Armando Suarez, ArsenyLebedev, Joe Gunshor, Rebecca Ryba, Jacob Turner, Joe Amelio, Nicole

Rizzuto

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Contents

1. Overview2. Prelude to Shift3. Cause of Crisis4. History of the Past5. Investment Strategies6. Remedy to Crisis7. When will the Crisis End?

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Nutshell

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Banks

Washington Mutual Barclays Capital

Citigroup Lehman Brothers

Merrill Lynch UBS

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Businesses

-30%

Dow YTD

•Money is tight•Lowered consumer spending

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Households

~14 Million People

Difficulty to get loans Sub-prime mortgage problems

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2006-2007

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2008

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What’s Wrong?

The lack of organic demand is an important issue to look at.

everybody that wanted to buy a house did over the past 4 years.

The only real demand right now for the housing market are investors.

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Trade Account

An indicator of a country’s financial position vs the rest of the world. US historically always in the blackDuring the 70’s oil crisis deficit never

exceeded $15 BnTilted into free fall in ’99.2006 deficit = $750 BnTotal current account deficit ~ $800

Bn

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The Deficit

Being financed by foreignersIn 2006, US deficit consumed about

70% of the rest of the world’s surpluses.

Comes from private investors from Russia, China, and the Gulf countries.

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Central Banks Increasing amount coming from

official sources, mostly central banks.2001, $35 Bn from official sources2006, $440 Bn from official sources

Investments for policy reasons, not due to returns

What if policy is reversed? What will they do with the money?

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Central Banks and Government-Controlled Bodies Hold large concentrations of

cashlike dollar assetsChina, $1.2 TnRest of non-Chinese Asia, $1.2 TnOPEC Nations, $600 BnRussia, $400 Bn

2006 Total foreign held dollar reserves, $5 Tn

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US as Center of Trade and Investment Flows Emerging countries had no choice

but to adopt an export-led growth strategyLack basic banking and credit for

internal consumption-led boom Dollar investments would benefit

from most liquid security and trading markets.

Belief that China, India, oil exporters would have to absorb dollars.

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Not today…

America had all the world’s money, so countries would sign up in order to borrow

Today, America is still the center, but it is the world’s biggest borrower, while other countries have all the money.

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Dollars not so attractive

Holding dollars is increasingly against other countries interests.Countries may price their trades in

dollars and invest surpluses in dollar-denominated assets

BUT, primary trade flows may not be with US

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Asia

Asian countries are dollar-based Since their economies are tied to

China, and China’s trade is primarily with US, they must stay that way

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Wrong.

China is diversifying customer base50% of exports go to other Asian

countries, MidEast, and LatAm NOT US, Europe, Japan

US share of Chinese exports is about 20%

Since most Asian countries are becoming large importers of oil and gas, why maintain the dollar peg?

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Gradual move away from the Dollar Most surplus countries are now

diversifying their currency holdings and moving away from the dollarPegging against a basket of reserve

currencies US must keep interests rates higher

than wanted to prevent a total currency rout

Countries do not want to be at Western mercy

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The shift

America used to buy foreign cheap, when its currency stood alone at the center, now foreigners are not willing to finance our deficits for free.

The “lords of the manor” are now Arab, Russian, and Chinese, while the peasant maidens are American.

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The Great Depression Causes

Rise in interest rates Credit Crunch massive de-leveraging,

Crash of 1929Central Bank Reduction in money supply,

bank failuresAsset Class DeflationRestricted World TradeTax IncreasesP/E Ratio 1929: 28 P/E Ratio 1941: 12Avg. Dow Return 1.69%

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1968-1982

CausesHigh InflationHigh Unemployment Oil ShocksEnd of Bretton WoodsAvg. Dow Return 1.59%P/E Ratio 1966: 21 P/E Ratio 1982: 9

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Black Monday

Causes Program tradingMarket ValuationIlliquidityMarket psychologyDow Down ~23% for the year

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2001 Recession

Production Slowdown (tech sector) High Unemployment September 11th attacks Consumer Credit Intact

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Home Prices

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LIBOR Spreads

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Market Volatility

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Dollar Strengthening?

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Future Prospects Under Capitalized banking system Unregulated Opaque markets (CDS,

Overnight Repo) Deflation in Housing Market Loss of Confidence in Economy Rising Unemployment Moderate Inflation Auto makers failure eminent Over levered Consumer

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Is the Economic Shift Cyclical?

Cyclical

Normal Pattern Following Past 6 Recessions

Atypical

Black hole More Contraction less

Expansion

In order to figure out how to tackle a solution, we need understand what type of predicament we are in.

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Worsened Cyclical Economic Shift

Deep Recession

2008

Defined By:1. Below average Economic

Growth2. Lower Incomes3. High Unemployment

Rates4. Decreased Consumer

Spending

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An Atypical Cycle

An Atypical Cycle Each of the past six recessions has been accompanied by a bear market, with the Standard & Poor's 500-stock index losing, on average, 31%. By that measure, the stock market's current decline -- with the S&P 500 down 43% from its peak -- is already worse than usual.

Bigger the Bubble Bigger Burst

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Problem Areas

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1 2

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Resuming Our Economic Position

Restoring Investor Confidence

Home Prices Home Prices Unfreeze Credit Unfreeze Credit MarketsMarkets

Decrease Decrease Unemployment Unemployment

Restore Consumer Restore Consumer Buying Buying

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Fixing Unemployment

Problem: Job market is deteriorating and that it is taking the unemployed longer to find work

Sub Problem A: Companies are less efficient due to workforce cutsSub Problem B: Family Incomes Down, less consumer buying powerSub Problem C: Unemployed become liability of Government

Solution:Fiscal Policy: Expand Government Spending to create projects that hire unemployed i.e. highway project , however increases government deficit

Monetary Policy: Option 1: Use its own reserve money to buy government bonds - Buying bonds translates to income for the U.S. government, will allow the Government to sufficiently expand monetary policy

Option 2: lower interest increase consumer spending and investment aggregate demand will rise, there will be an increase in economic growth and therefore firms will demand more workers (this has not been working due to poor investor confidence)

Tax Policy: Give Business tax breaks if hire onshore instead offshore

Recession Proof Jobs

Research in Energy AlternativesInternational Business in growing marketsEnvironmental Sector, targeting Global WarmingEducation, people go back to school during recession

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Fixing Home Market

These include an infusion of capital that would allow banks to step up their lending activity, Ms. Wachter, the University of Pennsylvania economist, said, and a restructuring of troubled mortgages in order to reduce the number of foreclosed homes flooding the market. If banks expect home prices to continue to tumble, they will be reluctant to lend, even if they have the capital to do so, and the number of people willing to buy a home will remain low.

Problem: Stop Downward spiral of home prices

Solution: Reduce Growing Inventory, Government help restructure loans to prevent defaults

Problem :Keeps banks doors open to new investors

Solution: Bail out will take bad loans off books, which will hopefully unfreeze credit markets due to reduce liabilities of banks

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Increase GDP

Problem 1: Higher than expected GDP but due to exports, indicate falling national consumption

Problem 2: Will no longer be able to depend on strong exports with falling global consumption Solution:•we must increase spending power of consumer (70% of GDP)•New Jobs need to be created•Companies need to produce for future demand

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Thaw the Credit Markets Problem: Consumers, Businesses, and Corporations do not have

access to capital because banks are hoarding cash

Solution: Bail Out: TARPTreasury taking Equity stakes down

Graph indicates banks and other financial institutions reluctance to lend as compared to previous years, due to fear of defaults and illiquidity

WSJ

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Confident Leadership The Government and Media is Contributing

to the Panic •The Fed, the Treasury and the SEC appear to be in a state of panic.

•A crisis mentality led them to jettison their lifelong commitments to the capital markets in favor of a series of short-term regulatory quick fixes.

•ignored the most primary responsibility of central bankers to promote stability and to maintain confidence

•central bankers appear to have suddenly lost confidence both in their own abilities and in the standard tools of fiscal and monetary policy.

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Despite Economic DownturnThe Equity Market Moves Upward

Hope for the Hope for the FutureFuture

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Expert Opinions

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“For the first time since the crisis intensified at the end of the summer, credit markets thawed slightly after the threats to the financial system were tamped down by the U.S. government's move to take stakes in major banks. But lending remained tight in nearly all markets and may not ease significantly for weeks, market participants said.

Referring to the possible fallout in the broader economy from the credit crisis, he added: "We don't yet know what that is, because this situation is so unprecedented. Every road sign has been obliterated."

»Kent Engelke, managing director at the brokerage Capitol Securities Management,

Source: WSJ 50

•Bernanke states that the credit crisis is on its way to being fixed, but has a long way to go.

–TARP, to create a set of mechanisms that would create market-based price discovery by buying assets from institutions.

»Bernanke

•The crisis moment may be past for the Big Four. They are due the biggest capital injections in the Treasury bailout plan, getting $100 billion of the $250 billion, including Merrill Lynch, which will soon belong to Bank of America.

–BIG FOUR J.P. Morgan Chase, Wells Fargo, Citigroup, Bank of America

•It would be foolish to bet against the Treasury's backstop, and these banks will make money again. It just isn't clear they will make it quickly enough to give investors reasons to rush back into them.

Source: WSJ 51