The Panic of 2007

Collection February 27, 2009

Roger G. PowellManaging DirectorInvestment BankingFinancial Institutions GroupPhone: 215-665-6687

Janney Montgomery Scott LLC

1.What is a financial panic?

2.What are the proximate causes of this one?

3.What is a probable outcome?

2? Service • Experience • Results

Source: Dictionary.com.

What is a financial panic?

pan ic ⋅ pæn ɪk/ [pan-ik]

noun, adjective, verb, -icked, -ick ing.⋅

–noun 1.a sudden overwhelming fear, with or without cause, that produces hysterical or irrational

behavior, and that often spreads quickly through a group of persons or animals.2.an instance, outbreak, or period of such fear.

3.Finance. a sudden widespread fear concerning financial affairs leading to credit contraction and widespread sale of securities at depressed prices in an effort to acquire cash.

4.Slang. someone or something that is considered hilariously funny: The comedian was an

absolute panic.

3? Service • Experience • Results

Financial Panics in the US

Source: US History Encyclopedia

Timeline courtesy of Vertex

The Great Crash

Creation of Federal Reserve

Rich Man's Panic

Baring's Panic

Post Civil War Panic

Ohio Life Panic

Jackson's Panic

2nd Bank of the United States Panic

1st Bank of the United States Panic

Continental Panic

FDIC Creation

Sub-prime Panic

1775 1825 1875 1925 1975

4? Service • Experience • Results

3Q:06

What is the proximate cause of this episode?

4Q:06 1Q:07 2Q:07 3Q:07 4Q:07 1Q:08 2Q:08 3Q:08 4Q:08

Credit CrisisRecession

Accounting Change

Liquidity Crisis

Government Interventions

Source: New York Times.

1Q:09

5? Service • Experience • Results

6? Service • Experience • Results

Credit Crisis

Source: OFHEO and S&P Case-Shiller

Residential Real Estate Index ValuesOFHEO US vs Case-Shiller 10 MSA Composite

3Q:98 - 3Q:08

-20

-15

-10

-5

0

5

10

15

20

25

3Q:9

8

3Q:9

9

3Q:0

0

3Q:0

1

3Q:0

2

3Q:0

3

3Q:0

4

3Q:0

5

3Q:0

6

3Q:0

7

3Q:0

8

An

nu

al R

ate

of

Ch

an

ge

(%)

OFHEO US Case-Shiller 10 MSA

7? Service • Experience • Results

Recession

Source: US Bureau of Labor Statistics

Maryland Employed Persons

2500000

2550000

2600000

2650000

2700000

2750000

2800000

2850000

2900000

2950000

3000000

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

8? Service • Experience • Results

Accounting Change

Banks required to record value declines in certain assets.

This caused losses and reductions in stated bank capital.

Banks can lend ~12 X capital.

When capital declines, banks must lend less.

This is an ‘accelerator’ for economic cycles.

9? Service • Experience • Results

Liquidity Crisis

1,300,000

1,450,000

1,600,000

1,750,000

1,900,000

2,050,000

2,200,000

Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08

Commercial Paper Outstanding Financial

Source: Federal Reserve Board of Governors

10? Service • Experience • Results

Complex financial instruments

…sub prime mortgages were bundled into Mortgage-backed Securities

…which were bundled and carved into Collateralized Debt Obligations

…which were partially guaranteed by insurance companies

…which were sold around the world to banks, pension funds and other investors, soWhen sub prime mortgages began to default investors and their lenders could not see where the losses would land.

Everyone became suspect….

Liquidity Crisis

11? Service • Experience • Results

Sleeping with an elephant…..Pierre Trudeau, Prime Minister of Canada, once said that living next to the U.S.

“. . . is in some ways like sleeping with an elephant. No matter how friendly or temperate the beast, one is affected by every twitch and grunt.”

Changes in government behavior

may appear to be capricious or arbitrary

may cause large gains or losses for an individual or company

may shift operating parameters suddenly

So every private investor stops… and waits for the new rulebook.

Government Interventions

12? Service • Experience • Results

What is a probable outcome?

13? Service • Experience • Results

Source: Dictionary.com.

What is a probable outcome?

There will be winners and losers….

"One of the funny things about the stock market is that every time one person buys, another sells, and both think they are astute." William Feather (1889 – 1991) The Cleveland Press

Increased regulation of financial transactions and institutions….

See “Blueprint for Modernization of Financial Regulation”U. S. Treasury, 2007

14? Service • Experience • Results

Source: Dictionary.com.

What are lessons for you and me?

1. Use debt wisely/ Debt to pay for college is an investment; debt to buy a fun, new wardrobe is not.

2. Never take on debt that you are not confident that you can pay even if something unexpected goes wrong for a while. Be especially sure that you can pay your credit card debt. It is expensive, and the failure to pay can cause you great problems later.

3. Save, save, save. It is the best investment you can make in yourself.

4. If something sounds too good to be true, it is. Look harder and ask for help in understanding why.

The most valuable things in life are not measured in monetary terms. The really important things are not houses and lands, stocks and bonds, automobiles and real estate, but friendships, trust, confidence, empathy, mercy, love and faith." Bertrand Russell, Philosopher (1872-1970)

15? Service • Experience • Results

3 Secrets of Financial Success

The Greatest – Thrift: spend less than you make

The Next – Industry: whatever task you undertake, do it with energy and attention; work hard and work smart.

The Least – Talent: find your true skill and love and pursue it, making your daily task a pleasure.