2.00%] 1.90% MMDA rate no minimum balance [July 6: 1.80%] 2.80% CD rate 1 year [July 6: 2.25%] - 3.10% - 3 years [July 6: 2.85%] - 3.50% - 5 years [July 6: 3.50%] No Penalty CD 9-mth APY is 2.50% (no fee for early withdrawal) [July 6: 2.05%] Check (Debit) Card 4 free transactions from non-GMAC Bank ATMs
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July 6, 2009

Ally Bank is Growing

Total deposits increased 46% over the last 12 months (2009 Q1 vs 2008 Q1) from $15.4 bn to $22.5 bn Net income in 2009 Q1 was -$133 million (loss) Bank argues that it is better capitalized than many ABA members (CNNMoney.com, June 11, 2009) [Of course, the federal government owns 35.4% of GMAC]

Government Subsidies Not Well Known

FDIC-Ins. Debt TARP

Bank of America JPMorgan GE Capital Goldman Sachs Citigroup Morgan Stanley Wells Fargo
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$ 44 38 75 29 27 24 0

$ 45 25 0 10 50 10 25

Bary, Andrew, How Do You Spell Sweet Deal? For Banks, Its TLGP, Barrons, April 20, 2009

FDICs Restrictions on Private Equity

Must retain ownership of bank for minimum of 3 years Minimum leverage capital ratio of 15% If they own another bank, must provide a crossguarantee Disclose greater information about owners Remember that - IndyMac was purchased by PE firm - BankUnited was purchased by PE firm

You Will Likely See

Mandatory loan modification / forbearance even CRAMDOWNS Loan originator must retain a portion (5%) of credit extended (AAA tranche or equity tranche?) PPIP buys toxic assets from large institutions; private equity makes a killing Higher taxes New regulations on: - Consumer protection see credit cards - Bank chartering requirements - Systemic risk regulator (regulate by function)

Too Big To Fail (Succeed) These firms have an implied (explicit) federal guarantee. They have guaranteed access to the FED for liquidity.

Proposal: Charge these firms a quarterly facility fee as a % of the available credit.

How Do you Resolve TBTF?

If bank cannot raise required capital, it is placed in conservatorship New management for any bank getting assistance Banks debt to bondholders is converted into equity Eliminate dividends and stock buybacks All compensation contracts of existing management are declared null and void Include banks, insurance companies, finance companies, hedge funds

Thought for the Day

Unless we demonstrate a strong commitment to fiscal responsibility in the longer term, we will have neither financial stability nor healthy economic growth
Ben Bernanke, 2009 before Congress

Timothy Koch Moore School of Business University of South Carolina Columbia, SC 29208 803-777-6748 timothywko@aol.com
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