The presentation discussed the economic crisis and its causes, including irrational exuberance in housing and stock markets, moral hazards created by bailouts, and the use of financial innovations like derivatives. It outlined the Fed's many interventions to provide liquidity and stabilize markets. While opinions varied, the recession was predicted to be long and deep. Oklahoma's economy would likely fare better than the nation due to more diversification, but still suffer impacts. Once the crisis passed, the financial system would need reform to avoid future moral hazards.

1. OK Trucking Association ConferenceFebruary 2010 Presentation In regard to the economy: How did we get here? Where are we now? Where are we going? What are the implications for Oklahoma? What do we, as citizens, have to guard against?

2. Title of Presentation Last Yearat OU/OSU Executive Program

3. Title This Past Summer Session “That's another fine mess you've gotten me into!” Oliver Hardy

4. First Chapters of Story Irrational Exuberance Stock Market Boom/Bust Recession of 2001 Floods of Liquidity Promoting Speculation and Low Rates Rise of the Housing Bubble

5. Irrational Exuberance Where the Story Begins We need to go back more than 12 years to December 5, 1996 where, in a speech, Alan Greenspan coined the term “irrational exuberance.” "But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?"

7. Greenspan “Put”: Expand the Money Supply in the Face of any Financial Trauma Has Greenspan created a MORAL HAZARD? 1987 Stock Market Crash Solution—Add liquidity 1990 Gulf War Solution—Add liquidity Mexican Financial Crisis Solution—Add liquidity Asian/Russian Financial Crisis Solution—Add liquidity Long-Term Capital Market Collapse Solution—Add liquidity Y2K Problems Solution—Add liquidity Stock Market Collapse Solution—Add liquidity 2001 Recession Solution—Add liquidity 9/11 Attack Solution—Add liquidity

8. Moral Hazards Wikipedia: “Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk.” It is related to information asymmetry, i.e., when one party to a transaction has more information that the other party. It poses problems in insurance, health care, finance, management (nepotism, sinecure, nepotism, project accountability)

9. From Stock Market Boom and Bust to Housing Market Boom and Bust Financial Innovation Banks as loan originators only Loans sold to Ginnie Mae and Freddy Mac and Others Strip principal from interest Packaged into various risk traunches Evaluated (over optimistically) by rating agencies (S&P, Moody’s) Sold to unwitting foreigners who happen to hold a lot of dollars Structured Investment Vehicles (SIV) Collateralized Debt Obligations (CDO) Collateralized Mortgage Obligations (CMO) Credit Default Swaps (CDS) Has Financial Innovation gotten “Too cute by half?”

11. Refinancing

12. Up-scaling

13. Vacation Homes

14. Flipping

15. Rising Home PricesLow Interest Rates and Liquidity Rise of Securitization: CDO, CMO, CDS, SIV, SPE Subprime, Alt-A, Liar’s Mortgage Loans Public Attitudes Toward Housing

16. Significance of Moral Hazards Economists Akerloff, Spence and Stiglitz received the Nobel Prize in 2001 for their work on asymmetric information, moral hazards and adverse selection. They showed that markets fail when moral hazards are present. Market failure is what we have seen in the housing market.

17. Adam Smith The first economist, famous for his “An Inquiry into the Nature and Causes of the Wealth of Nations” and his notion of the invisible hand, was first a moral philosopher. He considered his first work “The Theory of Moral Sentiments” to be his best work.

18. Exercise: Moral Hazard Meter Fannie and Freddie make contributions to the campaign funds of key committee members in the US House and Senate. Doctors pool funds to start a medical lab to serve their patient base. In originating a mortgage, the local bank knows that it will be able to sell the loan to either a government-backed or “private label” company. Senator Dodd receives a special rate from Countrywide Financial on his mortgages. Bond rating agencies (Fitch, Moody’s, Standard & Poors) receive fees from the same entities issuing the bonds. You are asked by a potential buyer what gas mileage you get on your used car you are trying to sell him. Retired military procurement officials go to work for industry suppliers. A professor requires the use of her textbook by her students. A revolving door of Treasury and Fed policy officials between Washington and Wall Street exists. Your employer provides free (to you), no-deductible health insurance including prescription drug coverage.

19. CRISIS TIMELINE Bear Stearns acquired by JPM Countrywide narrowly avoids bankruptcy Lehman bankruptcy AIG bonus controversy Am. New Century Financial (largest Subprime lender) files for bankruptcy Fed pumps in $41 B Merrill - BoA deal AIG Bailout 2007 2008 2009 4th 2nd 1st 3rd 4th 2nd 1st 3rd 1st IndyMac fails Freddie Mac stops buying subprimes First Fed TAF Paulson regulatory reform proposal Treasury systemic risk proposal Merrill has $5.5 B loss

21. Atypical Recession—Balance Sheet Recession

22. Housing Market Busts in Some Regions

23. Weak Labor Market, now in earnest

24. Volatile World Energy Prices

25. Financial Markets in Distress

26. Credit Market “locking up” but “easing”

27. Failures of Venerable Financial Institutions

28. Fed Reserve and Treasury Intervention

29. Falling Interest Rates—Negative Real Rates

30. 2008-09 Global Recession/Sovereign Debt

40. Balance Sheet Recession Emerges after bursting of a nationwide asset bubble. Leaves a large number of private-sector balance sheets with more liabilities than assets . In order to repair their balance sheets, private sector moves away from profit maximization to debt minimization. With the private sector de-leveraging, even at zero interest rates, newly generated savings and debt repayments enter the banking system but cannot leave the system due to the lack of borrowers. The deflationary gap created by the above leakage will continue to push the economy toward a contractionary equilibrium. In this type of recession, the economy will not enter self-sustaining growth until private sector balance sheets are repaired.

42. Fed, once again, to the Rescue Term Auction Facility (TAF)—12/12/07 Term Securities Lending Facility (TSLF)—3/10/2008 Primary Dealer Credit Facility (PDCF)—3/16/2008 Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (ABCPMMMFLF)—9/19/2008 Commercial Paper Funding Facility (CPFF)—10/14/2008 Interest on Reserves to Banks—10/6/2008 Money Market Investor Funding Facility (MMIFF)—11/10/08 Term Asset-Backed Securities Loan Facility (TALF)—11/25/2008

43. Term Asset-Backed Securities Lending Facility (TALF) Announced November 25, 2008 $800 Billion program $200B for consumer loans and small businesses $100B for Government Sponsored Enterprises $500B for Mortgage Backed Securities Program began in Feb ‘09

44. Quantitative Easing-Seigniorage Equation of Exchange: Money * Velocity = Price * Quantity Bank of Japan experience: Short-term interest rates at close to zero values since 1999. Flooding commercial banks with excess liquidity Buying more government bonds than would be required to set the interest rate to zero It also bought asset-backed securities, equities and extended the terms of its commercial paper purchasing operation. Said they would keep it up until prices rose New policies announced in December 2008 by the US Federal Reserve under “Ben Bernanke-san” to counter the effects of the on-setting recession have been likened to quantitative easing

45. Fed’s Magical Balance Sheet

46. The Fed’s Balance Sheet

47. Fed’s Magical Balance Sheet

48. So, where are we going? Wide divergence of opinion Deflation? Hyperinflation?

49. Zimbabwe’s $100 Trillion Bank Note

51. Major Stimulus Categories

52. Where is Oklahoma’s Stimulus Money Going?

53. Our Fair Share?

54. Economic Indicators

56. Price of Gold

59. US Economic FactorsBalance Sheet Assets Rule of Law Economic Freedom Low Taxes Population Growth High Living Standards Immigration Low Interest Rates/Inflation Human Capital Productivity Economic Resiliency Reserve Currency Status Liabilities Baby Boomers Retiring Fiscal & Generational Imbalance Corporate Legacy Benefits Costs Health Care Costs Debt & Federal Deficits Trade Imbalances Outsourcing of Jobs Factor Price Equalization Reliance on Foreign Energy Environmental Issues Housing Bubble

60. Conclusions Housing crisis is in the process of “bottoming.” Off-balance sheet derivatives appear to be the source of that difficulty, and that source has a long way to go. Fed will do everything in its power to stave-off deflation, including quantitative easing and socializing of private losses. The recession engendered and made worse by the financial crisis is likely to be long and deep. Oklahoma will compare favorably with the nation, but, with a more diversified economy, will likely suffer, too. Once the “fires are out” our financial system will need to be rebuilt: Don’t let moral hazards prevailby letting those who benefit write the new regulations.