The Current Economy and its Influence on Market Performance. Seddik Meziani, Ph.D. Professor of...

The Current Economy and its The Current Economy and its Influence on Market PerformanceInfluence on Market Performance

..

Seddik Meziani, Ph.D.Professor of Finance and Economics

[email protected]

Nov 19, 2008The Stoney Hill Inn

Hackensack, New JerseyFor

Estate Planning Council of Estate Planning Council of Bergen CountyBergen County

Current EconomyCurrent Economy

1. 1. Reviewing the Key Factors that Led to Reviewing the Key Factors that Led to Current Markets Performance of Key MarketsCurrent Markets Performance of Key Markets

2. 2. A Global response to the financial crisisA Global response to the financial crisis

3. 3. Are we slipping into a recession?Are we slipping into a recession?

1. Reviewing the Factors that 1. Reviewing the Factors that Led to the Current Led to the Current

Performance of Key MarketsPerformance of Key Markets

Collective performance has been negative overall:Collective performance has been negative overall: Inflationary pressuresInflationary pressures Housing slumpsHousing slumps

• US, Europe, AsiaUS, Europe, Asia Credit market turmoilCredit market turmoil Near-recessionary conditionsNear-recessionary conditions

U.S. prices rose by 5.6% in U.S. prices rose by 5.6% in the year to July 2008the year to July 2008 Fastest inflation rate for more Fastest inflation rate for more

than 17 yearsthan 17 years

The rate of inflation was The rate of inflation was much greater than much greater than economists had economists had predictedpredicted

Driven higher by the increase Driven higher by the increase in energy prices and food in energy prices and food costscosts

Inflationary PressuresInflationary PressuresREVIEWING THE PERFORMANCE OF KEY MARKETS

Corporate profit fell 7% from a year prior,Corporate profit fell 7% from a year prior, with inflation being a most likely culprit with inflation being a most likely culprit

Generally, inflation is bad for equity performance: Generally, inflation is bad for equity performance: With inflation at 5.6% in July 08., $1 of profit earned a With inflation at 5.6% in July 08., $1 of profit earned a

year from now is worth only $0.94 in today’s dollars year from now is worth only $0.94 in today’s dollars

For 1969-1979, the S&P 500 returned just 1.6%For 1969-1979, the S&P 500 returned just 1.6% A far cry from its historical average of close to 10%A far cry from its historical average of close to 10% This was a period of high inflationThis was a period of high inflation

Inflationary PressuresInflationary PressuresREVIEWING THE PERFORMANCE OF KEY MARKETS

The U.S. is suffering the worst housing market The U.S. is suffering the worst housing market downturn since the Great Depressiondownturn since the Great Depression

The battered housing market is a downward drag The battered housing market is a downward drag on economic growthon economic growth Impacting a range of sectors, from the construction Impacting a range of sectors, from the construction

industry to the sale of appliances and furnitureindustry to the sale of appliances and furniture

Real Estate: U.S.Real Estate: U.S.REVIEWING THE PERFORMANCE OF KEY MARKETS

Recent data on the U.S. Recent data on the U.S. housing market suggest a housing market suggest a grim outlook for the sectorgrim outlook for the sector Pending home sales remain lowPending home sales remain low


House prices were down 16.5% year on year in August House prices were down 16.5% year on year in August 2008 after a fall of 16.4 in July*2008 after a fall of 16.4 in July*

Separate government data states new home sales at an Separate government data states new home sales at an annual rate of 455,000 in September, down from 460,000 annual rate of 455,000 in September, down from 460,000 in August and 515,000 units in Julyin August and 515,000 units in July

A figure near a 16-year low, and half the rate of new home sales A figure near a 16-year low, and half the rate of new home sales one year agoone year ago


* According to S&P/Case Shiller survey of US National Home Prices in 20 metropolitan areas

With housing still falling many who bought their With housing still falling many who bought their houses in the past five years find their loans houses in the past five years find their loans exceed the market value of their homes exceed the market value of their homes


The Mortgage Bankers Assn. reports: The Mortgage Bankers Assn. reports: 1 in 10 U.S. homeowners were behind with their 1 in 10 U.S. homeowners were behind with their

mortgage payments or were in foreclosure proceduresmortgage payments or were in foreclosure procedures At 9.2%, the default rate is nearly double the rate one At 9.2%, the default rate is nearly double the rate one

year ago with Florida and California leading the wayyear ago with Florida and California leading the way

272,000 homeowners received a foreclosure 272,000 homeowners received a foreclosure notice in July 2008, 55% more than July 2007notice in July 2008, 55% more than July 2007 77,000 of those homes were repossessed*77,000 of those homes were repossessed*

17% of all homes for sale in the U.S. are 17% of all homes for sale in the U.S. are repossessed propertiesrepossessed properties


* According to Realytrac, an Irvine, California-based online marketplace for foreclosed properties

Both Spain and the U.K. are deep into a Both Spain and the U.K. are deep into a crisis while Eastern Europe is nearing a crisis while Eastern Europe is nearing a housing bubble bursthousing bubble burst

In Spain home starts dropped 50% over one In Spain home starts dropped 50% over one year year • Inventories of unsold homes jumped from 16.4 to Inventories of unsold homes jumped from 16.4 to

24.5 months24.5 months• Mortgage rates are not fixed, but change in line Mortgage rates are not fixed, but change in line

with the prime ratewith the prime rate

Real Estate: EuropeReal Estate: EuropeREVIEWING THE PERFORMANCE OF KEY MARKETS

In the U.K.In the U.K.• The year on year decline of house prices continues The year on year decline of house prices continues

acceleratingaccelerating According to the UK Nationwide Building Society, prices According to the UK Nationwide Building Society, prices

declined by 10.9% in August 2008, 12.4% in September and declined by 10.9% in August 2008, 12.4% in September and 14.3% in October (their 12th consecutive monthly fall) 14.3% in October (their 12th consecutive monthly fall)

• Mortgage approvals sank to just 32,000 in August 2008, Mortgage approvals sank to just 32,000 in August 2008, the lowest level since records began in 1993the lowest level since records began in 1993

• Difficulties refinancing adjustable-rate mortgages as Difficulties refinancing adjustable-rate mortgages as interest rates reset and credit crunch worsensinterest rates reset and credit crunch worsens


Germany remains the exceptionGermany remains the exception Their property market has been in a prolonged slump Their property market has been in a prolonged slump

while house prices have skyrocketed across Europewhile house prices have skyrocketed across Europe Unlike the rest of Europe, Germany experienced its Unlike the rest of Europe, Germany experienced its

housing market bubble burst in the late 1990s. housing market bubble burst in the late 1990s. After the real estate price correction of the late 1990s and After the real estate price correction of the late 1990s and

the Dot Com stock market bubble in 2000, Germans were the Dot Com stock market bubble in 2000, Germans were too shell shocked to get involved in any sort of too shell shocked to get involved in any sort of speculation speculation


In China, real estate In China, real estate brokers report prices are brokers report prices are down from peaks down from peaks reached earlier this year, reached earlier this year, while the number of while the number of transactions has plungedtransactions has plunged

Steepest downturns are in Steepest downturns are in real estate markets of export-real estate markets of export-dependent coastal cities while dependent coastal cities while cities deep in China’s interior cities deep in China’s interior have yet to be impacted have yet to be impacted

Real Estate: AsiaReal Estate: AsiaREVIEWING THE PERFORMANCE OF KEY MARKETS

Unlike the subprime meltdown in the U.S., Unlike the subprime meltdown in the U.S., weaknesses in China’s real estate market do not weaknesses in China’s real estate market do not appear to pose a threat to the vitality or stability of the appear to pose a threat to the vitality or stability of the financial system -- assuming economic troubles don’t financial system -- assuming economic troubles don’t spread spread

One reason is that Chinese banks require down One reason is that Chinese banks require down payments of at least 30 percent, giving banks an payments of at least 30 percent, giving banks an ample cushion of cash against losses. American ample cushion of cash against losses. American banks require only 20, 10 or 5 percent, or no down banks require only 20, 10 or 5 percent, or no down payment at allpayment at all

Real Estate: AsiaReal Estate: AsiaREVIEWING THE PERFORMANCE OF KEY MARKETS

As house prices eroded so did the value of As house prices eroded so did the value of securities based on these assets. Those firms securities based on these assets. Those firms holding these securities faced deep losses and holding these securities faced deep losses and many could not withstand the rapid deterioration many could not withstand the rapid deterioration of their assetsof their assets

The ensuing subprime crisis led to a credit crunch The ensuing subprime crisis led to a credit crunch that has “so far” claimed a number of companies that has “so far” claimed a number of companies even among those considered “too big to fail”even among those considered “too big to fail”

Credit Market TurmoilCredit Market TurmoilREVIEWING THE PERFORMANCE OF KEY MARKETS

Lenders and investors have become very reluctant Lenders and investors have become very reluctant to take risks, which continues to have far-reaching to take risks, which continues to have far-reaching consequences:consequences:

Bear Stearns taken over by JP Morgan Chase in MarchBear Stearns taken over by JP Morgan Chase in March Both FNMA and FHLMC seized by the U.S. government. Both FNMA and FHLMC seized by the U.S. government.

Between them they hold or guaranty half of the nation’s Between them they hold or guaranty half of the nation’s $10 trillion in mortgage debt$10 trillion in mortgage debt

Merrill Lynch sold to Bank of America for $50 billionMerrill Lynch sold to Bank of America for $50 billion


AIG was effectively taken over by the U.S. government after AIG was effectively taken over by the U.S. government after racing to find someone capable to arrange a $75 billion line racing to find someone capable to arrange a $75 billion line of credit. The Fed started with an $85 billion loan to AIG in of credit. The Fed started with an $85 billion loan to AIG in exchange for 79.9% equity stake in the insurer. After 2 more exchange for 79.9% equity stake in the insurer. After 2 more capital infusions, Its stake in AIG is now approaching $150 capital infusions, Its stake in AIG is now approaching $150 billion. billion.

Lehman collapsedLehman collapsed Goldman Sachs and Morgan Stanley allowed to become Goldman Sachs and Morgan Stanley allowed to become

conventional, deposit –taking institutionsconventional, deposit –taking institutions WAMU, the largest savings and loan, sold to JP Morgan WAMU, the largest savings and loan, sold to JP Morgan Citigroup cedes Wachovia to Well Fargo after a fightCitigroup cedes Wachovia to Well Fargo after a fight No major independent investment bank is left in its pre-crisis No major independent investment bank is left in its pre-crisis

formform


Meanwhile, the credit channel continues to dryMeanwhile, the credit channel continues to dry The spread between yields investors require on The spread between yields investors require on

investment-grade securities and those on safe Treasuries investment-grade securities and those on safe Treasuries have widenedhave widened

This translates into a deteriorating confidence among This translates into a deteriorating confidence among banksbanks

As a result, edgy investors here and abroad have As a result, edgy investors here and abroad have sent the financial markets spiraling downsent the financial markets spiraling down


The prevailing market sentiment has certainly The prevailing market sentiment has certainly created a flight to safetycreated a flight to safety

Investors who have just sold their risky debt are rushing Investors who have just sold their risky debt are rushing into Treasuries into Treasuries

This panic situation has generated an interesting eventThis panic situation has generated an interesting event In driving prices up and yields lower, the yield on three-In driving prices up and yields lower, the yield on three-

month T-bills fell near zero on September 17month T-bills fell near zero on September 17 This means that investors were willing to pocket almost This means that investors were willing to pocket almost

no interest in exchange for the certainty that they would no interest in exchange for the certainty that they would get all their cash back in 90 daysget all their cash back in 90 days


Investors are increasingly hesitant to Investors are increasingly hesitant to take corporate debt onto their bookstake corporate debt onto their books

Yields on investment-grade corporate Yields on investment-grade corporate bonds were more than four percentage bonds were more than four percentage points higher than comparable Treasury points higher than comparable Treasury bonds by September 17bonds by September 17

A large spread indicates investors are less A large spread indicates investors are less comfortable holding companies' debtcomfortable holding companies' debt


Other measures of financial conditions are as badOther measures of financial conditions are as bad• On September 17, junk bonds ended the day more than nine On September 17, junk bonds ended the day more than nine

percentage points over Treasuries, thus approaching the 2002 percentage points over Treasuries, thus approaching the 2002 high of 10.6 percentage pointshigh of 10.6 percentage points

With the dwindling ranks of investment banks and With the dwindling ranks of investment banks and commercial banks pulling back, one wonders who is going commercial banks pulling back, one wonders who is going to be the credit provider going forwardto be the credit provider going forward

This less-than-ideal conjuncture will prolong the credit crunchThis less-than-ideal conjuncture will prolong the credit crunch Having fewer credit providers means higher costs of borrowing going Having fewer credit providers means higher costs of borrowing going

forwardforward As such, bond sales come at an expensive time for companiesAs such, bond sales come at an expensive time for companies

As a result, edgy investors here and abroad have sent the As a result, edgy investors here and abroad have sent the financial markets spiraling downfinancial markets spiraling down


Stocks have lost $7.5 trillion in market value since Stocks have lost $7.5 trillion in market value since indexes hit a record on Oct 9, 2007indexes hit a record on Oct 9, 2007

Almost half of 2007 U.S. GDP is $13.8 trillionAlmost half of 2007 U.S. GDP is $13.8 trillion Exceeds the GDP of China and Japan combinedExceeds the GDP of China and Japan combined About three quarters the U.S. national debt ($10.19 tril)About three quarters the U.S. national debt ($10.19 tril)

In the U.S.In the U.S.REVIEWING THE PERFORMANCE OF KEY MARKETS

MarketMarket action has been action has been hectic particularly in Octhectic particularly in Oct• There were nine days in There were nine days in

which the S&P 500 closed which the S&P 500 closed up or down at least 4 up or down at least 4 percentpercent

• During two of those days, During two of those days, the index had at least ±9 the index had at least ±9 percent movespercent moves

• Market volatility comparable Market volatility comparable to that of Nov 2009, 1968to that of Nov 2009, 1968

In the U.S.In the U.S.REVIEWING THE PERFORMANCE OF KEY MARKETS

European Markets Continue to TumbleEuropean Markets Continue to Tumble• Europe's stock markets have seen steeper falls Europe's stock markets have seen steeper falls

than the U.S. Indeed,than the U.S. Indeed, The Dow Jones Stoxx 600 has plunged 34% YTD The Dow Jones Stoxx 600 has plunged 34% YTD The Dow Jones Industrial Average is down 29%The Dow Jones Industrial Average is down 29%

• Helping drive the historic selloff is the sense that Helping drive the historic selloff is the sense that Europe's economies are closer to a recession than the Europe's economies are closer to a recession than the

U.S. economy. And,U.S. economy. And, As the thinking goes, European stocks are likely to be As the thinking goes, European stocks are likely to be

harder hit than U.S. stocks by any global slowdown harder hit than U.S. stocks by any global slowdown because companies in France, Italy, Spain and because companies in France, Italy, Spain and Germany rely more heavily on exports than their U.S. Germany rely more heavily on exports than their U.S. peerspeers

In EuropeIn EuropeREVIEWING THE PERFORMANCE OF KEY MARKETS

Asia is also experiencing significant fallout from the crisisAsia is also experiencing significant fallout from the crisis Last Friday, Tokyo's stock market fell by 9.4%; its biggest one-day percentage Last Friday, Tokyo's stock market fell by 9.4%; its biggest one-day percentage

drop since the stock market crash of October 1987drop since the stock market crash of October 1987 About 75% of listed-Japanese companies are now trading below book valueAbout 75% of listed-Japanese companies are now trading below book value In China the stock market has lost three-fifths of its value since October 2007In China the stock market has lost three-fifths of its value since October 2007 Other markets around Asia fell heavily as investor confidence wiltedOther markets around Asia fell heavily as investor confidence wilted

Asia's financial markets are also in total disarray in spite Asia's financial markets are also in total disarray in spite of the fact that of the fact that

Most Asian countries’ fundamental economic performance is solid (but for Most Asian countries’ fundamental economic performance is solid (but for some such as Korea) banks have been borrowing heavily on overseas some such as Korea) banks have been borrowing heavily on overseas markets to fuel growth.markets to fuel growth.

China and Japan in particular are awash with cashChina and Japan in particular are awash with cash

In AsiaIn AsiaREVIEWING THE PERFORMANCE OF KEY MARKETS

In AsiaIn AsiaREVIEWING THE PERFORMANCE OF KEY MARKETS

S&P/Citigroup Global Equity Indices, YTD through 9/16/2008Emerging Markets -36.43%

Russia -51.48% Hungary -29.76%

Pakistan -51.03% South Africa -28.66%

India -47.53% Brazil -28.38%

China -45.82% Peru -26.25%

Turkey -43.71% Czech Republic -26.24%

Slovenia -43.22% Chile -19.70%

Philippines -41.32% Mexico -19.13%

Indonesia -39.68% Nigeria -18.90%

Malaysia -36.09% Argentina -17.94%

Poland -33.17% Israel -15.49%

Taiwan -32.90% Colombia -13.48%

Egypt -30.99% Morocco -6.84%

Thailand -30.35% Jordan -0.70%

Source: Standard & Poor’s, Howard Silverblatt

S&P/Citigroup Global Equity Indices, YTD through 9/16/2008World Ex U.S. -28.26%

World -22.77%

Iceland -58.25% Singapore -31.00%

Ireland -44.56% Germany -30.98%

Greece -42.16% Sweden -30.84%

Portugal -40.61% Spain -30.56%

South Korea -40.31% United Kingdom -30.35%

Norway -39.71% France -29.16%

Finland -39.65% Netherlands -26.66%

Belgium -37.62% Denmark -25.18%

Hong Kong -35.86% Luxembourg -24.67%

New Zealand -35.26% Canada -20.24%

Italy -34.48% Japan -19.99%

Austria -33.43% Switzerland -18.45%

Australia -32.87% United States -16.12%Source: Standard & Poor’s, Howard Silverblatt

Mapping the crisisMapping the crisisREVIEWING THE PERFORMANCE OF KEY MARKETS

A picture is worth a thousand wordsA picture is worth a thousand wordsREVIEWING THE PERFORMANCE OF KEY MARKETS

2. A Global response to the 2. A Global response to the financial crisisfinancial crisis

Broad contours of the original rescue plan Broad contours of the original rescue plan referred to as referred to as The Troubled Asset Relief Program The Troubled Asset Relief Program (TARP)(TARP)

Created and capitalized within the $700 billion bailout bill Created and capitalized within the $700 billion bailout bill of September 2008of September 2008

TARP’s mandatesTARP’s mandates• Invest directly into the banking systemInvest directly into the banking system• Act to guarantee bank debtAct to guarantee bank debt• Purchase distressed securities and,Purchase distressed securities and,• In some cases, nationalize banksIn some cases, nationalize banks

TARP’s mandates (cont’d)TARP’s mandates (cont’d)

• Gave the Treasury Department authority to acquire, hold Gave the Treasury Department authority to acquire, hold and eventually sell distressed securities on the books of and eventually sell distressed securities on the books of banks and other financial service companies distressed banks and other financial service companies distressed assetsassets

• The plan also includes buying pools of mortgages and The plan also includes buying pools of mortgages and refinance them into new mortgages that homeowners can refinance them into new mortgages that homeowners can afford, thus stemming the tide of foreclosuresafford, thus stemming the tide of foreclosures

• The rescue package has the potential to The rescue package has the potential to outweigh by far the initial $700 billion packageoutweigh by far the initial $700 billion package

U.S. - Promoting Financial StabilityU.S. - Promoting Financial Stability

A GLOBAL RESPONSE TO THE FINANCIAL CRISIS

TARP was jointly formulated jointly byTARP was jointly formulated jointly by

The Treasury departmentThe Treasury department The Federal Reserve and The Federal Reserve and The Federal Deposit Insurance Corp.The Federal Deposit Insurance Corp.



The plan for the Treasury: shoring The plan for the Treasury: shoring up the banking sectorup the banking sector

Many banking institutions need to be Many banking institutions need to be recapitalized before they can resume recapitalized before they can resume regular lendingregular lending

New capital will be injected into the banking New capital will be injected into the banking sectorsector



The plan for the Treasury (cont’d)The plan for the Treasury (cont’d)

The Treasury will use up to $250 billion from the $700 The Treasury will use up to $250 billion from the $700 billion to take preferred equity stakes inbillion to take preferred equity stakes in

• Bank of America-including Merrill Lynch ($25 billion)Bank of America-including Merrill Lynch ($25 billion)• JP Morgan, Citigroup and Wells Fargo ($25 billion each)JP Morgan, Citigroup and Wells Fargo ($25 billion each)• Goldman Sachs and Morgan Stanley ($10 billion each) Goldman Sachs and Morgan Stanley ($10 billion each) • Bank of New York Mellon ($3 billion)Bank of New York Mellon ($3 billion)• State Street ($2 billion) and potentiallyState Street ($2 billion) and potentially• Several other banksSeveral other banks



Preferred equity will be purchasedPreferred equity will be purchased• Avoid hurting existing shareholdersAvoid hurting existing shareholders• Preferred stakes will carry 5% annual dividendsPreferred stakes will carry 5% annual dividends• Annual dividends will rise to 9% after 5 yearsAnnual dividends will rise to 9% after 5 years• Invest in several big banks to avoid placing a stigma on any Invest in several big banks to avoid placing a stigma on any

bank in particular for getting government helpbank in particular for getting government help



The plan for FDIC The plan for FDIC

will address the fear among financial institutions that it’s will address the fear among financial institutions that it’s unsafe to lend to each otherunsafe to lend to each other

• Will temporarily guarantee 100% of newly issued senior Will temporarily guarantee 100% of newly issued senior unsecured debt with maturities up to 3 years issued by unsecured debt with maturities up to 3 years issued by banks, thrifts and some holding companiesbanks, thrifts and some holding companies

• If fear is removed, short term lending rates such as Libor, a If fear is removed, short term lending rates such as Libor, a benchmark for consumer and business loans will go downbenchmark for consumer and business loans will go down

U.S. - Promoting Financial StabilityU.S. - Promoting Financial StabilityA GLOBAL RESPONSE TO THE FINANCIAL CRISIS

The plan for FDIC (cont’d) The plan for FDIC (cont’d)

Deposit insurance will increase its backing of deposits above Deposit insurance will increase its backing of deposits above the current $250,000 limit in non-interest bearing checking the current $250,000 limit in non-interest bearing checking accountsaccounts

This action is intended to stem the tide of business owners This action is intended to stem the tide of business owners yanking their money out of troubled financial institutionsyanking their money out of troubled financial institutions

U.S. - Promoting Financial StabilityU.S. - Promoting Financial StabilityA GLOBAL RESPONSE TO THE FINANCIAL CRISIS

The Plan for Federal Reserve BankThe Plan for Federal Reserve Bank

Buy high quality, 3-month maturity commercial paper (a Buy high quality, 3-month maturity commercial paper (a form of short-term corporate borrowing) through April form of short-term corporate borrowing) through April 30, 200930, 2009

The commercial-paper market has come under intense The commercial-paper market has come under intense pressure in recent weeks , constraining businesses and pressure in recent weeks , constraining businesses and consumers from borrowingconsumers from borrowing



$290 billion represents the capital already $290 billion represents the capital already committedcommitted

• $125 allocated to nation’s nine biggest banks and $125 allocated to nation’s nine biggest banks and investment banks and investment banks and

• Another $125 billion for publicly traded regional banks. Another $125 billion for publicly traded regional banks.

• The remaining $40 billion were used to expand the The remaining $40 billion were used to expand the existing bailout of AIG to a total of $150Bexisting bailout of AIG to a total of $150B

U.S. - Promoting Financial Stability U.S. - Promoting Financial Stability (cont’d)(cont’d)


What has worked so farWhat has worked so far

• Some parts of the credit markets have gotten betterSome parts of the credit markets have gotten better

Commercial paper rates have fallen markedly in the last few Commercial paper rates have fallen markedly in the last few weeksweeks

As has another key rate, the London interbank offered rate As has another key rate, the London interbank offered rate (Libor), the benchmark for trillions of dollars of corporate (Libor), the benchmark for trillions of dollars of corporate loans (the three-month Libor has fallen to 2.15 percent, from loans (the three-month Libor has fallen to 2.15 percent, from 4.82 percent in early October, when many banks were 4.82 percent in early October, when many banks were reluctant to lend to each other)reluctant to lend to each other)

• A few solid companies have been able to borrow A few solid companies have been able to borrow money at these ratesmoney at these rates



What hasn’t worked so farWhat hasn’t worked so far• InIn spite of massive capital infusion, banks remain largely spite of massive capital infusion, banks remain largely

unwilling to lend unwilling to lend

• The credit markets remain largely stalled as loans remains The credit markets remain largely stalled as loans remains scarce in both the consumer and corporate sectorsscarce in both the consumer and corporate sectors

While a few solid corporations were able to borrow money, While a few solid corporations were able to borrow money, others are still virtually shut out of the credit marketsothers are still virtually shut out of the credit markets

The markets for bonds backed by credit card debt, auto loans The markets for bonds backed by credit card debt, auto loans and student loans also remains shut down. For example, and student loans also remains shut down. For example, there has been no issuance of bonds backed by credit card there has been no issuance of bonds backed by credit card loans in the U.S. or Europe in October 2008loans in the U.S. or Europe in October 2008

Home mortgage rates have barely eased keeping the housing Home mortgage rates have barely eased keeping the housing market in a prolonged state of doommarket in a prolonged state of doom

The markets also remain frozen for state and local The markets also remain frozen for state and local governmentsgovernments



Possible reasons for the new program: Possible reasons for the new program:

• The original plan was devised with hardly any conditions The original plan was devised with hardly any conditions imposed on the beneficiariesimposed on the beneficiaries

• One of the few notable conditions: money received One of the few notable conditions: money received cannot be spent on executive bonuses and golden cannot be spent on executive bonuses and golden parachutesparachutes

U.S. - TARP II: The government’s financial U.S. - TARP II: The government’s financial rescue program enters a new phaserescue program enters a new phase


Possible reasons for the new program (cont’d)Possible reasons for the new program (cont’d)

• And as such…And as such… Massive capital infusion didn’t trickle down as exceptedMassive capital infusion didn’t trickle down as excepted Banks remain unwilling to lend to consumers and corporations Banks remain unwilling to lend to consumers and corporations Instead, some of the infused capital was used by some banks to Instead, some of the infused capital was used by some banks to

acquire weaker rivalsacquire weaker rivals

• As an illustration, PNC Financials became the first bank to As an illustration, PNC Financials became the first bank to make use of the US government’s recapitalization program to make use of the US government’s recapitalization program to merge with National City Corpmerge with National City Corp

• To help pay for the deal valued at $5.2 billion, PNC said it had To help pay for the deal valued at $5.2 billion, PNC said it had received approval for a $7.7 billion government investment received approval for a $7.7 billion government investment as part of the Treasury Department’s capital injection as part of the Treasury Department’s capital injection programprogram. .



Possible reasons for the new program (cont’d)Possible reasons for the new program (cont’d)

• And as such… (cont’d)And as such… (cont’d)

Banks have yet to produce reliable accounts of their balance Banks have yet to produce reliable accounts of their balance sheets suggesting significant write-downs to flush out sheets suggesting significant write-downs to flush out distressed securities,distressed securities,

This could call for more capital injectionsThis could call for more capital injections

In the revised version of TARP, the focus will be on In the revised version of TARP, the focus will be on helping consumers instead of financial institutionshelping consumers instead of financial institutions



• By signaling the switch on Wednesday Nov 12 , Mr. Paulson has By signaling the switch on Wednesday Nov 12 , Mr. Paulson has officially conceded that the plan originally presented to Congress officially conceded that the plan originally presented to Congress in September was being revisedin September was being revised

• Although the plan being revised is still called TARP for Troubled Although the plan being revised is still called TARP for Troubled Asset Relief Program, troubled assets are no longer its main focus: Asset Relief Program, troubled assets are no longer its main focus: they will not be bought (by the Treasury) under the new planthey will not be bought (by the Treasury) under the new plan

• Capital infusion will continue but includes this time non-federally Capital infusion will continue but includes this time non-federally insured financial institutions such as GE Capital and CIT Financialinsured financial institutions such as GE Capital and CIT Financial

• Although troubled car manufacturers are not in included, the new Although troubled car manufacturers are not in included, the new plan offers to recapitalize their financing subsidiaries which plan offers to recapitalize their financing subsidiaries which constitutes a backdoor supportconstitutes a backdoor support

U.S. - TARP II: The government’s U.S. - TARP II: The government’s financial financial rescuerescue program enters a new phase program enters a new phase


Propping their banking systemPropping their banking system Some European governments such as the U.K. have Some European governments such as the U.K. have

already taken over or arranging to takeover their most-already taken over or arranging to takeover their most-at-risk banks such as Royal Bank of Scotland Group at-risk banks such as Royal Bank of Scotland Group PLC and HBOS PLC following the takeover of mortgage PLC and HBOS PLC following the takeover of mortgage lender Bradford & Bingley whereas others,lender Bradford & Bingley whereas others,


What’s Being Done in EuropeWhat’s Being Done in Europe

Propping their banking system Propping their banking system (cont’d)(cont’d)

Germany, Greece and Ireland will Germany, Greece and Ireland will guarantee all of their banks’ guarantee all of their banks’ consumers depositsconsumers deposits

Germany also adopted a plan to Germany also adopted a plan to guarantee inter-bank lending. This guarantee inter-bank lending. This could cost up to €400 billion in could cost up to €400 billion in Germany aloneGermany alone



The major central banks including the Fed are also The major central banks including the Fed are also cutting interest ratescutting interest rates

This is quite a turnaround for Europe which has been This is quite a turnaround for Europe which has been more hawkish on inflation than the U.S. Fedmore hawkish on inflation than the U.S. Fed



Loosening mark-to market rulesLoosening mark-to market rules Both financial and non-financial institutions will be Both financial and non-financial institutions will be

allowed as necessary to value their assets with risk of allowed as necessary to value their assets with risk of default assumptions rather than immediate market value Idefault assumptions rather than immediate market value I

Immediate market value has proved to be irrelevant in Immediate market value has proved to be irrelevant in illiquid marketsilliquid markets




Let’s All Hope ThatLet’s All Hope That

1.1. 3 Are we slipping into a recession3 Are we slipping into a recession Perhaps, and it could be a long onePerhaps, and it could be a long one

Why?Why?• Data from the labor Department show rising unemploymentData from the labor Department show rising unemployment

The Current Economy

Jobless Rate at 14-Year High After October Losses— the worst Jobless Rate at 14-Year High After October Losses— the worst toll since November 2001toll since November 2001

Employers had cut 284,000 jobs in Employers had cut 284,000 jobs in September followed by 240,000 cutsSeptember followed by 240,000 cutsIn OctoberIn October

Number of Americans collecting joblessNumber of Americans collecting jobless benefits jumped to 3.9 million in the weekbenefits jumped to 3.9 million in the week

that ended Nov 1, hitting a 25-year highthat ended Nov 1, hitting a 25-year high

Are we slipping into a recession?

The Conference Board Consumer Confidence Index fell to an all-The Conference Board Consumer Confidence Index fell to an all-time low in October low in Octobertime low in October low in October

• The Index now stands at 38.0 (1985=100), The Index now stands at 38.0 (1985=100), down from 61.4 in Septemberdown from 61.4 in September

• By comparison, in the spring of 2000, as theBy comparison, in the spring of 2000, as theNasdaq composite index plummeted from its Nasdaq composite index plummeted from its March 2000 high, the consumer confidence March 2000 high, the consumer confidence hovered around 140hovered around 140

This means that consumers are more afraid about their economic This means that consumers are more afraid about their economic future and shopping lessfuture and shopping less


This survey of consumer behavior means that most people are afraid This survey of consumer behavior means that most people are afraid about economic conditions and as a result, they are cutting back on about economic conditions and as a result, they are cutting back on spendingspending

The Commerce Department reported Friday Nov 14 that its broad measure The Commerce Department reported Friday Nov 14 that its broad measure of U.S. retail sales dropped by 2.8% in October of U.S. retail sales dropped by 2.8% in October

The largest monthly drop since records began in 1992The largest monthly drop since records began in 1992 Sales have fallen for four straight months, a longer streak than during the Sales have fallen for four straight months, a longer streak than during the

2001 recession, with declines worsening each month2001 recession, with declines worsening each month As consumers continue to pull back, the threat rises of a deep and As consumers continue to pull back, the threat rises of a deep and

prolonged recessionprolonged recession


New orders for manufacturers are falling everywhereNew orders for manufacturers are falling everywhere

In the indexes, a figure of 50 indicates that the flow of orders is In the indexes, a figure of 50 indicates that the flow of orders is neither rising nor fallingneither rising nor falling

• In the U.S., the figure fell to 32.2 in OctoberIn the U.S., the figure fell to 32.2 in October• It had been under 50 for a yearIt had been under 50 for a year• But it was not until September that the plunge beganBut it was not until September that the plunge began• The October level is the lowest since early 1980The October level is the lowest since early 1980


U.S. exports fell $9.9 billion from August to September U.S. exports fell $9.9 billion from August to September due to due to

• Weakening foreign demandWeakening foreign demand, ,

• A 57-day strike by Boeing machinists that A 57-day strike by Boeing machinists that caused civilian aircrafts to fall by $3.3 billion caused civilian aircrafts to fall by $3.3 billion from August to September andfrom August to September and

• A rising dollar and A rising dollar and

Why is the dollar rising?Why is the dollar rising?• The dollar's status as the world's main The dollar's status as the world's main

reserve currency makes it popular as a refuge investment reserve currency makes it popular as a refuge investment during times of global economic weaknessduring times of global economic weakness


The euro-zone is technically in a recession (defined as The euro-zone is technically in a recession (defined as two consecutive quarters of negative growthtwo consecutive quarters of negative growth

• This is the first recession for the This is the first recession for the 15-member region since 1999.15-member region since 1999.

• The combined economy of the euroThe combined economy of the euro-zone (equal to that of the U.S. in size)-zone (equal to that of the U.S. in size) shrank 0.2% in the 3Q08 after a shrank 0.2% in the 3Q08 after a similar decline in 2Q08similar decline in 2Q08

• As in the U.S., the resulting crunch on As in the U.S., the resulting crunch on credit markets has made borrowing increasingly difficult, crimping spending credit markets has made borrowing increasingly difficult, crimping spending and investmentand investment


The U.S. economy also is widely believed to be falling The U.S. economy also is widely believed to be falling into recession, though numbers to confirm whether that into recession, though numbers to confirm whether that is the case won't come until Januaryis the case won't come until January

• U.S. GDP has already contracted at an annual rate of 0.3% in 3Q08. U.S. GDP has already contracted at an annual rate of 0.3% in 3Q08.

• Numbers for 4Q08 to confirm whether that is the case won’t come until JanuaryNumbers for 4Q08 to confirm whether that is the case won’t come until January

• But falling house prices, ongoing financial crisis and a deteriorating job market But falling house prices, ongoing financial crisis and a deteriorating job market (all weighing on consumer spending) seem to indicate that 4Q08 won’t be any (all weighing on consumer spending) seem to indicate that 4Q08 won’t be any better and most likely worsebetter and most likely worse

• Historically, recessions preceded by episodes of banking-related financial Historically, recessions preceded by episodes of banking-related financial stress have tended to be more profound and long-lastingstress have tended to be more profound and long-lasting


On the other hand,On the other hand, Commodities are in a brutal correctionCommodities are in a brutal correction

• Heavily overbought headingHeavily overbought headinginto 2008into 2008

• Now heavily oversold as theNow heavily oversold as the global economy is now slowingglobal economy is now slowing

• Crude oil prices has fallen 60%Crude oil prices has fallen 60%since their July high since their July high

• Other commodities such as grains, copper Other commodities such as grains, copper and gold had also fallen significantly and gold had also fallen significantly

• This is good for the economy as it will put This is good for the economy as it will put billions of dollars back in the pockets ofbillions of dollars back in the pockets ofconsumers and in corporate coffersconsumers and in corporate coffers


On the other hand…On the other hand… Also…Also…

• Lower oil prices helped to narrow the U.S. trade deficit in Lower oil prices helped to narrow the U.S. trade deficit in September 2008September 2008

The trade deficit shrank by $2.6, to 56.5 billion in September from $59.1 The trade deficit shrank by $2.6, to 56.5 billion in September from $59.1 billion in Augustbillion in August

Much of that decline is attributable to a 15.7% decline in petroleum Much of that decline is attributable to a 15.7% decline in petroleum imports (crude oil is now trading at $60 a barrel) imports (crude oil is now trading at $60 a barrel)

This, however, might have at best a positive on the depth and duration of This, however, might have at best a positive on the depth and duration of the recession, not avert itthe recession, not avert it

Are we due for a recession?

THANK YOUTHANK YOU

The Current Economy and its Influence on Market Performance. Seddik Meziani, Ph.D. Professor of...

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