Skip Victor November 4, 2010

“I have learned in my life as a composer chiefly through my mistakes and pursuits of false assumptions, not by my exposure to founts of wisdom and knowledge.” Igor Stravinsky

• • • • • • • • • 1956 1974 1978 1981 1983 1984 1990 2005 2006 Born in Detroit, Michigan Cranbrook High School Cornell University, A.B. in Economics Bankers Trust Company UCLA Anderson, MBA in Strategy & Policy Drexel Burnham Lambert Chanin Capital Partners Balmoral Advisors Duff & Phelps / Chanin Capital Partners

• Assumptions • Questions • Listen • Synthesize • Mistakes and Failures and Rejections • Luck and Serendipity

• Severe Decline in Stock and Bond Markets • Record Foreclosures • High and Persistent Unemployment • (Near) Collapse of the Financial System • Decline of American Pre-eminence

• Home Ownership • Low Interest Rates • Financial Innovation • Globalization / New Prosperity • Ratings Agencies • Optimism

In 2004 the George W. Bush administration urged Congress to pass the American Dream Downpayment Act.

Federal Housing Commissioner John Weicher said, “the White House doesn’t think those who can afford the monthly payment but have been unable to save for a down payment should be deprived from owning a home.” He added, “We do not anticipate any costs to taxpayers.”

“These two entities Fannie May and Freddie Mac are not facing any kind of financial crisis. . .” “I want to roll the dice a little bit more in this situation towards subsidized housing. . . “ Rep. Barney Frank House Financial Services Comm.

September 2003

“Improvements in lending practices driven by information technology have enabled lenders to reach households with previous unrecognized borrowing capacities.“ Alan Greenspan October 2004

“Derivatives have permitted the unbundling of financial risks.” Alan Greenspan May 2005

“Derivatives are financial weapons of mass destruction.” Warren Buffett

“As long as the music is playing, you’ve got to get up and dance.” “We’re still dancing.” Charles Prince, July 2007 CEO of Citibank

Citigroup’s stock market value dropped from $244 billion to $6 billion, 75,000 in employee layoffs, and approximately $45 billion in TARP/government assistance.

• • • • • • • • • Policy Confusion about Home Ownership Home Values Don’t Always Increase Spending Beyond Your Means Usually Doesn’t Last Financial Economy vs. Real Economy: Volatility Global Interdependence Faulty Assumptions and Reliance on Ratings Agencies Severe Under-pricing of Risk Most of the Experts Missed It Lessons Likely to Be Forgotten

• • • • • •

What Economic Crisis Doesn’t Mean

Never Buy a House Never Use Leverage Don’t Buy Derivatives Restrict Globalization Prosperity is Over Will Never Be Another Bubble / Crisis

• • • • • •

What Economic Crisis Means For You

Tough Job Market Lower Housing Prices Harder to Obtain Financing “Less” Less Optimism, More Pessimism Less Confidence, More Anxiety

“ . . . Human beings assume that the existing state of affairs will continue indefinitely, except in so far as we have specific reasons to expect change.” John Maynard Keynes

• • • • • • 9-11 Savings & Loan Crisis Long Term Capital Management Internet Bubble “Flash Crash” – May 6, 2010 Recovery in Financial Markets in 2010

1,100 1,000 900 800 700 600 500 Jan-73 Mar-73 May-73 Jul-73 Sep-73 Nov-73 Jan-74 Mar-74 May-74 Jul-74 Sep-74 Nov-74

16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 - Jan-70 Jan-75 Jan-80 Jan-85 Jan-90 Jan-95 Jan-00 Jan-05 Jan-10

• • • • • • • Pensions – Public and Private Medical Care Government Debt Social Security Environmental Political Terrorism

Costs to Taxpayers

Savings and Loan Crisis Troubled Asset Relief Program(“TARP”) Fannie May / Freddie Mac Underfunded State Pensions Source: Taxpayers for Wilson $124.6 Billion $109-127 Billion $389 Billion $3 Trillion

Defined Contribution vs. Defined Benefit

– Difference between setting aside a fixed amount of money each year and promising to pay a fixed amount in the future for an unknown amount of time – All about risk allocation

Predictions:

– Move to defined contribution and away from defined benefit – Some promises will be broken

– Federal and state deficits and debt loads skyrocketing – History is littered with ruins of empires and kingdoms that have taken on debt they couldn’t repay

“The Federal Reserve can make a difference, but

it doesn’t have a magic bullet. It can’t take a weak economy facing a lot of major challenges and rapidly turn it into a strong economy.” Donald Kohn Former Federal Reserve Vice Chairman

“Consumption when brought forward must be

financed, and that financing is a two way bargain between borrower and creditor.

When debt levels become too high lenders balk and even lenders of last-resort sovereigns, central bankers and supernatural agencies – approach limits beyond which private enterprises productivity itself is threatened.” Bill Gross PIMCO July 2010

• • • • • • • Good News / Bad News Humility, Curiosity, Flexibility Mentor(s) Think Independently Read The Fine Print Move up the Problem Hierarchy: – – Cause Identify – Solve Assumptions Drive Behavior