2009 Fed Challenge Venisha Powell Justin Durso Aaron

2009 Fed Challenge Venisha Powell Justin Durso Aaron Naisbitt Ray Tannheimer Robert Searle 1

Introduction State of the Economy Fed Response and Exit Strategy Long Term Stability Regulatory Reform and Beyond Final Recommendations 2

09 q 3 20 09 q 2 20 09 q 1 20 08 q 4 20 08 q 3 20 08 q 2 20 08 q 1 20 07 q 4 20 07 q 3 20 07 q 2 20 07 q 1 20 06 q 4 20 06 q 3 20 06 q 2 20 06 q 1 20 05 q 4 20 05 q 3 20 05 q 2 20 05 q 1 20 % Change in GDP 6. 0 4. 0 2. 0 0. 0 -2. 0 -4. 0 -6. 0 -8. 0 3

Real GDP 4

Real GDP 2. 8% rd (3 Q) Personal Consumption 2. 9% Government Spending Business Investment Exports Imports 8. 3% 4. 1% 17% 20. 8% GDP = C+I+G+(X-M) 5

UM Consumer Sentiment 6

FOMC GDP Forecast 2004 2005 2006 2007 2008 3. 1 2. 7 2. 4 2. 5 -1. 9 Actual 2009 2010 2011 2012 Longer Run - - - 5 3 Upper End of Range - - - 0 4 4. 6 Lower End of Range - - -0. 5 2 2. 5 2. 8 2. 4 http: //www. federalreserve. gov/monetarypolicy/fomcminutes 20091104 epa. htm#figure 1 7

Unemployment 12 Nov 2009: 10. 0% 10 8 6 Jan 2008: 4. 9% Nov 2009 15. 4 Million Unemployed 4 2 0 Jan 2007 Jul 2007 Jan 2008 Jul 2008 Jan 2009 Jul 2009 8

Establishment Data Nonfarm payrolls Year Jan Feb Mar Apr May Jun 36 184 35 156 54 Jul Aug Sep Oct Nov Dec -65 -28 100 165 2007 180 2008 -72 -144 -122 -160 -137 -161 -128 -175 -321 -380 -597 -681 (3, 078, 000) 2009 -741 -681 -652 -519 -303 -463 -304 -154 -139 -111 215 120 Annual -11 1, 152, 000 (4, 078, 000) 2008 – 2009 Job Losses: 7, 156, 000 9

Unemployment Claims November jobs numbers better than expected A positive sign that the economy is turning around 10

Unemployment Time Frame Long-term unemployment is already much worse than in the 1980 s November 5. 9 million 38 % unemployed six months + (highest on record) 20% unemployed 1 year or more (Financial Times www. ft. com) 11

FOMC Unemployment Forecast Actual Upper End of Range Lower End of Range 2004 2005 2006 2007 2008 2009 2010 2011 2012 Longer Run 5. 4 4. 9 4. 4 4. 8 6. 9 - 10. 3 10. 2 8. 7 7. 6 6. 3 - 9. 8 8. 6 7. 2 6. 1 4. 8 http: //www. federalreserve. gov/monetarypolicy/fomcminutes 20091104 epa. htm#figure 1 12

Underemployment & Job Elimination U 6 October 17. 2% Down from 17. 5% in October Increase in underemployment 9. 2 Million working part time Increase in discouraged workers Discouraged workers 861, 000 Jobs Being Eliminated 13

CPI 14

CPI - Inflation The inflation rate after a recession is often well below the rate prior to the recession Inflation and Monetary Policy in Extraordinary Times by Eric S. Rosengren, President & Chief Executive Officer The Greater Boston Chamber of Commerce: Financial Services Forum Boston, MA October 2, 2009 15

FOMC Inflation Forecast 2004 2005 2006 2007 2008 3. 3 1. 9 3. 6 1. 7 2009 2010 2011 2012 Longer Run - - - 2 Actual 3 Upper End of Range - - - 1. 7 Lower End of Range - - - 1 2. 4 2. 3 2 1. 1 0. 6 0. 2 1. 5 http: //www. federalreserve. gov/monetarypolicy/fomcminutes 20091104 epa. htm#figure 1 16

Housing 17

Housing Bubble Home price increases greatly outpacing GDP 18

Housing 19

Small Business Cash Flow Issues Alternative lender cannot obtain credit from traditional banks Small Business cannot obtain credit from traditional banks Cash Flow Alternative lender develops cash flow issues Alternative lender has difficulty collecting collateralized A/R Seeks alternative funding from small business lender With cash flow Issues and liquidity problems, small businesses have no choice but to reduce costs, and reduce capacity utilization. Unemployment rises, and consumption decreases further 20

Inflation and Business The forecasters that are predicting relatively low inflation over the next several years – and I generally share this view – highlight the importance of excess capacity in the economy Inflation and Monetary Policy in Extraordinary Times by Eric S. Rosengren, President & Chief Executive Officer The Greater Boston Chamber of Commerce: Financial Services Forum Boston, MA October 2, 2009 21

Deflation for Business Deflating prices • Lead to lower revenues • Hurt profit margins Businesses trying to keep profit margins steady will look to reduce costs - thus unemployment will tend to rise 22

Small Businesses • Employ more than half of private sector workers • Generate half of new net jobs annually over past decade • Account for more than 1/2 of nonfarm GDP • Small firms cannot offer innovative new products or services without credit http: //www. federalreserve. gov/newsevents/testimony/mishkin 20080416 a. htm 23

Fixed Investment 24

PPI 25

Corporate Profits 26

Total Inventories 27

Durable Goods Orders 28

ISM MPI 29

Budget Deficits 30

National Debt as % of GDP 31

Structural Deficits 32

Glass-Steagall Banking Act of 1933 is also known as the Glass-Steagall Act • Established the FDIC as a temporary agency • Separated commercial banking from investment banking - establishing them as separate lines of commerce. Regulation Q • Limit on Interest Rates Banks could pay (Including rate of 0 on checking accounts) 33

Gramm-Leach-Bliley • Widened the range of activities banks can conduct • Repealed restrictions separating commercial banking from securities • Separated commercial banking from the insurance GLB Permits single holding companies to offer banking, securities, and insurance as they had before the Great Depression 34

Mergers and Acquisitions Citigroup merges with Travelers, Primerica and Smith Barney Financial Services – • Banking • Securities • Insurance services 35

Mergers and Acquisitions 36

2009 Bank Failures 124 Bank Failures in 2009 as of 11/30* Another possible 117 banks have liquidity problems according to the Wall Street Journal Liquidity Problems are Confidence Based Banks don’t trust the accounting for assets on balance sheets Asset reporting regulations that make the bank balance sheets transparent will be key to restoring confidence in banking system http: //www. fdic. gov/bank/individual/failed/banklist. html 37

Excess Reserves 38

Monetary Base 39

Money Multiplier 40

TED Spread http: //www. bloomberg. com A Eurodollar is an American dollar on deposit in any bank outside the United States, and is therefore not subject to regulation by the U. S. Federal Reserve. 41

Global & Domestic Credit Internationally, credit markets have been stabilized as central banks have alleviated Systemic Risk fears Domestically large businesses use banks for 30% of their financing, while banks provide 90% of all small business financing needs 27 million small businesses nationally employ ½ the nation’s private sector workforce, and have roughly $1 trillion in debt outstanding 42

Fed’s Response to the Crisis • Use of Traditional Tools • Currency Swaps • Balance Sheet Expansion (Credit Easing) • Support for Institutions Posing Systemic Risk • Exit Strategy 43

Use of Traditional Tools • Target Fed Funds Rate Reduced to 0 -. 25% • Discount Rate Reduced to. 5% • Limits to traditional tools Fed Funds rate at floor Stigma attached Discount Window use 44

Currency Swaps http: //www. economagic. com 45

Balance Sheet Expansion Credit vs. Quantitative Easing • Credit Easing: asset focus Loans and purchases are made to effect change in specific markets • Quantitative Easing: liability focus Volume of bank reserves are target of policy 46

Fed Balance Sheet Expansion (Source: Calculated. Risk from Atlanta Fed data) 47

Categories of Credit Easing • Short-term lending for financial institutions TAF, PDCF, MMIF, AMLF • Targeted lending TALF, & CPFF • Purchase longer-term marketable securities Treasury and GSE-related securities 48

Short Term Lending for Financial Institutions • Term Auction Facility Provides short-term liquidity without stigma of discount window • Primary Dealer Credit Facility Supports Fed’s ability to buy and sell securities • Money Market Investor Funding Facility Stunted run on money market by providing investors with liquidity • Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility 49

D W I I S N N C T D O O U W 50

Targeted Lending • Term Asset-Backed Securities Loan Facility Aimed at restarting flow of credit in auto, student, credit card, and small business lending markets. Expanded to include commercial mortgage market • Commercial Paper Funding Facility Aimed at backing stable commercial paper issuers 51

TALF Initiated S L E O C D A U N R S E 52

CPFF Success & Wind-Down 53

Purchase of Long-Term Securities • Treasury Securities • Government-Sponsored Enterprise Debt • Government-Sponsored Enterprise Mortgage Backed Securities 54

Support for Specific Institutions • Lehman Brothers’ collapse caused significant systemic faltering • Institutions posing systemic risk Bear Stearns AIG • Fed’s decision to act Threats to global financial system special programs 55

Exit Strategy • Transition from easing to tightening • Paying Interest on reserves • Reducing the balance sheet 1. 2. 3. 4. Recovery and Runoffs Reverse Repurchase Agreements Term Deposits at Fed Sale of Long Term Securities 56

Monetary Policy & Asset Prices Debate over Fed’s role in preventing asset bubbles is being reconsidered Low Interest rates have fueled “excessive speculation and risktaking” 57

USD Index 58

Gold vs. USD Index Source: WSJ 59

Surging Commodity Prices 60

Crude Oil Source: WSJ 61

MSCI World Equities Index 62

Mortgage Backed Securities 1995 - 2007 Financial institutions issue huge amounts of MBS Investors buy and sell assets at 10 – 12 underlying value Source: Gerald P. Dwyer, Jr. , 2008 and 2009 63

Excessive Leverage 2003 - 2007 64

“Leaning against the wind” Raising interestrates to dampen potential excesses Evidence from 1999 and 2004 suggests asset bubbles may not respond to policy tightening “Monetary Policy, for which we in the Federal Reserve are responsible, is a blunt instrument with economy-wide effects” -Gary Stern, President FRB of Minneapolis 65

Alternative Approach: Regulation Targeted effort to mitigate excessive speculation and risk • Micro-prudential • Macro-prudential “The best approach here if at all possible is to use supervisory and regulatory methods to restrain undue risk-taking and to make sure the system is resilient in case an asset price bubble bursts in the future. ” -Ben Bernanke, Federal Reserve Chairman 66

Micro-Prudential Regulation Enhance Regulatory Capital Standards • Higher Capital Requirements • Contingent Capital Instrument Regulate OTC Derivatives Markets • Centralized clearing • Standardized reporting • Supervision of derivatives dealers Consumer Financial Protection Agency • Reduce predatory lending and deceptive practices Regulation of Hedge Fund Industry • Register with SEC International Coordination • Accounting standards 67

Macro-Prudential Regulation Resolution Authority for “Too Big To Fail” Reduce moral hazard Eliminate taxpayer liability Increase incentives for sound management Systemic Risk Identify regulatory gaps, perverse incentives, sources of market instability 68

Financial Stability and Oversight Commission Chair Appointed by President FEDERAL RESERVE Financial Services Advisory Council TREASURY SEC FDIC CFTC CFPA Legend SEC Securities Exchange Commission FDIC Federal Deposit Insurance Commission CFTC Commodity Futures Trading Commission CFPA Consumer Financial Protection Agency 69

Policy Recommendations Maintain Target Fed Funds Rate 0. 0 - 0. 25% Economic conditions likely to “warrant exceptionally low levels for an extended period” Continue Asset Purchases Improve regulation and supervision of the financial services system Systemic Risk Regulation Financial Stability and Oversight Commission 70

Questions 71