1.

• • The Credit Crunch

• or

• What happened to my investments?

2. Today, you will learn...

Why what most people thought happened in mortgages was a fairy tale

Lots of exciting technical terms like CDO

Why Moral Hazard isn't a Jane Austen character

What might happen next if we're lucky... ... and if we're not

3. Once upon a time 4. Here's how it's meant to work Low interest rate X Higher interest rate Y Y X = Gross Profit (ie before other costs like staff) 5. Let's look at incentives... Wants to lend to a stable bank, but actually the Government will pick up most of the risk of bank collapse Only wants to lend to buyers who will make payments each month. Wants to get money back if they have to repossess 6. ... and risks A few customers might default, but negotiation, or repossession kept things working (plus, the profit was enough anyway) 7.

• OK, so far?

• Well, what about the nasty risk hidden there...

8. Timing... Depositors want to be able to get at their cash at any time Want to repay their mortgage over a long period (25 years) 9.

• WARNING

• The previous slides contained big, fat, oversimplifications...

10. Money in = Money available to lend Piffle 11. Money available to lend 12.

• The Problem With Magic

• as a basis for the global financial system

• Do not meddle in the affairs of Wizards, for they are subtle and quick to anger.

• - Tolkein, TLOTR

• OK, that wasn't really relevant, but it's a great quote, and the whole financial wizardry thing is kind of critical here...

13. How to structure the finance industry for fun and profit (Part 1) 14. Acronym Soup

SPV Special Pupose Vehicle

• Bank sets of new company, transfers mortgages into it, and sells it off... the risk is now with the owners of the new company, not the bank, which continues to get a processing fee

MBS Mortgage Backed Securities

• Securities is American for Shares

• MBSs are basically shares in SPVs

15.

• Sitting comfortably, because we've only just got started

16. How to structure the finance industry for fun and profit (Part 2) 17. What's a CDO?

Collateralised Debt Obligation

? 18. If a borrower defaults, who loses and who gains? aka Moral Hazard for Dummies 19. Underpinnings.....

As long as the markets carrying on going up, everyone makes money

Move to ARMs (variable rate mortgages) in US

Those responsible for making lending decisions still make money even if the wheels fall off

Everyone believes that the Governments will bail out, well, everyone if things go pear-shaped

• Because of the dot com bust, interest rates are low to prevent recession

• TBTF theory

20. Consequences...

More money continually available to support this

Buyers / remortgagers encouraged to borrow more, irrespective of their ability to pay the loans

Prices go up, up and away and everyone lived happily ever after...

21. Then....

About November / December 2007, the big investors in CDOs realised that they might not have quite enough money, and stopped buying for about 3 months

Actually, it turned out that many of them had had enough money, but it took a while to work this out, and in the meantime...

22. No more CDO buyers...

No more CDO buyers, leads to

No more SPV / MBS buyers, leads to

No more magic funding for mortgages, leads to

Fewer mortgages issued, leads to

Buyers don't have lots of mortgage companies beating down their doors, leads to

Buyers have to pay higher rates, leads to

Buyers offer less

23. Buyers Offer Less, leads to...

Markets no longer going up, plus...

... fixed rate periods start coming to an end...

Buyers' ability to pay interest suddenly an issue

Repossessions start, so

Market goes down further

• If Mr. BMV is the only buyer in town, he's setting MV

24. ... and, for the banks...

Please sir, I sold all these mortgages, but now no-one wants to buy my MBSs

Perception of trouble leads to run on banks... ... governments have to step in to lend cash

Other banks assets turn out to be mainly made of property, which isn't worth what it used to be

Share prices (a reflection of what the banks are worth) collapse, as fears that the banks will be caught short

25. Casualties...

Homeowners caught in negative equity

Estate agents have no deal volume, no income

Ditto mortgage brokers, valuers, etc.

Banks

• Nationalised

• Bought out for a fraction of their former value

• Closed

26. Bank Closure (USA) - 2008

September

• Silver State Bank, Henderson, NV

August

• Integrity Bank, Alpharetta, GA

• The Columbian Bank and Trust, Topeka, KS

• First Priority Bank, Bradenton, FL

July

• First Heritage Bank, NA, Newport Beach, CA

• First National Bank of Nevada, Reno, NV

• IndyMac Bank, Pasadena, CA

Earlier in year: 2 in May, 1 in March, 1 in January

27. MegaBanks in trouble

Fannie Mae Nationalised

Freddie Mac - Nationalised

Bear Stearns

• Shares went from high of $153 to $4.78

• 14 thMarch, emergency loan from US Government

• 16 thMarch, sold at $2 ($10) a share by JP Morgan Chase

Merril Lynch

• Bought by Bank of America on 14 thSeptember, for 40% of value a year ago

Lehman - 4 thlargest US investment bank

• Filed for Chapter 11 (Bankruptcy) on 15 thSeptember

• Debts of $768 billion - assets worth $639 billion

$12 trillion between them ... $12,000,000,000,000 28. What to expect Q4 2008

My personal view I am NOT an IFA

I am expecting a further fall in house prices

• See next slide

I am expecting it to get harder to get mortgages

I'm expecting a witchhunt, shorty

29. Where do house prices need to be?

2 bedroom EOT/Semi in Maidenbower

I bought two

• 28 SC

• • Bought for 165k in August 2003

• • Sold for 205k in early 2008

• 5, BC

• • Bought for 135 in October 2001

• • Sold for 180k in April 2005

• Currently worth about 180k

• • All the gain between April 2005 and Early 2008 is gone

• I will buy again back at about 140k

30. The Elephants in the Room

Stagflation

• Why being a member of the MPC is a hard job

Bailout Central, DC ( Saturday morning's update )

AIG Insurer

• As of 1 stJanuary, 18 thlargest COMPANY in the world

• 17 thSeptember

• Loan of $85 billion in exchange for 80% of shares

• If it fails, it's pretty much game over for the world credit market, and the property market will crash, crash, crash

31. Important things to learn...

At the moment, so-called BMV is SETTING the market price

Now is a better time to buy than any time since early 2005 but Patience is a key skill of the good investor

BMV today? Better be sure

Better start getting ready, though

• Cash is not so much King as God-Emperor

• Rising tides are out, skill is back in play