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THE SUBPRIME CRISIS
What (the Hell) Happened and Why
Presented by:
Ken Roberts
Foster Pepper, LLP
Alphabet Soap
ABS
Alt-A
ARS
BHC
CDO
CDS
CP
CRA(2)
CSE
EESA
FDIC
FHFA
FHLMC
FNMA
FRB
FVA
GDP
GSE
Hedge Funds
LIBOR
MBS
Moral Hazard
Naked Short
Ninja
OCC
OTTI
Prime
Risk-Based Assets
RPF
Securitization
Shorts
SIV
Subprime
TARP
Teaser
TED
Tier 1
Traunches
“_______* makes the
world go ‘round”
*(Perry Como – 1958)
*(Bernanke – 2008)
The Numbers
US GDP:
$14.0 Trillion
Us Mortgage Debt (most held in MBS) $12.0 Trillion
US Federal Debt:
$10.6 Trillion
US Debt Held by the Public
$5.0+ Trillion
US Federal Obligations
$60.0 Trillion
($560,000
per household)
The Numbers (continued)

US Commercial Paper
$1.5 Trillion

Money Market Funds
$3.4 Trillion

Collateralized Debt Obligations
$3.0 Trillion

Credit Default Swaps
$58.0 Trillion
How To Sell Big Ticket Items?
“No One Cares what the Price is, They Only
Want to Know what the _________ is.”
Why Did it Happen?
Interest Rates at Historic Lows
Dot.com Bubble Bust and 9/11
Fed Funds Rate drops to 1% in 2003
Prime Rate at 4% in 2003
Why Did it Happen?
Government Policy Promoting Home Ownership
 CRA
 Freddie Mac & Fannie Mae Mandated to:
Lower credit standards
 Increase ownership of mortgages to
subprime borrowers
 Capital ratios lowered

 SEC Adopts Consolidated Supervised Entity
Why Did it Happen?
Affordability
ARMs
Interest Only
Teaser Rates
Ninja Loans
Why Did it Happen?
Securitizations
MBS
GSE
CDO
SIV
Credit Agencies
CDS
Why Did it Happen?
Moral Hazard
“Reducing Risk too much exposes people to
the Hazard of Irresponsible Risk-taking”
 Mortgage Originators
 Securitization
 Credit Agencies
 CDO & SIV
 CDS
Boom in the US Housing Market
1997-2006 124% price increase
 Price to median income moved from
3.0x to 4.6x
 Housing starts: 2.0 million annually
The Bust
Gravity Happens
Excess Supply
Speculators
ARMs Reset
Mortgage Debt



1190:
1908:
2008:
First Reported Mortgage
Standard Down Payment 50%
US Single Family Mortgage Debt
$12.0 Trillion
(amount held by Freddie Mac and Fannie Mae: $6.0)
Subprime & Alt-A Mortgage Debt
$3.0 Trillion
(virtually all securitized)
Estimated Subprime Mortgage
Losses
$500 Billion –
$1.0 Trillion
The Effect
 10.0 million homeowners
underwater (12%)
 10% Mortgage Loans
Delinquent
 Huge Losses (aggravated by FAS 157)
 Job Losses Mounting
 Retail Sales – Big Ticket
Items, down sharply
The Names








Barney Frank: Ranking Democrate on House
Financial Services Committee (2000-2008)
Alan Greenspan: Fed Chairman (1987-2006)
Mark Brickell: Managing Director JP Morgan (1994)
Henry Cisneros: Secretary of HUD (1993-1997)
William Donaldson: SEC Chairman (2003-2005)
Richard Fuld, Jr.: CEO of Lehman Brothers (19942008)
Ben Bernanke: Current Fed Chairman
Henry Paulsen: Current Secretary of the Treasury
The Investment Banking Meltdown

Bear Stearns



June 2007: Bailed out Two Highly leveraged CDO
Funds.
July 2007: Two of it’s Subprime Hedge Funds lost
nearly 100% of their value
March 2008: FRB Loans $29.0 Billion backed
solely by certain pledged assets; JP Morgan
Purchases Bear Sterns
The Investment Banking Meltdown

July 17, 2008: IndyMac Bank closed by FDIC
(largest failed bank to date)
The Investment Banking Meltdown

September 7, 2008: Fannie Mae & Freddie
Mac Nationalized ($6.0+ Trillion).
The Investment Banking Meltdown

Lehman Brothers


Born: 1844
Bankruptcy: September 15, 2008 ($600
Billion)
The Investment Banking Meltdown

Reserve Primary Fund

September 16, 2008: Broke a Buck
($65.0 Billion)
The Investment Banking Meltdown

September 16, 2008:

AIG (essentially) Nationalized
The Investment Banking Meltdown

September 22, 2008:

Morgan Stanley and Goldman Sachs become
Bank Holding Companies; increased access to
the Fed Window
The Investment Banking Meltdown

September 30, 2008:



$25.0 Billion in US Loans available to US auto
makers
FASB Statement No. 157 reinterpreted
IRS revised NOL rules for Bank mergers
The Investment Banking Meltdown

October 3, 2008:


EESA passes both Houses (includes $700 Billion
for TARPs)
FDIC increases deposit insurance
The Investment Banking Meltdown

October 14, 2008:


30 Day T-bill rate drops to all time low of 5bp
Treasury reserves $250 Billion of TARPs for
investment in banks and other financial institutions
The Investment Banking Meltdown

October 21, 2008:

Fed commits $540 Billion to buy commercial
paper adding liquidity to money market funds.
The Great Depression

Unemployment:
25%

Stock Market Dropped
90%

First Mortgages in Default
44%
“I would have lost more but that was
all the money I had.”
Groucho Marx, 1929
AND THIS TOO SHALL PASS