The Debt Crisis 2007/2008
Wednesday 24th & Thursday 25th
•How it has happened
•Putting it into context
•Where to from here
•Strategic Decisions for Individuals
Slide 1 - How It Happened….
• It really did start with mortgages to people who
could not afford them.
• They were sold by salespeople (mortgage
brokers) on commission.
• The loans did not ‘stay’ with the financial
institution who provided the loan (as tends to
happen in Australia), they were ‘sold’ to other
financial institutions. Therefore institutions were
not so concerned over the credit worthiness of
borrowers, because they were just selling the
Slide 2 - Non Recourse Loans
• These loans were ‘non recourse’ loans – that is
if the borrower could not pay the loans back, the
lender could take back the property – without
any further claim on their assets or income.
(again, unlike Australia where borrowers have to
pay back all of the loan amount).
• This is where the term ‘jingle mail’ comes from:
USA homeowners posting their keys back to
their lenders – because that is where the
responsibility for their loan ends.
Slide 3 – Bundling the Loans
• The loans were bundled together,
sometimes with further borrowing, into
various products including ‘Collateralised
Debt Obligations (CDO’s)’.
• In Australia some superannuation funds,
councils and banks invested in CDO’s.
Slide 4 – No-one Trusts
• The problem is in debt markets. If these
CDO’s can cause an investment bank to
fail (Bear Sterns), then no-one wants to
lend money to an institution that might
have significant exposure to them.
Slide 5 – This is a Debt Problem
Slide 6 – The Credit Rating
• In the early part of this decade there was
another ‘sub-prime’ mortgage crisis in the
USA. However house prices were still
going up, so more than 90% of the value
of loans were recovered.
• This time house prices are falling…..so far
less is being recovered.
• Credit ratings agencies rated a lot of debt
as much less risky that it really was.
Slide 7 – Why House Prices
(in the USA) Matter
• Stopping the fall of house prices in the
USA will put a floor under the valuations of
• It is an important plank in resolving the
Slide 8 – Putting it into Context
• We don’t want to diminish what is
happening in any way – this is a very
serious financial problem; however there
have been others that have gone before.
Slide 9 – Putting it into Context
The media enjoys reporting ‘fear or greed’.
– "This economic convulsion is unprecedented in the post-World
War II era.” Robert J. Samuelson, "A World Meltdown?" Newsweek September 7, 1998
– "This time it is different. This time the market won't be so quick to
bounce back. . . . Who can look at the world right now and not
conclude that things have changed dramatically?”
Joseph Nocera, "Requiem for the Bull," Fortune, September 28, 1998.
– "The nation's top auditor said today that many more banks were
effectively bankrupt than regulators had recognized. . . . 'The
bank insurance fund is nearly insolvent, and I cannot
overemphasize how important it is to restore it as quickly as
possible,' Mr. Bowsher [Comptroller General] told the Senate
Banking Committee.“ Stephen Labaton, "Bank Deposit Fund Nearly Insolvent, US
Auditor Says," New York Times, April 27, 1991.
Slide 10 – USA Investment Banks
vs. Australian Banking System
• Lehman Brothers is an investment bank –
a trading bank dealing in investment
• Australia’s banks are better ‘capitalised’,
the Government’s credit rating is AAA (can
raise cheap debt if needed), the RBA has
not had to ‘prop up’ any institutions and we
have an official interest rate of 7% - which
provides room to cut interest rates if
Slide 11 – The Real Economy
• In Australia:
– Unemployment is at historical lows (less than 5%)
– There is no serious expectations of a recession
– The economy is forecast to continue to grow (albeit at a slowing
rate – which is not a bad thing in that it keeps inflation under
– An International Monetary Fund (IMF) study suggests Australia
is well placed to weather the global economic downturn
– Even in the USA the ‘real economy’ seems to be surprisingly
strong, unemployment is reasonable, consumer spending strong
– and against forecasts they seem to have avoided a recession
up till now (although that may change in the future).
Slide 12 – Corporate Activity
• In the last week Warren Buffett has made 2
significant investments, including $5 billion into
Goldman Sachs overnight.
• Talk of BHP making a hostile bid for Rio Tinto.
• Lehman Brother’s assets purchased.
• Macquarie purchasing Channel 10??
Corporate activity might be a sign of increased
confidence in markets, and the values of companies.
Slide 13 – The Bailout
• The proposal for the USA Government is to buy
back large amounts of the mortgage debt.
• This potentially improves the situation by taking
this ‘toxic debt’ out of the companies – making it
easier for companies to lend and borrow with
• Many commentators have said that this takes
the ‘depression scenario off the table’.
Slide 14 - The Bailout
• It does seem to be a potentially solid
• However, it has the ‘political risk’ that
means that until it is passed, there will be
Slide 15 - What is Priced Into
• There is an obvious desire to sell shares, and
put the money into cash at such a difficult time.
However, the price of shares at the moment
must reflect a great deal of fear – from the USA
problems and the reporting of this as a ‘crisis’.
• The value of shares at the moment would likely
– The probability of a USA recession
– Continued problems in credit markets
– A slow down in company earnings
Slide 16 – Strategic Decisions for
• Keep a reasonable level of cash
• Diversification is a positive strategy (avoid collapses like MFS,
ABC Learning, Macquarie Fortress Notes, Asset Loans, Babcock and Brown, Basis Capital,
Absolute Capital, City Pacific, MFS Premium Income Fund, Centro Property………………)
• Aggressive Long Term Investors – possibility to
buy in a distressed market (but a strategy with
• Keep an eye on the ‘income’ from investments –
Australian shares are paying a dividend yield of
5.02%; that is very attractive
• Get in contact with us at any stage that you want
to discuss your situation