Finance Highlights 2008 1118 - Laserfiche WebLink

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UPQATE C]N SEPTEMBER}5 MARKET VCILATILITY In September, financial markets experienced unprecedented volatility. The government bailed out several large financial institutions, and other firms were forced to merge with stronger partners. At the same time, markets around the world gyrated wildly, as fear and lack of confidence engulfed the marketplace. This article presents a summary of the events leading up to September's market action, and a recap of the historic events of this month. Credit Crisis Summary The current market crisis had its roots in the bursting ofthe housing bubble Sub-prime borrowers are defaulting and going into foreclosure at high rates Many sub-prime mortgages were securitized and sold to investors around the world Trillions of dollars of these mortgages and securitized mortgages are held on the balance sheets of major global financial institutions These mortgage securities and mortgages are difficult to value, resulting in uncertainty about the liquidity and capitalization of majorfinancial institutions Inaccessibility toliquidity and additional capital has forced some financial institutions into bankruptcy and others into takeovers forced by federal regulators The federal government has taken many actions to provide the financial markets with liquidity and attempt to contain any systemic risk that recent events might pose Congress approved the $700 billion bailout package and the government will continue to seek additional solutions to mitigate the effects of this crisis Unprecedented Market Volatility On September 7, the Federal Housing Finance Agency, the new housing regulatory authority created to oversee Fannie Mae and Freddie Mac, in conjunction with the Treasury Department placed Fannie and Freddie under conservatorship aspart of afour part plan to strengthen the housing agencies. In addition to conservatorship, the Treasury pledged to: inject up to $100 billion in each agency if needed to maintain a positive net worth; provide unlimited short term liquidity if needed; and purchase mortgage backed securities in the open market. It was hoped that these government actions would restore confidence to the marketplace and help mitigate recent volatility. Unfortunately, while the credit profile of Fannie Mae and Freddie Mac improved, the broader markets moved from bad to worse. In fact, the remainder of the month of September witnessed an incredible reshaping of the financial landscape and some of the highest levels of financial marketvolatility on record. Shortly after the housing agencies' situation was presumably resolved, confidence in a number of venerable financial institutions began to evaporate. On September 14, Lehman Brothers (the 4th largest Wall Street investment bank) declared bankruptcy following 158 years of business and Merrill Lynch (the 3rd largest Wall Streetfirm)agreed to be purchased by Bank of America. On September 16, American International Group (AIG), once the largest insurance company in the United States, received an $85 billion emergency loan from the federal government in order to prevent the company's bankruptcy and the chaos that might have ensued in the financial system. Over the course of the next several days fear of bankruptcy continued to swirl among a wide variety of financial firms. These concerns caused Goldman Sachs and Morgan Stanley, the two largest and most prestigious investment banks on Wall Street, to change their regulatory status in order to become bank holding companies. Although this change may result in lower profitability for Goldman and Morgan, both firms saw the ability to access relatively stable customer deposits as essential to their surviva I. On September 25, Washington Mutual was seized by the Federal Deposit Insurance Corporation (FDIC) and its assets were sold to JP Morgan in what is officially the nation's largest bank failure. On September 29, the banking operations of Wachovia (at one point the nation's 4th largest bank) were purchased by Citigroup in a deal that included the backing of the FDIC. Wells Fargo has also seen value in Wachovia's assets, and Citigroup and Wells are currently fighting for control of the bank. In addition to these failures and takeovers of very large financial institutions, the markets demonstrated extreme turmoil. At one point demand for Treasury securities wassa great that the thirty-day Treasury bill was actually paying negative interest as investors fled to the world's safest asset. The importance of the negative interest rate is that in this crisis environment, investors essentially preferred to pay the treasury to hold their cash, instead of accepting interest earnings from any other borrower. Credit spreads (the additional compensation required for investing in risky assets) reached all-time highs and many fixed income and short-term money markets essentially ceased to function. Fage 2 ® 2008. Chandler Asset Management, Inc, A Registered Investment Adviser.