Credit Crunch: Thomas A.Russo

ru fThirty, Washington, DC Group of Where DoWe Stand? Credit Crunch: Thomas A.Russo

30 Occasional Paper 76 About the Author Thomas A. Russo Vice Chairman and Chief Legal Officer of Lehman Brothers

The views expressed in this paper are those of the author and do not necessarily represent the views of the Group of Thirty.

This material has been prepared by Thomas A. Russo and is not a product of the Lehman Brothers Research Department. It is for informational purposes only. Lehman Brothers makes no representation that the information contained in this document is accurate or complete. Opinions expressed herein are those of Thomas A. Russo and not Lehman Brothers. All levels, prices and spreads are historical and do not represent current market levels, prices or spreads, some or all of which may have changed since the issuance of this document.

ISBN I-56708-140-1 Copies of this report are available for $20 from:

Group of Thirty 1726 M Street, N.W., Suite 200 Washington, DC 20036 Tel.: (202) 331-2472, Fax: (202) 785-9423 E-mail: [email protected] WWW: http://www.group30.org Occasional Paper No. 76

Credit Crunch: Where Do We Stand?

Thomas A. Russo

Published by Group of Thirty© Washington, DC 2008

Contents Page

Acronyms and Abbreviations 5

Introduction 7 Consumer spending as a share of GDP 9 Real personal consumption and disposable income 9 Household net worth 9 Unemployment rate and average hourly earnings 10 Consumer confidence 10 Energy “tax” on consumer spending 10 Household debt burden — financial obligations ratio 11 The consumption challenge 11 Mortgages outstanding 11 Non-agency mortgage resets 12 Subprime mortgages 60-day delinquencies 12 Foreclosure forecasts 12 National home price inflation 13 Wealth effect on consumer spending growth 13 Net mortgage equity extraction 13 Mortgage lending standards 14 ABX.HE implied spreads over libor 14 Credit card debt outstanding 15 Credit card 30+-day delinquencies 15 Credit card and other consumer lending standards 15 Credit card fixed-rate spreads over swap rates 16 Subprime auto ABS 60-day delinquencies 16 Prime auto fixed-rate spreads over swap rates 16 Securitizations 17 Credit card securitizations 18 Auto securitizations 18 S&P 500 implied volatility (VIX) 18 Treasury yields 19 Gold and oil prices 19 How does global liquidity play into this? 19 U.S. M&A transaction value 20 The Fed’s global reach 20 U.S. trade position with Europe, Canada, OPEC, China 20 International reserve assets excluding gold (world) 21 Comparative returns 21 #1 Gold bubble (gold spot prices) 22 #2 Tech bubble (Nasdaq composite index – CCMP) 22 #3 Housing bubble (S&P super composite homebuilding index – S15Home) 22 #4 Global liquidity bubble? (iShares MSCI Emerging Market index – EEM) 22 Bank balance sheets 23 Reduction in asset growth 23

Conclusion 24

Recommendations 25

APPENDIX: 27 Contribution to GDP growth from net exports 27 GDP share of exports to U.S. 27 Share of growth due to exports to U.S. 27 Uses of cash-out refinancing 28 Size of sovereign wealth fund market 28 Recent SWF investments in banks / investment banks 29

Group of Thirty Members 31

Group Of Thirty Publications Since 1990 35 Acronyms and Abbreviations

ABCP Asset-backed commercial paper ABS Asset-backed security ABX A series of credit default swap indices referencing deals in the home equity loan sector, issued half-yearly and broken down into sub-indices by rating buckets (AAA, AA, A, BBB and BBB-). Each ABX index references 20 home equity loan deals, and each sub index is composed of 20 equally weighted ABS credit default swaps referencing cash bonds, one from each deal (see also ABX.HE) Alt-A Mortgage loans for those with a good credit score, but who lack normal documentation Alt-B Mortgage loans that straddle the credit score spectrum between subprime and Alt-A mortgages. Typical borrowers have very little equity in their homes ARM Adjustable Rate Mortgage bp or bps Basis points bn Billion CCMP Nasdaq composite index CDO Collateralized debt obligation CIA Central Intelligence Agency DPI Disposable personal income ECB European Central Bank EEM iShares MSCI Emerging Markets Index Fund FHA Federal Housing Administration FX Foreign exchange GDP Gross domestic product HUD U.S. Department of Housing and Urban Development HY High yield IMF International Monetary Fund LIBOR London Interbank Offered Rate LHS Left-hand scale LTV Loan-to-value M&A Mergers and acquisitions MBS Mortgage-backed securities NAFTA North American Free Trade Agreement OECD Organisation for Economic Co-operation and Development OFHEO Office of Federal Housing Enterprise Oversight OPEC Organization of the Petroleum Exporting Countries PCE Personal consumption expenditures pp Percentage point Q Quarter q-o-q Quarter-over-quarter RHS Right-hand scale S&P Standard & Poor’s SAAR Seasonally adjusted annualized rate SIVs Structured investment vehicles SWFs Sovereign wealth funds tr Trillion VIX Volatility index y-o-y Year-over-year

Introduction

This paper was presented by Thomas A. Russo on November 30, 2007, during the Group of Thirty’s 58th plenary on a panel entitled: “Credit Crunch: Where Do We Stand?” The paper was updated as of January 17, 2008, in preparation for the World Economic Forum Annual Meeting 2008 in Davos, Switzerland. In the paper, Mr. Russo weaves together a narrative of the interrelated forces that are unfolding in the current economic environment. To begin, he focuses on the U.S. consumer, who has been crucial to economic growth and yet now finds himself increasingly levered and under duress. Mr. Russo explains how the declining housing market, exacerbated by stress in the mortgage market, has left consumers unable to borrow from their homes to finance consumption. He then details the increasing signs of contagion from mortgage-backed securitizations to other markets such as credit cards and auto loans, as general uneasiness grows and as challenged consumers begin to struggle to pay other debts. As nervousness spreads across markets, Mr. Russo describes a flight to quality and to hard assets, leading to rising prices for gold, fine art, oil, etc. The paper goes on to tackle the role of liquidity, questioning whether we are in the midst of a global liquidity bubble contributing to excess valuations of certain assets. Finally, Mr. Russo comes full circle to the U.S. financial “crisis” where bank balance sheets are backing up with assets, potentially further reducing credit creation, further pinching the consumer. Against this backdrop, the paper concludes with policy proposals aimed at ameliorating the current situ- ation. Mr. Russo calls for broad-brush approaches to addressing subprime mortgages; an extension of the U.S. Department of Housing and Urban Development and Federal Housing Administration programs to keep borrowers in their homes; targeted tax incentives; discount window action; an expansion of volume caps of state housing authorities; and a lowering of the federal funds rates.

Thomas A. Russo is Vice Chairman and Chief Legal Officer of Lehman Brothers.

Consumer spending as a share of GDP

% Consumer spending is the main driver of U.S. GDP 73

71 • Consumer spending has been a rising share of GDP, currently accounting for about 70%. 69 67 • The health of the consumer is therefore a major 65 driver of the overall economy.

63 • U.S. consumer spending is important to global 61 growth. Exports to the U.S. account for 25% of 59 Canada’s GDP, 22% of Mexico’s, and 8% of China’s Mar-52 Mar-62 Mar-72 Mar-82 Mar-92 Mar-02 (see appendix, page 27).

Source: Commerce Department; data through 3Q07.

Real personal consumption and disposable income

% y-o-y Consumption is supported by income… 10 • The marginal propensity to spend out of a dollar of 8 PCE income is nearly 1, leaving the savings rate close to 6 zero.

4 • Consumer spending virtually never falls outside of 2 recessions. Even in periods of weak income growth, 0 consumers will continue to spend by drawing down DPI -2 their savings.

-4 • Even in recessions, spending on essentials such as Mar-52 Mar-61 Mar-70 Mar-79 Mar-88 Mar-97 Mar-06 medical and housing services virtually never turns negative. Note: PCE = personal consumption expenditures; DPI = disposable personal income. Source: Commerce Department; data through 3Q07. Shaded bars • Healthy income gains over the past few years have denote recessions. underpinned consumer spending.

Household net worth

% y-o-y ….and wealth 20.0 Housing boom • Consumers respond with long and variable lags to 15.0 changes in wealth.

10.0 • About 60% of household assets are financial, and 5.0 roughly 30% are residential real estate. 0.0 • However, changes in financial wealth affect only -5.0 a portion of the population since the majority is -10.0 Tech bust held by the top tier of the income distribution. In -15.0 contrast, homeownership is spread more evenly Mar-60 Mar-68 Mar-76 Mar-84 Mar-92 Mar-00 across income levels.

Source: Federal Reserve Flow of Funds; data through 3Q07. • Household net worth will likely start to decline on a year-over-year basis in the first half of 2008.

Unemployment rate and average hourly earnings

% Average hourly %y-o-y Signs of a softer job market are starting to emerge… earnings, rhs 6.5 4.5 • There is an inverse relationship between unemploy-

6.0 4.0 ment and earnings. 5.5 3.5 • Higher unemployment reduces employee bargaining 5.0 3.0 power and as such leads to slower wage growth.

4.5 2.5 • The unemployment rate increased from 4.4% in 4.0 2.0 Unemp rate, lhs March 2007 to 5.0% in December 2007. 3.5 1.5 • Higher unemployment leads not only to lower Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 per capita wages, but it also hurts consumer

Source: Bureau of Labor Statistics. confidence.

Consumer confidence

Index (1985 = 100) …contributing to a decline in consumer confidence 115 110 • Consumer expectations of future financial and 105 economic conditions trend with personal consump- 100 tion. 95 90 • If consumers expect the economy to weaken, they 85 may cut back spending and increase precautionary 80 saving. 75 70 • Consumer confidence has been falling amid Jan-05 Jun-05 Nov-05 Apr-06 Sep-06 Feb-07 Jul-07 Dec-07 concerns about housing weakness, turbulence in

Source: Conference Board; data through December 2007. financial markets and rising energy prices.

Energy “tax” on consumer spending

% y-o-y Higher energy prices add to the strain 4.0 • About 6% of consumption is directed toward 3.0 energy. 2.0 • In periods of rising energy prices, a greater portion 1.0 of consumer budgets must be used for energy 0.0 consumption, causing consumers to cut back on

-1.0 discretionary spending.

-2.0 • This is an energy “tax,” which equals change in Mar-60 Sep-67 Mar-75 Sep-82 Mar-90 Sep-97 Mar-05 energy prices weighted by the share of personal

Source: Commerce Department; Lehman Brothers Economics; data consumption. through 4Q07 (December estimate). • The latest increase in energy prices amounts to about a 1% “tax” on income.

10 Household debt burden — financial obligations ratio

% of disposable income Meanwhile, the consumer is very levered 19 • Total household debt has grown rapidly over the 18 past five years, largely due to a jump in mortgage 17 debt. 16 • The burden of servicing debt is at an all-time 15 high. 14

13 • The financial obligations ratio, which estimates

12 required payments on outstanding debt (including Mar-80 Mar-85 Mar-90 Mar-95 Mar-00 Mar-05 mortgages, consumer loans and auto loans), has been rising as a share of disposable income. Source: Federal Reserve Flow of Funds; data through 3Q07.

The consumption challenge

Mortgage market problems and the contagion into credit markets and banks pose an additional challenge to consumers

Prices

Confidence Offers Sales Inventories

Construction Consumption ?

Mortgage credit Non-mortgage Bank lending problems credit

Mortgages outstanding

Subprime ($1.2tr) The housing boom, in its later stages, was 14% supported by aggressive mortgage lending in an environment of lower underwriting standards Alt-A/Alt-B • Subprime mortgage origination surged in 2005 and ($1.2tr) Agency 13% ($4.0tr) 2006 in response to lower underwriting standards 44% and higher home prices.

• In 2006, subprime loans accounted for just over 20% of total origination, up from 8.6% in 2001. Jumbo ($2.7tr) • Similarly, origination of Alt-A/Alt-B (near-prime) 29% mortgages climbed. Source: Lehman Brothers Mortgage Strategy; LoanPerformance; data through 3Q07.

11 Non-agency mortgage resets

$bn Subprime ARMs originated in 2005–06 will reset to

180 higher rates over the next several quarters 160 • About two-thirds of subprime mortgages outstanding 140 have adjustable rates. 120 100 • About $550bn or 2.8 million subprime loans will 80 60 reset before 2009. 40 20 • On average, monthly payments will likely jump 0 20% to 25%, boosting average monthly payments 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 by $300 a month. Subprime Prime • Given tight lending standards, weak demand, and Source: Lehman Brothers Mortgage Strategy. falling home prices, it will be difficult to refinance or make a sale. As such, many borrowers will be forced to default on their mortgages.

Subprime mortgages 60-day delinquencies

% outstanding The jump in subprime resets should add to already-

30 high delinquency rates…

25 • Early performance of 2006 and 1H07 loans has shown more than twice as many delinquencies as 20 normal (e.g., 2002). 15 • Based on early performance, cumulative defaults of 10 2001 2002 2003 2004 subprime loans originated in 2006 and 1H07 could 5 2005 2006 be about 40%. 2007 0 • The 2005 subprime vintage has performed better 0 12 24 36 48 60 Deal Age (months) relative to 2006 and 2007. However, there have been recent signs of deterioration in the 2005 Source: Lehman Brothers Mortgage Strategy; LoanPerformance. vintage.

Foreclosure forecasts

Units, 000s % …and ultimately to foreclosures given the weak 1,200 Forecasts 2.5 housing market and reduced availability of mortgage credit 1,000 2.0

800 • Based on early performance and subprime resets, 1.5 600 Lehman Brothers mortgage strategists estimate 1.0 there will be a total of 2 million homes foreclosed 400 over the next two years. 0.5 200 • This is about 3 times the normal foreclosure rate. 0 0.0 1992 1994 1996 1998 2000 2002 2004 2006 2008 • Foreclosures will add to already-bloated inventory Foreclosure, lhs Foreclosure rate, rhs and sell at discounted prices, putting downward Note: The graph only measures foreclosures of single-family existing pressure on home prices. home sales. With condos/coops, foreclosures would likely be about 20% higher. Source: Lehman Brothers Mortgage Strategy.

12 National home price inflation

% y-o-y Forecasts Stress in the mortgage market has exacerbated 20 the huge imbalance between housing demand and Case-Shiller national index 15 OFHEO index supply, further depressing home prices 10 • National home prices will most likely fall by the

5 most since the Great Depression.

0 • Expect the Case-Shiller index to fall 15% from peak

-5 to trough and OFHEO to fall 10%, with risks to the downside. -10 Mar-88 Mar-92 Mar-96 Mar-00 Mar-04 Mar-08 • Case-Shiller is likely a better representation of actual

Source: OFHEO; S&P Case-Shiller; Lehman Brothers Economics; home prices since it tracks homes with all types of forecasts as of 4Q07. mortgages, unlike OFHEO which is limited to agency (conforming).

Wealth effect on consumer spending growth

% q-o-q, ar Falling home prices and tighter credit should Forecast restrain consumer spending 2.0 housing • The literature on the “wealth effect” suggests

1.0 consumers boost spending anywhere from 2 to 8 cents on every dollar of perceived permanent gains

0.0 in housing wealth. • Given easy credit and financial innovation, the -1.0 stock mkt upper end of this range probably applies.

-2.0 • Using a 6 cents wealth effect and assuming home Mar-90 Jun-93 Sep-96 Dec-99 Mar-03 Jun-06 Sep-09 prices fall 10% over the next 2 years, the housing wealth effect on consumption has swung from an Note: Analysis uses OFHEO home prices. Source: Lehman Brothers Economics; forecasts as of 3Q07. estimated 1.4pp to -0.4pp by end of 2009.

Net mortgage equity extraction

$bn, SAAR % One of the major channels to realize changes in

1,200 12 housing wealth is mortgage equity extraction

1,000 10 • Mortgage equity extraction is one way to realize changes in housing wealth (in addition to changing 800 8 savings patterns or other borrowing). 600 6

400 4 • Net equity extraction has tumbled from a peak of an annualized $989bn, or 10% of disposable income, 200 2 in 1Q06 to $436bn in 3Q07. 0 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 • There are likely lags between changes in equity net equity extraction, lhs % disposable income, rhs extraction and consumption.

Note: SAAR = seasonally adjusted annualized rate. • See appendix (page 28) for uses of cash-out Source: James Kennedy, Federal Reserve Board; Lehman Brothers refinancing. Economics; forecasts for 4Q 2007.

13 Mortgage lending standards

Net % reporting tighter standards In response to rising delinquencies and weak 68 housing fundamentals, mortgage lenders have 56 aggressively tightened lending standards All 44 prime • Lending standards have tightened for all types of nontraditional 32 subprime mortgages. 20 • Lending standards for subprime loans started to 8 tighten markedly in the beginning of 2007, virtually -4 eliminating the space. -16 Jan-01 Apr-02 Jul-03 Oct-04 Jan-06 Apr-07 • Subprime originators have left the market or have laid off people. Source: Federal Reserve Senior Loan Officer Survey; data through October 2007. • In contrast, we have just started to witness tighter lending standards for prime mortgages, which is largely driven by jumbo loans.

ABX.HE implied spreads over libor

bp Financial markets have responded in a similar

3,500 fashion—demand for mortgage-backed securities AAA has plunged, pushing up spreads and dragging 3,000 AA down prices 2,500 A BBB • We have witnessed a jump in even highly rated 2,000 BBB- subprime securities in response to both poor 1,500 remittance performance and risk aversion. 1,000

500 • The market is pricing about a 25% loss in pools of mortgages underlying subprime MBS, which 0 translates into an assumption of a 50% default Jul-06 Nov-06 Mar-07 Jul-07 Nov-07 Source: Markit Partners; data through January 16, 2008. rate. • By way of example, the ABX market for single-A bonds is assuming 100% principal loss on these bonds and receipt of interest only.

• 6 months ago, before the turmoil, the market was pricing about 8% to 9% losses, and 1 year ago it was pricing 4% to 5% losses.

14 Credit card debt outstanding

% y-o-y The challenge to liquidate money from home equity 25 has left consumers to finance spending through During housing boom, other sources (e.g., credit cards and anticipation of 20 growth in credit card debt slowed increased wages) 15 • During the housing boom consumers could clean

10 up their credit card problems by taking money out of their homes. 5 • Over the past year, credit card debt has been growing 0 at a faster pace than it has in the previous 4 years. Jan-86 Jan-90 Jan-94 Jan-98 Jan-02 Jan-06 • However, year-over-year growth in credit card debt Source: Federal Reserve Board; data through November 2007. is still below the 10% average growth rate of the past decade.

Credit card 30+-day delinquencies

% There are signs of stress in the credit card sector 6.5 6.0 • Credit card delinquencies have started to pick up 5.5 for the major issuers. 5.0 4.5 • It is likely that credit card delinquencies will increase 4.0 further with a lag as consumer budgets become 3.5 stretched and mortgage delinquencies continue to 3.0 2.5 rise. 2.0 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Citibank Capital One BofA Chase

Source: Company 10D filings; data through November/December 2007.

Credit card and other consumer lending standards

Net % reporting tighter standards Lenders are tightening standards for non-credit 60 card debt, and further tightening in the coming 50 40 quarters is expected 30 • Banks have started to tighten lending standards for 20 consumer loans (such as auto and other big-ticket 10 items) with the exception of credit cards. 0 -10 • Loose lending standards for credit cards suggests -20 consumers can boost credit card borrowing to 1Q96 3Q97 1Q99 3Q00 1Q02 3Q03 1Q05 3Q06 finance consumption. credit card non-credit card consumer loans • However, anecdotal evidence suggests banks are Source: Federal Reserve Senior Loan Officer Survey; data through starting to grow increasingly concerned, which will October 2007. likely encourage banks to ultimately tighten lending standards.

15 Credit card fixed-rate spreads over swap rates bp The market is already anticipating credit problems 450 400 • A jump in spreads likely reflects both averse market 350 sentiment and concern about credit card loan 300 performance. 250 200 150 100 50 0 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08

AAA A BBB

Source: LehmanLive; data through January 10, 2008.

Subprime auto ABS 60-day delinquencies

% Early signs of credit problems in the auto loan 4.5 market are starting to emerge... 4.0 3.5 • Delinquencies have started to pick up in the recent 3.0 vintages for subprime, particularly 2007. 2.5 2.0 • Similar signs of deterioration are appearing in the 1.5 1.0 prime sector. 0.5 0.0 0 12 24 36 48 Deal Age (months) 2003 2004 2005 2006 2007

Source: Lehman Brothers and Intex; based on representative deals from one selected subprime issuer (AmeriCredit).

Prime auto fixed-rate spreads over swap rates bp …which are also seemingly priced into financial 450 markets 400 350 • The rise in spreads reflects both increasing concerns 300 about future performance and overall market 250 sentiment. 200 150 100 50 0 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

AAA A BBB

Source: LehmanLive; data through January 10, 2008.

16 Securitizations

Parts of the securitization markets are frozen, and parts are still functioning at higher spreads

Value ($bn) • Mortgage issuance has fallen sharply, while auto Asset Class 2004 2005 2006 2007 securitizations are down less than mortgages, and Autos Autos Total $73 $99 $85 $69 credit cards were actually up through 2007. Prime 29 58 54 45 • August was a very low issuance month because Nonprime 34 28 25 18 Floorplan 10 13 6 5 of the spread increase in securitized products and broader market volatility. Credit Cards Credit Cards • Credit cards and auto securitizations rebounded in Total $61 $72 $66 $93 the fall, but spreads remain high. MBS MBS Total $743 $1,069 $1,063 $620 • At a minimum, 2008 credit card and auto securitiza- Prime 395 591 584 404 tions will only get done at higher spreads. Nonprime 349 478 479 216

Much of the decline in mortgage issuance has been over the past 6 months. Autos have shown signs of a decline in volume, and for now credit cards have remained somewhat stable

Credit Cards Autos Prime MBS Subprime MBS Value ($bn) # of deals Value ($bn) # of deals Value ($bn) # of deals Value ($bn) # of deals Nov-06 $5 8 $13 9 $42 52 $41 44 Dec-06 3 4 3 3 45 53 35 39 Jan-07 5 9 3 4 44 57 27 34 Feb-07 11 17 8 8 60 68 35 40 Mar-07 9 14 2 4 50 62 28 33 Apr-07 7 10 6 5 50 57 36 42 May-07 9 15 9 7 50 59 30 35 Jun-07 8 14 11 11 52 66 24 34 Jul-07 8 14 3 3 30 39 4 6 Aug-07 3 4 5 4 20 30 7 10 Sep-07 11 8 6 8 21 28 15 13 Oct-07 16 19 9 8 15 20 7 11 Nov-07 5 3 4 3 10 17 1 3 Dec-07 2 1 2 1 3 6 0 0

Source: Intex (as of January 10, 2008; final ’07 volumes may adjust higher); Lehman Brothers' Public and Private Issues ABS Database.

17 Credit card securitizations Auto securitizations

Credit card securitizations are less likely to have Auto securitizations also have some characteristics the same performance deterioration as mortgages that may insulate the market relative to mortgages • Credit card securitizations use a revolving master • The payment size (approximately $300/month on trust that purchases new receivables monthly. average) is smaller, and since the loans are fixed rate, there is no reset/payment shock. • Credit card issuers can more easily alter the quality of the credit card receivables sitting in • But auto loans are sensitive to unemployment the trust. levels; if unemployment keeps rising, auto loan performance could deteriorate significantly. • However, those credit card issuers would have to warehouse higher credit risk receivables on • Already, delinquencies are rising as consumers get their balance sheets. stretched, which can restrain auto sales, ultimately lowering securitization volumes. • Plus, spreads have widened, indicating nervousness. • For domestic captive/quasi-captive issuers (Ford, GMAC, and Chrysler), this is important since • Recent unemployment data, together with securitization is core to their funding strategies. growing recession concerns, will translate into higher charge-offs and losses on credit card • Spreads have widened (BBBs by about 400 bps), and portfolios. issuers are retaining lower-rated assets as demand has dried up for risky assets. • We have already started to see credit card issuers react by increasing their loss reserves. • Coming full circle, as ABS markets tighten, credit to consumers to purchase autos is restricted, further reducing auto sales, which further hurts the economy.

S&P 500 implied volatility (VIX)

% The “fixed income infection” is impacting the 35 equity markets

30 • The S&P is about 13% off of its highs.

25 • There are other factors such as expectations of 20 future corporate profits; however, it all becomes

15 somewhat circular in nature since credit impacts future profitability. 10

5 • Nevertheless, volatility is rising, scaring many Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 “committers of capital.”

Source: Bloomberg; data through January 16, 2008.

18 Treasury yields

% This is creating a flight to quality and away from 9.0 credit extension… 8.0 7.0 • Treasuries are rallying, while swap spreads are 10 yr 6.0 widening, reflecting a willingness to hold only the 5.0 highest quality counterparty risk (i.e., not financial 4.0 institution risk). 3.0 2.0 • Long-term U.S. government bonds are relatively 2 yr 1.0 scarce as well; perhaps this is why U.S. term 0.0 rates appear to have lost their link with domestic Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 economic fundamentals.

Source: Bloomberg; data through January 16, 2008.

Gold and oil prices

…and the ultimate flight to quality and/or to hard $/oz $/brl 925 105 assets (e.g., commodities) 900 100 • Gold and oil prices have risen dramatically since the 875 gold, lhs 95 850 90 market troubles began. 825 oil, rhs 800 85 775 80 • Even fine art, an asset with a finite supply, has 750 75 725 70 appreciated dramatically in the face of the global 700 65 liquidity glut. 675 60 650 625 55 • The rally in commodities reflects a safe-haven invest- 600 50 ment, but it also reflects excess global liquidity. Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 oz = ounce; brl = barrel. Source: Bloomberg; data through January 16, 2008.

How does global liquidity play into this?

Credit creation = LQ + Bc+ Lc, where LQ equals liquidity, Bc equals borrowers’ confidence, and Lc equals lenders’ confidence…So how does credit creation slow? • Liquidity is driving technicals and perhaps even fundamentals, not the other way around.

• Liquidity glut leads to artificially tight spreads and high valuations.

• This sends incorrect signals to real economy operators.

• In search of returns, lenders misprice risk.

• This leads to too much debt creation with not enough collateral value.

• Disequilibria and asset bubbles result.

19 U.S. M&A transaction value

$bn, 60-day moving avg Tighter spreads drove transaction volume to cyclical 14 highs 12 • Like residential real estate, the M&A wave appears 10 to have collapsed under its own weight. 8

6 • In both cases, it was lenders’ confidence that disappeared—not liquidity. 4

0 Jan-01 Mar-02 May-03 Jul-04 Sep-05 Nov-06 Jan-08

Note: 60-day average of announced M&A deals (sum of mergers, acquisitions, divestitures, self-tenders, and spinoffs). Source: Bloomberg; data through January 11, 2008.

The Fed’s global reach

Today’s discussions of the appropriateness of Fed Share of Share of U.S. Trade Currency Non-U.S. policy do not reflect the Fed’s global reach...The Country Deficit ‘07 Regime Global GDP Fed heavily influences monetary policy for much of China 31.4% managed 7.5% the world by virtue of pervasive managed currency Nigeria 3.4% managed 0.3% regimes Venezuela 3.2% pegged 0.5% • Global GDP is about $48tr and the U.S. makes up Saudi Arabia 2.9% pegged 1.0% about $13tr (27%). Malaysia 2.7% managed 0.4% • Together, the U.S. and countries that “shadow” the Algeria 2.2% managed 0.3% dollar represent nearly 40% of global GDP. Russia 1.6% managed 2.8% India 1.5% managed 2.5% • While many countries are dramatically different from Angola 1.5% managed 0.1% the U.S. and need their own policy mechanisms, mercantilist proclivities leave them constrained by 50.4% 15.6% generic managed currency regimes. Note: Trade deficit through 2Q07; GDP as of 2006, current US$. Source: International Monetary Fund; International Trade • All else being equal, rates are too low, and growth Administration / Commerce Department. is too hot and not in equilibrium.

U.S. trade position with Europe, Canada, OPEC, China

When markets are free to set policy based on US Dollar Trade deficit fundamentals, things tend to balance % Nov 06/Nov 07 % Nov 06/Nov 07 • The U.S. trade position with Europe and Canada $ / Euro (10.50%) (7.70%) has improved as the dollar weakened, as one would $ / Canada (12.50%) (11.90%) expect. $ / China (5.50%) 11.50% $ / OPEC 0.00% 12.10% • However, when a currency is pegged to the dollar, trade balances are not allowed to correct and Note: Dollar change is November month-end; trade deficit is 12 things can even get worse, such as with China and months ending November. Source: Commerce Department; Bloomberg. OPEC.

20 International reserve assets excluding gold (world)

$ trillion Large and growing capital flows to developing 6.50 6.00 countries are largely the result of undervalued 5.50 currencies 5.00 • Ongoing trade deficits that are not allowed to self- 4.50 4.00 correct lead to massive build-ups of official foreign 3.50 currency reserves. 3.00 2.50 • Global FX reserves have grown 168% since January 2.00 2003 compared to global GDP, which has grown by Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 about 20% over the same time.

Source: Bloomberg; data through January 11, 2008. • In addition, sovereign wealth funds (SWFs) are conservatively estimated to have about $2tr–$2.5tr in assets and are rapidly growing—assuming SWF assets get levered, it is clear SWFs will become very influential on markets (see appendix, page 28).

Comparative returns

% y-o-y When will it end? 70 • So far, strong global growth, led by exploding

50 liquidity has continued, while the U.S. financial sector has tried to feel for a bottom. 30

10 • Blue chip emerging market stocks (shown by IShares-EMG on the graph, ticker EEM) demonstrate -10 this. -30 Nov-06 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 • Ultimately, the question is whether the global IShares-EMG S&P 500 index SPDR-FINL select liquidity dynamic is so great that the growing U.S. financial “crisis” can unfold in a vacuum. Note: EEM holds about 300 stocks from emerging market countries and seeks to provide results corresponding to the MSCI Emerging Markets Index. Source: Bloomberg; data through January 16, 2008.

21 If history is any guide, the “liquidity bubble” has room to run…this may continue to underpin strong global asset markets in 2008 • Asset bubbles typically experience three stages: (1) denial, (2) conventional wisdom, and (3) speculative frenzy.

• Below (in quadrants #1 – #3) are three asset bubbles: o The gold bubble in the late 1970s in which prices rose about 6.5 times over about 3.5 years. o The tech bubble in the late 1990s in which prices rose about 6.7 times over 5 years. o The recent housing bubble where major homebuilder stocks rose about 7.8 times over about 5.5 years. • Is excess global liquidity the next bubble? o Quadrant #4 shows an emerging market index (EEM) that is up about 4.1 times in about 4.5 years. o EEM is a possible proxy for a liquidity bubble since it is liquid, big, and popular, but one could also look at charts for fine art, gold, and oil, which can also be driven by global liquidity.

#1 Gold bubble (gold spot prices) #2 Tech bubble (Nasdaq composite index – CCMP)

$ $

900 3 5500 3 5000 800 4500 700 2 4000 2 600 3500 500 3000 400 2500 1 1 2000 300 1500 200 1000 100 500 0 0 Jun-76 Feb-77 Oct-77 Jun-78 Feb-79 Oct-79 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00

Source: Bloomberg. Source: Bloomberg.

#3 Housing bubble (S&P super composite #4 Global liquidity bubble? (iShares MSCI homebuilding index – S15Home) Emerging Market index – EEM)

$ $ 1100 3 200 3 ? 1000 900 180 2 800 2 160 700 140 600 120 500 1 100 1 400 300 80 200 60 100 40 0 20 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Apr-03 Apr-04 Apr-05 Apr-06 Apr-07 Apr-08

Source: Bloomberg. Source: Bloomberg.

22 Bank balance sheets Bank balance sheets are backing up with assets… ($bn) Jun-07 +/(-) Dec-07 • As of end-December, Lehman Brothers estimated Assets $8,361 $250 $8,611 that about $250bn in unanticipated assets ($120bn Equity 691 (65-115) 626 - 576 Equity/Assets 8.3% 7.3% - 6.7% of HY Bonds/Loans and $130bn in ABCP Assets, Ratio including SIVs) had been brought onto bank balance Deterioration in Ratio (1.0%) - (1.6%) sheets. Risk Weighted $5,863 $186 $6,049 Assets • Risk-weighted assets were estimated to be Tier 1 Capital 486 (65-115) 421 - 371 $186bn. Teir 1 Ratio 8.3% 7.0% - 6.1% Deterioration in Ratio (1.3%) - (2.2%) • In addition, losses are estimated at about $65bn– $115bn ($10bn due to HY Bonds/Loans, $15bn Note: Based on top 30 commercial banks covered by Lehman Brothers Equity Research (represents approximately 80% in ABCP Assets, $15bn in ABS CDOs, and $25bn– of assets in all depository institutions). $75bn in mortgage losses). Note: HY loans/bonds notional estimated using pipeline and league table share of U.S. banks in 2007. ABCP notional estimated from amount of decline in ABCP and U.S. banks share of • This significantly reduces banks’ capital ratios liquidity puts. Losses assumed at 10–15% of notional for relative to June-07 (prior to the market troubles), high-yield and non-CDO ABCP. CDO losses and potential losses from mortgage assets from Lehman Brothers Mortgage assuming they had raised no fresh capital. Strategy group. Note: Unanticipated assets include SIVs brought onto balance sheet. • To the extent securitization markets are closed or Source: Lehman Brothers Equity Research and Lehman Brothers Fixed Income Research (“Buyers of Last Resort: Do Banks Have too pricey, banks will be forced to keep additional Enough Balance Sheet?” November 13, 2007). assets on balance sheets.

Reduction in asset growth …which could lead to a reduction in credit creation ($bn) Optimistic Pessimistic further pinching the consumer Mortgage Losses $25 $75 • Prior to recent events, Lehman Brothers Equity Total Losses $65 $115 Research forecast $685bn in asset growth for 2008.

Capital Raised • If banks want to bring Tier-1 capital ratios back Reduced Buybacks $10 $10 to 8% in a year, they would need to reduce asset Fresh Issuance $40 $60 growth by anywhere from $160bn to $540bn.

Total $50 $70 • Banks have other options such as reducing buybacks Previously Forecast and dividends, or raising fresh capital (into a difficult Asset Growth for 2008 $685 $685 market) as Citi has just done, which could bias the Asset Growth to slowdown in asset growth to the lower end of the Meet 8% Ratio $522 $147 range.

Slowing in Growth ($163) ($538) • In either event, asset growth (i.e., credit extension) Slowing in Growth (%) (1.8%) (6.0%) could slow between $160bn–$540bn, compared with average annual credit growth over recent years Note: Credit growth of $2tr includes only non-financial sectors (i.e., primarily households, corporates, and governments). of $2tr for the entire economy. Source: Lehman Brothers Fixed Income and Equity Research; Flow of Funds. • Demand for credit will slow, too, given the slowing economy; however, non-bank supply of credit will also slow, given stress in securitization markets. These two effects likely offset each other, thus the slowing in bank asset growth is still relevant.

• Stress on bank balance sheets not only affects consumers, but it also impacts lending to foreign banks that depend on dollar lending.

23 Conclusion

In the next year or two: o If consumer spending falls, it can lead to • Pressure on the consumer grows as: falling corporate profits, which leads to falling equity markets, which reduces wealth, and o Home prices fall, reducing the wealth leads to falling consumption, etc. effect. • Liquidity in general will continue to grow in countries o Energy tax weighs heavily. through reserves and sovereign wealth funds o Credit conditions tighten. o This will lead to increased prices where o Unemployment rate edges higher. investor confidence is present, particularly for assets with finite supplies. • Consumers need their incomes to grow or to seek additional sources of credit to consume, or o A weakened dollar will lead to more otherwise slow consumption investment in the U.S., but only in areas with a perception of value and investor confidence. o Problems in one market can spread to other markets, further damaging access to o This liquidity could find its way into mortgage credit. markets once there is an understanding of the value proposition—at that point the short o Rising delinquencies from levered side will add upward pressure as it unwinds. consumers exacerbate the credit problem. o Mortgage losses will be indirectly financed o This is causing pressure on asset-backed through capital infusions in financial securities and indexes… institutions primarily through sovereign o Resulting in pressure on balance sheets wealth funds (see appendix, page 29). and funding vehicles… • Severe losses in the mortgage market lower o SIVs that cannot finance themselves will consumer confidence, which coupled with a sell the assets. weaker economy, will lead to greater government o Mortgage and bond insurers own these involvement both fiscally and monetarily assets. Their balance sheets deteriorate. o The Federal Reserve will most likely continue o This creates pressure on what they to lower interest rates and adopt various guarantee. methods to add liquidity to the market. So will other central banks, including, most o Counterparty risk of these institutions importantly, the ECB. grows…Liquidity continues to dry up in the mortgage space. o The U.S. Congress will move forward with fiscal stimuli aimed at the economy and o Capital needs to be raised, but the market perhaps targeted to the housing market. is concerned about the underlying assets… Consequently, the cost to raise capital o The combination of strong monetary and becomes high and for some prohibitive. fiscal policy will be an important factor in reversing the trend. o Some bleed into other consumer credit assets creates more fear. In the long run: o Hence, the willingness to lend becomes • Lower home prices spur sales recovery. extraordinarily constrained. • Securitization returns for less exotic products. o All of this lowers consumption, unless • A broader array of mortgage credit returns. incomes rise to make up for it. • Liquidity growth rates through reserves will slow o However, higher unemployment will since countries with pegged currencies will need to cause further problems through loss of use monetary policy to be able to manage growth jobs and more generally through a loss of and fight inflation. confidence. • Like all cycles, this too will come to an end.

24 Recommendations

Something needs to be done • The recent market has been, in many respects, o The insuring agency would receive a worse than it was in August percentage (e.g., 75%) of the home appreciation between the new and old loan o The lack of confidence in pricing has balances to compensate for its guarantee. led most buyers away from mortgage products, and there are few buyers in the o Combination of reduced LTV and the market with both the balance sheet and appreciation share enables more affordable expertise to understand any “bargains.” loan terms for borrowers to keep them in their homes. o Such players are currently dealing with the less risky assets in the mortgage asset o Agency insurance would enable securitization class (particularly agencies). and enhanced liquidity for the program to enable it to reach more at-risk borrowers. o Directed liquidity is needed to restore confidence. o If the new cash payment is lower than the original, a floor could be created at the Some things that might be done are: original cash payment to prevent a windfall. 1. We need legal clarity that the fundamental o Congress has appropriated funds to be policy for dealing with the subprime issue should made available through HUD to non-profits involve broad-brush approaches rather than to help homeowners modify or refinance traditional loan-by-loan analyses their mortgages. Conceivably, some of such money might be used as seed money for the o Servicers are reluctant to implement development of such programs. innovative loan modification protocols because of perceived litigation exposure. 3. Since the U.S. housing stock is worth about $23tr (or about $10tr more than annual U.S. GDP) a drop of o The Paulson/HOPE NOW initiative reflects 15% would reduce wealth by about $3.5tr. Policy- the need for formulaic approaches that makers should carefully evaluate opportunities to insulate servicers from liability. reverse the trend in this diminution of wealth and, o Regulators and legislators alike should thereby, also stimulate all the by-products of the consider granting servicers comfort if they housing industry. One such idea directed at the epi- act in “good faith” based on homeowner centre of the credit crunch is to consider targeted tax payment history. incentives to stimulate single-family home purchase 2. Develop and expand the reach of programs to activity. This would help reduce inventories that keep at-risk borrowers in their homes. HUD and are dragging down the housing market and reduce FHA have shown great leadership, and we need future problems due to the overhang of scheduled to consider ways of developing new programs resets. It would also liquify many of the mortgages and scaling programs like FHASecure that are in present securitized products thereby giv- ing greater certitude to their value. The following o Programs should be targeted to program should be considered: homeowners (not investors) with ARMs who are or will become delinquent as a o Borrowers would receive an income tax result of resets and are unable to refinance credit in lieu of the interest deduction equal because of credit issues or property value to a designated percentage of the interest they declines. pay on a mortgage loan used to purchase For example: a home they will use continuously as a principal dwelling. o Loan servicers could offer a new FHA- insured fixed-rate amortizing loan at 90% of the current appraised value of the home.

25 Recommendations Continued

o The credit would be reduced as the value 4. Broaden access to the discount window for financial of the dwelling increases. For example, the institutions that are significant players in this credit would equal 100% of the interest market on the first $400K of purchase price. On o The assumption would be that the utilization the next $200K, the credit would fall (on of the discount window would be for a straight-line basis) from 100% to 80%. purposes of adding liquidity to the mortgage There would be no credit for any home market. bought in excess of $600K. o The vehicles for this could be the primary o The $400K/$600K numbers are not magic, bond dealers or depository institutions owned but rather were selected as a starting point by them. for discussions. In addition, the duration of the tax credit need not extend forever o Consideration should also be given to and policymakers could set the duration as lowering the discount rate to coincide with appropriate, keeping in mind the need for the federal funds rate. it to be enticing enough to create buyers o These measures could be done on a (demand). temporary basis. o The home must be the borrower’s primary 5. Expand volume caps of various state housing residence. authorities to issue loans to first-time buyers and o Borrowers would be required to have expand the limitation on such loans to cover made a 20% down payment. To preserve refinancing for such buyers equity, subordinate financing that resulted in a combined LTV in excess of 80% would o This will enable the utilization of the tax- be prohibited at any time. exempt market to help, in particular, the refinancing of first-time buyers. o The borrower’s ability to repay the loan would have to have been fully o Such loans would be under the same credit documented. limitations that currently exist but with expanded volume caps. o This program would apply only for single- family homes purchased in 2008. 6. Sharply lower the federal funds rate o Such a program would need to have o This could negatively affect the dollar and an anti-abuse provision similar to the inflation, but must be considered given the learning experience from rent-controlled high possibility that markets will get worse apartments. and could dramatically affect the economy as a whole. o To further increase liquidity, FHA could develop a program to insure loans meeting o Measures 1–5 are more surgical in nature. these parameters. o Such loans should have natural buyers such as pension funds because of the long-dated nature of the product, thereby minimizing the need to put such loans on bank balance sheets. In addition, aside from the tax credit it does not require government support.

A lot is at stake for the economy, and all actions that add liquidity or help prevent distressed sales that exacerbate the problem, are worthy of consideration (even if they are somewhat “out of the box”). Emphasis should be placed on developing a portfolio of actions, some of which could be temporary in nature, rather than finding a magic bullet!

26 APPENDIX:

Contribution to GDP growth from net exports

Contrib, pp Forecast • Trade made a positive contribution on growth in 2.0 2007 for the first time in nearly a decade. 1.5 1.0 • Exports have been underpinned by a weaker US$. 0.5 From its peak in 2002, the US$ has fallen roughly 0.0 35% from the Federal Reserve’s major basket of -0.5 currencies. -1.0 • In addition, buoyant growth in the Euro Area, -1.5 Canada, Mexico and Emerging Asia has led to -2.0 Mar-00 Sep-01 Mar-03 Sep-04 Mar-06 Sep-07 Mar-09 healthy demand for U.S. exports.

Source: Commerce Department; Lehman Brothers Economics. • Net exports are expected to improve further in 2008 and 2009 in response to both stronger exports and weaker imports.

GDP share of exports to U.S. % of GDP 1980 1990 2000 2006 • Those countries closest to the U.S. and which are Euro Area 1 1 2 2 members of NAFTA, namely Canada and Mexico, have the highest share of exports to the U.S. Japan 3 3 3 3 UK 2 2 3 2 • But in a number of other economies outside of Canada 15 16 33 25 NAFTA, notably China, their shares have been Mexico 5 7 25 22 growing. Korea 7 7 7 5 • The rising share of exports to the U.S. in economies’ Australia 2 1 2 1 GDP means that integration with the U.S. has been India 1 1 2 3 increasing. It also suggests that exports to the U.S. China 1 1 4 8 may have been making an important contribution G10 ex-US 2 3 5 5 to growth in these economies in recent years.

Source: OECD; Datastream; Lehman Brothers Economics. Source: “Global Decoupling,” Lehman Brothers Economics, July 2007.

Share of growth due to exports to U.S.

Annual average 2000–2006, pp • Three economies stand out as having benefited from 1.2 1.0 U.S. demand: Canada, Mexico and China. 0.8 • The former two are easily explained by these 0.6 countries’ proximity to the U.S. and, perhaps, from 0.4 0.2 an effect from NAFTA membership. 0.0 • China’s contribution probably reflects its export- -0.2

UK led growth strategy, epitomized by its managed India Japan Korea China Mexico Canada exchange rate policy against the dollar. Australia Euro area

* Lehman Brothers calculations; change in nominal trade balance • There are also linkages between countries, which with the US as a percentage of the previous year’s GDP. adds to the impact from U.S. growth. Source: OECD; Datastream; Lehman Brothers Economics. Source: “Global Decoupling,” Lehman Brothers Economics, July 2007. 27 Uses of cash-out refinancing

% 0 10 20 30 40 • Consumers use the equity extracted in a variety of

Home improvements 35 ways. The majority is spent to repay other debts and home improvement. Repayment of other debts 26 • Some of the money is spent on consumer expen- Consumer expenditures 16 ditures including vehicles, education, medical ex- Financial investments 11 penses, living expenses, and consumer purchases.

Real estate, business inv 10

Taxes 2 share of dollars

Source: Federal Reserve Survey of Consumers.

Size of sovereign wealth fund market

Assets, $bn • Accurate information regarding the size of some 7,000 sovereign wealth funds (SWFs) is hard to obtain. 6,000 with diversified 5,000 monetary • $2.0tr is a very conservative estimate excluding authorities 4,000 diversified monetary authorities.

3,000 • $2.5tr is a conservative estimate including estimated 2,000 excess reserves of diversified monetary authorities. 1,000

0 Hedge Fund Sovereign Global Official FX Industry Wealth Funds Reserves

Note: Diversified monetary authorities are select central banks/ monetary authorities that have significantly diversified their assets and investment objectives beyond traditional reserve management, but not exclusively through a separate SWF entity. Source: Central Banking Publications; Lehman Brothers; IMF; CIA data; Bloomberg.

28 Recent SWF investments in banks / investment banks

Estimated Value • Since the market turmoil, SWFs and other investors Date Target Investors ($bn) have made a number of investments to shore up 15-Jan-08 Citigroup Government of Sin- $12.5 capital in banks and investment banks. gapore Investment Corporation (GIC), • The adjacent table does not include the additional Kuwait Investment investments SWFs have made in alternative Authority (KIA), Prince Alawaleed investment managers (e.g., Blackstone) or in banks bin Talal, et al. for other strategic purposes (e.g., Barclays). 15-Jan-08 Merrill KIA, Korea Invest- $6.6 Lynch ment Corp (KIC), et al. 24-Dec-07 Merrill Temasek $4.4 Lynch 19-Dec-07 Morgan China Investment $5.0 Stanley Corporation (CIC) 10-Dec-07 UBS GIC, Middle East $11.5 investor 26-Nov-07 Citigroup Abu Dhabi Invest- $7.5 ment Authority (ADIA) 22-Oct-07 Bear Citic Securities $1.0 Stearns Company Total $48.5

Note: Deal sizes and stakes estimated and could change due to changes in FX rates, share prices, and deal terms. Source: News reports; Dealogic; company press releases.

Group of Thirty Members

Paul A. Volcker Chairman of the Board of Trustees, Group of Thirty Former Chairman, Board of Governors of the Federal Reserve System Jacob A. Frenkel Chairman, Group of Thirty Vice Chairman, American International Group Former Governor, Bank of Israel Montek S. Ahluwalia Deputy Chairman, Planning Commission of India Former Director, Independent Evaluation Office, International Monetary Fund Abdulatif Al-Hamad Chairman, Arab Fund for Economic and Social Development Former Minister of Finance and Minister of Planning, Kuwait Leszek Balcerowicz Former President, National Bank of Poland Former Deputy Prime Minister and Minister of Finance, Poland Geoffrey L. Bell Executive Secretary, Group of Thirty President, Geoffrey Bell & Company, Inc. Jaime Caruana Counsellor and Director, MCM Department, International Monetary Fund Former Governor, Banco de España Former Chairman, Basel Committee on Banking Supervision Domingo Cavallo Chairman and CEO, DFC Associates, LLC Former Minister of Economy, Argentina E. Gerald Corrigan Managing Director, Goldman Sachs & Co. Former President, Federal Reserve Bank of New York Andrew D. Crockett President, JP Morgan Chase International Former General Manager, Bank for International Settlements Guillermo de la Dehesa Romero Director and Member of the Executive Committee, Grupo Santander Former Deputy Managing Director, Banco de España Former Secretary of State, Ministry of Economy and Finance, Spain Mario Draghi Governor, Banca d’Italia Member of the Governing and General Councils, European Central Bank Former Vice Chairman and Managing Director, Goldman Sachs International Martin Feldstein President, National Bureau of Economic Research Former Chairman, Council of Economic Advisers Roger Ferguson Chairman, Swiss Re America Holding Corporation Former Vice Chairman, Board of Governors of the Federal Reserve System Former Chairman, Financial Stability Forum Stanley Fischer Governor, Bank of Israel Former First Managing Director, International Monetary Fund

31 Arminio Fraga Neto Partner, Gavea Investimentos Former Governor, Banco do Brasil Timothy F. Geithner President and Chief Executive Officer, Federal Reserve Bank of New York Former U.S. Undersecretary of Treasury for International Affairs Gerd Häusler Vice Chairman, Lazard International Managing Director and Member of the Advisory Board, Lazard & Co. Former Counsellor and Director, International Capital Markets Department; International Monetary Fund Mervyn King Governor, Bank of England Former Professor of Economics, London School of Economics Paul Krugman Professor of Economics, Woodrow Wilson School, Princeton University Former Member, Council of Economic Advisors Guillermo Ortiz Martinez Governor, Banco de Mexico Former Secretary of Finance and Public Credit, Mexico Tommaso Padoa-Schioppa Minister of Economy and Finance, Italy Former Chairman, International Accounting Standards Committee Former Member of the Executive Board, European Central Bank Lawrence Summers Charles W. Eliot University Professor, Harvard University Former President, Harvard University Former U.S. Secretary of the Treasury Jean-Claude Trichet President, European Central Bank Former Governor, Banque de France David Walker Senior Advisor, Morgan Stanley International Inc. Former Chairman, Morgan Stanley International Inc. Former Chairman, Securities and Investments Board, UK Zhou Xiaochuan Governor, People’s Bank of China Former President, China Construction Bank Former Asst. Minister of Foreign Trade Yutaka Yamaguchi Former Deputy Governor, Bank of Japan Former Chairman, Euro Currency Standing Commission Ernesto Zedillo Director, Yale Center for the Study of Globalization, Yale University Former President of Mexico senior Members William McDonough Vice Chairman and Special Advisor to the Chairman, Merrill Lynch Former Chairman, Public Company Accounting Oversight Board Former President, Federal Reserve Bank of New York William R. Rhodes Senior Vice Chairman, Citigroup Chairman, President and CEO, Citicorp and Citibank

32 Ernest Stern Partner and Senior Advisor, The Rohatyn Group Former Managing Director, J.P. Morgan Chase Former Managing Director, World Bank Marina v. N. Whitman Professor of Business Administration & Public Policy, University of Michigan Former Member, Council of Economic Advisors

Emeritus Members Lord Richardson of Duntisbourne, KG Honorary Chairman, Group of Thirty Former Governor, Bank of England Richard A. Debs Advisory Director, Morgan Stanley & Co. Gerhard Fels Former Director, Institut der deutschen Wirtschaft Wilfried Guth Former Spokesmen of the Board of Managing Directors, Deutsche Bank AG Toyoo Gyohten President, Institute for International Monetary Affairs Former Chairman, Bank of Tokyo John G. Heimann Senior Advisor, Financial Stability Institute Former US Comptroller of the Currency Erik Hoffmeyer Former Chairman, Danmarks Nationalbank Peter B. Kenen Senior Fellow in International Economics, Council on Foreign Relations Former Walker Professor of Economics & International Finance, Department of Economics, Princeton University Jacques de Larosière Conseiller, BNP Paribas Former President, European Bank for Reconstruction and Development Former Managing Director, International Monetary Fund Former Governor, Banque de France Shijuro Ogata Former Deputy Governor, Bank of Japan Former Deputy Governor, Japan Development Bank Sylvia Ostry Distinguished Research Fellow Munk Centre for International Studies, Toronto Former Ambassador for Trade Negotiations, Canada Former Head, OECD Economics and Statistics Department

Group Of Thirty Publications Since 1990

REPORTS Sharing the Gains from Trade: Reviving the Doha Study Group Report. 2004 Key Issues in Sovereign Debt Restructuring Study Group Report. 2002 Reducing the Risks of International Insolvency A Compendium of Work in Progress. 2000 Collapse: The Venezuelan Banking Crisis of ‘94 Ruth de Krivoy. 2000 The Evolving Corporation: Global Imperatives and National Responses Study Group Report. 1999 International Insolvencies in the Financial Sector Study Group Report. 1998 Global Institutions, National Supervision and Systemic Risk Study Group on Supervision and Regulation. 1997 Latin American Capital Flows: Living with Volatility Latin American Capital Flows Study Group. 1994 Defining the Roles of Accountants, Bankers and Regulators in the United States Study Group on Accountants, Bankers and Regulators. 1994 EMU After Maastricht Peter B. Kenen. 1992 Sea Changes in Latin America Pedro Aspe, Andres Bianchi and Domingo Cavallo, with discussion by S.T. Beza and William Rhodes. 1992 The Summit Process and Collective Security: Future Responsibility Sharing The Summit Reform Study Group. 1991 Financing Eastern Europe Richard A. Debs, Harvey Shapiro and Charles Taylor. 1991 The Risks Facing the World Economy The Risks Facing the World Economy Study Group. 1991

THE WILLIAM TAYLOR MEMORIAL LECTURES Two Cheers for Financial Stability Howard Davies. 2006 Implications of Basel II for Emerging Market Countries Stanley Fisher. 2003 Issues in Corporate Governance William J. McDonough. 2003 Post Crisis Asia: The Way Forward Lee Hsien Loong. 2001 Licensing Banks: Still Necessary? Tommaso Padoa-Schioppa. 2000 Banking Supervision and Financial Stability Andrew Crockett. 1998 Global Risk Management Ulrich Cartellieri and Alan Greenspan. 1996 The Financial Disruptions of the 1980s: A Central Banker Looks Back E. Gerald Corrigan. 1993

35 SPECIAL REPORTS Global Clearing and Settlement: Final Monitoring Report Global Monitoring Committee. 2006 Reinsurance and International Financial Markets Reinsurance Study Group. 2006 Enhancing Public Confidence in Financial Reporting Steering & Working Committees on Accounting. 2004 Global Clearing and Settlement: A Plan of Action Steering & Working Committees of Global Clearing & Settlements Study. 2003 Derivatives: Practices and Principles: Follow-up Surveys of Industry Practice Global Derivatives Study Group. 1994 Derivatives: Practices and Principles, Appendix III: Survey of Industry Practice Global Derivatives Study Group. 1994 Derivatives: Practices and Principles, Appendix II: Legal Enforceability: Survey of Nine Jurisdictions Global Derivatives Study Group. 1993 Derivatives: Practices and Principles, Appendix I: Working Papers Global Derivatives Study Group. 1993 Derivatives: Practices and Principles Global Derivatives Study Group. 1993 Clearance and Settlement Systems: Status Reports, Autumn 1992 Various Authors. 1992 Clearance and Settlement Systems: Status Reports, Year-End 1990 Various Authors. 1991 Conference on Clearance and Settlement Systems; London, March 1990: Speeches Various Authors. 1990 Clearance and Settlement Systems: Status Reports, Spring 1990 Various Authors. 1990

OCCASIONAL PAPERS 75. Banking, Financial, and Regulatory Reform Liu Mingkang, Roger Ferguson, Guillermo Ortiz Martinez. 2007 74. The Achievements and Challenges of European Union Financial Integration and Its Implications for the United States Jacques de Larosiere. 2007 73. Nine Common Misconceptions About Competitiveness and Globalization Guillermo de la Dehesa. 2007 72. International Currencies and National Monetary Policies Barry Eichengreen. 2006 71. The International Role of the Dollar and Trade Balance Adjustment Linda Goldberg and Cédric Tille. 2006 70. The Critical Mission of the European Stability and Growth Pact Jacques de Larosiere. 2004 69. Is It Possible to Preserve the European Social Model? Guillermo de la Dehesa. 2004 68. External Transparency in Trade Policy Sylvia Ostry. 2004 67. American Capitalism and Global Convergence Marina v. N. Whitman. 2003 66. Enron et al: Market Forces in Disarray Jaime Caruana, Andrew Crockett, Douglas Flint, Trevor Harris, Tom Jones. 2002 65. Venture Capital in the United States and Europe Guillermo de la Dehesa. 2002

36 64. Explaining the Euro to a Washington Audience Tommaso Padoa-Schioppa. 2001 63. Exchange Rate Regimes: Some Lessons from Postwar Europe Charles Wyplosz. 2000 62. Decisionmaking for European Economic and Monetary Union Erik Hoffmeyer. 2000 61. Charting a Course for the Multilateral Trading System: The Seattle Ministerial Meeting and Beyond Ernest Preeg. 1999 60. Exchange Rate Arrangements for the Emerging Market Economies Felipe Larraín and Andrés Velasco. 1999 59. G3 Exchange Rate Relationships: A Recap of the Record and a Review of Proposals for Change Richard Clarida. 1999 58. Real Estate Booms and Banking Busts: An International Perspective Richard Herring and Susan Wachter. 1999 57. The Future of Global Financial Regulation Sir Andrew Large. 1998 56. Reinforcing the WTO Sylvia Ostry. 1998 55. Japan: The Road to Recovery Akio Mikuni. 1998 54. Financial Services in the Uruguay Round and the WTO Sydney J. Key. 1997 53. A New Regime for Foreign Direct Investment Sylvia Ostry. 1997 52. Derivatives and Monetary Policy Gerd Hausler. 1996 51. The Reform of Wholesale Payment Systems and Impact on Financial Markets David Folkerts-Landau, Peter Garber, and Dirk Schoenmaker. 1996 50. EMU Prospects Guillermo de la Dehesa and Peter B. Kenen. 1995 49. New Dimensions of Market Access Sylvia Ostry. 1995 48. Thirty Years in Central Banking Erik Hoffmeyer. 1994 47. Capital, Asset Risk and Bank Failure Linda M. Hooks. 1994 46. In Search of a Level Playing Field: The Implementation of the Basle Capital Accord in Japan and the United States Hal S. Scott and Shinsaku Iwahara. 1994 45. The Impact of Trade on OECD Labor Markets Robert Z. Lawrence. 1994 44. Global Derivatives: Public Sector Responses James A. Leach, William J. McDonough, David W. Mullins, Brian Quinn. 1993 43. The Ten Commandments of Systemic Reform Vaclav Klaus. 1993 42. Tripolarism: Regional and Global Economic Cooperation Tommaso Padoa-Schioppa. 1993 41. The Threat of Managed Trade to Transforming Economies Sylvia Ostry. 1993 40. The New Trade Agenda Geza Feketekuty. 1992 39. EMU and the Regions Guillermo de la Dehesa and Paul Krugman. 1992

37 38. Why Now? Change and Turmoil in U.S. Banking Lawrence J. White. 1992 37. Are Foreign-owned Subsidiaries Good for the United States? Raymond Vernon. 1992 36. The Economic Transformation of East Germany: Some Preliminary Lessons Gerhard Fels and Claus Schnabel. 1991 35. International Trade in Banking Services: A Conceptual Framework Sydney J. Key and Hal S. Scott. 1991 34. Privatization in Eastern and Central Europe Guillermo de la Dehesa. 1991 33. Foreign Direct Investment: The Neglected Twin of Trade DeAnne Julius. 1991 32. Interdependence of Capital Markets and Policy Implications Stephen H. Axilrod. 1990 31. Two Views of German Reunification Hans Tietmeyer and Wilfried Guth. 1990 30. Europe in the Nineties: Problems and Aspirations Wilfried Guth. 1990 29. Implications of Increasing Corporate Indebtedness for Monetary Policy Benjamin M. Friedman. 1990 28. Financial and Monetary Integration in Europe: 1990, 1992 and Beyond Tommaso Padoa-Schioppa. 1990

Group of Thirty Credit Crunch: Where Do We Stand? Thomas A. Russo

Group of Thirty 1726 M Street, N.W., Suite 200 Washington, DC 20036 ISBN I-56708-140-1