Good afternoon everyone. Im really excited and honored to be here with you today and wanted to thank Dr. Mahar for inviting me to speak. As you might be aware, Im going to talk about the financial crisis of 2007/2008, what happened and - from a very high level why. Im also going to sprinkle in some of my own memories of that time for good measure. So the genesis for my talk today stemmed from a facebook post more like a rant in my own estimation I wrote a few months ago after I previewed, the Big Short, a movie about financial crisis during a screening in my hometown just outside of NYC. The Big Short is a drama based on the best-selling book by Michael Lewis about the mortgage debacle of the 2007/2008 era. Having worked for Bear Stearns, one of the Wall Street firms that seemed to be a focus of the movie, I was already well-familiar with the excesses and greed of the mortgage business during that era, but the movie definitely brought me back to what were very dark days indeed for the country and for me personally. I was literally having flashbacks as I watched the movie. During the 18 month period of time during the eye of the financial crisis storm, I lost two jobs, my father to cancer, a significant portion of my net worth and probably would have lost my home had it not been for the inheritance I received from my father's estate. All of these events seemed to converge on me just as liquidity was evaporating before my eyes (including Chase Manhattan Bank suddenly cancelling the undrawn portion of my home equity line of credit). With a family of four depending on me to pay the bills and buy groceries, to say that I was feeling a little stress would be an understatement. Talk about sleepless nights. The real eye of storm did not last for many months, but it was terrifying to those of us in the middle of it who knew how close we came to total and absolute economic Armageddon. Now, let me take a step back to the spring of 2006, which is where this story starts for me. I was down in Naples Florida visiting family and was at a local barber getting a haircut. Once inside the shop I could overhear one particular barber boasting in a somewhat loud voice, mind you - about his real estate investing prowess. It seemed odd to me that a barber would have enough cash to buy real estate in beautiful and affluent Naples Florida, so naturally my ears perked up a bit and I listened intently. Over the next 20 minutes or so, I heard this fellow brag to his fellow barbers and customers about how he was able to purchase multiple homes, for purposes of flipping them which is essentially buying real estate and quickly reselling in the hopes of a quick profit after making a few minor improvements all using mortgage loans that did not require putting any money down. In addition, these mortgages did not require that he verify his stated income, which had been inflated for purposes of qualifying for the loans. Can you say mortgage fraud? If this wasnt a bubble, I dont know what would be. As a credit-trained corporate lender, I knew that being able to verifying a borrowers ability to repay a loan (by looking at looking at historical and projected cash flow) and relying on some sort of equity cushion in the value of underlying collateral were two extremely important pillars of any fundamental credit analysis, yet here in Florida in 2006, that didnt seem to matter to anyone. Why was that? Simply put, there were Wall Street underwriters who, for a fee, were willing to package up these shaky loans, also known as subprime loans, and sell tranches of debt securities backed by them to investors all over the world, there were rating agencies willing to rate certain tranches of these securities as investment grade and, as a result of these ratings, there were investors willing to buy debt these shaky debt securities backed by pools of these subprime mortgages. It wouldnt be until the spring of the following year before the cracks started to appear in the faade of normalcy within the mortgage market. The landslide, which would become an avalanche, started in February 2007 with an announcement by Freddie Mac, one of the largest public government-sponsored enterprise purchasers of mortgage backed securities, that it would no longer buy the most risky subprime mortgages and mortgage-related securities. Then, only two months later, New Century Financial Corporation, a leading subprime mortgage originator/lender, filed for Chapter 11 bankruptcy protection. By then, the crisis was in full-swing. It had become obvious to every market participant that the housing market was collapsing as overleveraged borrowers were defaulting on their mortgages in record numbers driven by poor underwriting standards and teaser rates on adjustable rates mortgages that made owning a home affordable at first but not during the inevitable rate resets. One example of the sort of loans being offered during those boom years was the so-called NINJA Loan - a nickname for a very low quality subprime loan with NINJA standing for No Income, No Job, (and) no Assets because the only thing an applicant had to show was his/her credit rating, which was presumed to reflect willingness and ability to pay. With the higher default rates, a significant number of homeowners and real estate investors all rushed to sell their homes at the same time, hoping to avoid a default. This flood of inventory into the market triggered a significant decline in market prices, and with that decline, the value of mortgage backed securities fell off a cliff when it became clear that there were a significant number of homes that were under water (meaning the value of the home was less than the value of the mortgage balance).During that same period, I was working in leveraged finance at Bear Stearns where we financed leveraged buyouts of companies by a variety private equity sponsors such as Blackstone, KKR and Bain Capital. Typically, in any leveraged finance transaction, the private equity client would line up debt financing (typically bank loans and/or bonds) for an LBO which might provide 75% of the purchase price of a company and they would use their funds equity for the balance of the purchase price. Typically the financing would be agreed-upon several months before the M&A transaction was ready to close and the rate spreads on the debt would be decided upon months before the debt financing was ready to be marketed to debt investors. This timing mismatch created somewhat of a conundrum since we and other underwriters would typically be taking market risk (basically the risk that rates, or credit spreads on rates, would increase between the time the commitment had been agreed-upon and the time the debt was sold). While underwriters attempted to address this market risk by including so-called market flex language in our debt commitments, the flex was typically capped, so that there was still some degree of risk involved in syndicating the debt commitments since wed be potentially be on the hook for a huge unsold or hung debt commitment if spreads moved more than the flex. During the spring of 2007, the leveraged finance market was on fire with private equity firms buying up private and public companies alike and our firm was definitely in the mix with a massive pipeline of forward commitments. As spring turned into summer, it was clear that the troubles in the mortgage market were beginning to spill over into the leveraged finance market. Loans that might have cleared the market at LIBOR plus 350 bps in March now required much higher spreads and with our market flex capped out in many cases at 150 bps, we needed to start selling these loans at a loss in order to move the risk off our books. Of course, we stopped booking new credit commitments just another reflection of the credit crunch that was unfolding - but spent the entire summer and early part of the fall clearing our inventory of unclosed deals initially in the mid-90s (meaning 95 cents on the dollar) and by the fall of that year, the same sort of loans were selling at 85 cents on the dollar. The market for corporate loans and bonds was drying up as investors became more and more risk averse. Meanwhile, as trouble brewed in our area of the firm, there were other areas of Bear Stearns experiencing stress. In June of that year, our mortgage department disclosed that two internal hedge funds that had used significant amounts of borrowed money to leverage third-party capital to invest in primarily mortgage-related debt that had declined significantly in value. By the end of July, despite a $1.6 billion bail-out from the parent company, the two funds filed for bankruptcy and were unwound, effectively wiping out all of the $600 million of capital that investors had contributed. The two managers of these funds were arrested and faced criminal charges of misleading investors but were ultimately acquitted. In December of that year, I along with about 20% of the firms employees at the time, were let go. It was a tough blow, to be sure, but I collected my severance and began searching for another job once the holidays were over. Several months later, as my search process neared a conclusion, I happened to be at an interview with a distressed debt fund out in Denver when I was asked: Did you know your old firm (Bear Stearns) was having liquidity problems? Turning on the television in the conference room, I saw Alan Schwarz, Bears CEO, emphatically denying that the firm had any liquidity problems. This assertion turned out to be the kiss of death for Bear, a firm that significantly relied on overnight loans which could be withdrawn at any time to fund its business. By the end of the following week in March of 2008, faced with the option of filing for bankruptcy or accepting a US Treasury brokered bailout and sale to JPMorgan, Bear Stearns agreed to be purchased for $2/share after having trading as high as $140/share less than two years before. The deal, which had been put together in less than 48 hours, had only gone through after the NY Fed agreed to purchase up to $30 billion of Bear Stearns mortgage assets that JPMorgan found too risky to assume. From the US Governments perspective, a Bear Stearns' bankruptcy would have affected the real economy by causing a "chaotic unwinding" of investments (forced selling) across the US markets. From a personal standpoint, since a portion of my annual compensation each year had paid in the form of restricted stock units which I could only sell after a three year vesting period, the transaction effectively translated into a personal loss of nearly $500 thousand dollars. On the other hand, I was one of the lucky ones as I was able to find and start a new job only a few weeks later at Bank of Tokyo. Of course, the last-minute acquisition of Bear Stearns did little to stem the malaise in the markets- but the panic had not reached a crescendo yet. In July, after a bank run reminiscent of Its a Wonderful Life, the Office of Thrift Supervision closed California-based IndyMac Bank, the second largest financial institution to close in the United Stated up until that point, after it was forced to mark down a portfolio of mortgages that had been originated with the intent to sell into the secondary market. By the end of the summer of 2008, it was clear that a variety of financial institutions were under pressure. Nearly every financial institution became unwilling to lend to other financial institutions on an unsecured basis since an unsecured loan would likely see a poor recovery in bankruptcy compared to a secured loan. Those who were still willing to lend at all would only do so on a secured basis (backed by collateral) and required more and more margin (decreasing the loan to value), effectively reducing liquidity available in the market. The upshot was - financial institutions did not have access to the dollars they needed to grow, or even to sustain their businesses. Among the financial institutions that appeared to be most at risk were the investment banks, Lehman Brothers and Merrill Lynch, primarily due to the perception that they were holding assets (including real estate and toxic mortgage backed securities) on their balance sheets at values that were dramatically overstated compared to their current market values. In addition, after being forced to recognize untold billions of dollars of losses on its mortgage portfolios which had apparently nearly depleted their respective capital bases, the federal two Government-sponsored enterprises (or GSEs), Fannie Mae and Freddie Mac, who were the two largest purchasers of conforming home mortgage loans (not subprime) were placed into conservatorship of the US government with additional backing being provided by the US Treasury of up to $100 billion in each GSE. Within a week of Fannie and Freddie being seized, Lehman Brothers was attempting to sell itself to either Barclays Bank or Bank of America in the days leading up to the weekend of September 13th and 14th and got so far as to reach a preliminary agreement for a transaction with the UK-based Barclays. However, the U.K. regulators who govern Barclays, the Financial Services Authority, declined to provide their approval of the deal on Sunday, September 13th, which triggered the Lehman bankruptcy filing the largest bankruptcy in US history as measured by assets - the following day on September 14th. At the same time, in a transaction that probably averted a similar bankruptcy, the investment bank Merrill Lynch agreed to sell itself to Bank of America for $50 billion. Nearly concurrent with the Lehman Brothers crisis, the NY Fed learned that AIG, the largest insurer in the world, was teetering on collapse due to margin-calls on its portfolio of credit default swaps (or CDS). Credit Default Swaps are essentially contracts which permit the purchaser, in exchange for an ongoing fee, to sell a set amount of a reference debt security to the seller at par (face value) in the event of a credit event such as a bankruptcy filing. Essentially, this protects the owner of the CDS against their exposure/investment in an enterprise in the event the enterprise would declare bankruptcy. An AIG affiliate had sold billions of CDS on super-senior tranches of mortgage backed bonds to a variety of third party financial institutions including Societe Generale, Deutsche Bank, UBS, Goldman Sachs and Merrill Lynch. As the financial crisis raged, despite the insurance being on the super-senior tranches which were the safest, the credit spreads on these tranches widened which required AIG to post additional collateral with its trading counter-parties to cover the swing in the valuation of the derivative contracts. In response to these collateral calls, S&P reduced AIGs credit rating due to the combination of reduced financial flexibility caused by meeting additional collateral needs and concerns over increasing residential mortgage-related losses. This rating agency downgrade in and of itself required AIG to post even more collateral, which ultimately became a death spiral for the company. Faced with the prospect of letting AIG fall into bankruptcy like Lehman brothers, and seeing the financial crisis accelerate further and to prevent the domino effect of additional bankruptcies of other financial institutions who had counterparty exposure to AIG , the Federal Reserve stepped in on September 17, 2008, announcing the creation of a secured credit facility of up to US $85 billion (a figure which was ultimately increased to $182 billion) to prevent the company's collapse and enabling AIG to deliver additional collateral to its CDS counterparties. Now switching gears back to my own experience, at the time this was going on, I was working at Bank of Tokyo, who was a lender to both Lehman and AIG and its subsidiaries. As AIG neared insolvency, I was asked to create an analysis over the weekend as to the likely recovery (or loss) on a significant unsecured loan we had outstanding to ILFC, an investment grade aircraft leasing company subsidiary of AIG. It wasnt pretty. If ILFC had been forced to file for bankruptcy, which almost certainly would have happened if its parent, AIG, had filed (since ILFC depended upon AIG for financial backing) the forced sale of a portfolio of hundreds of aircraft may have led to a significant loss for Bank of Tokyo. Needless to say, folks were pretty relieved when the government stepped in when it did. Less than ten days later, on September 25, 2008, following a 9 day bank run, the United States Office of Thrift Supervision (OTS) seized Washington Mutual Bank, the sixth largest bank in the United States at the time, and placed it into receivership with the FDIC before being sold to JPMorgan for $1.9 billion in a transaction that wiped out WAMUs shareholders and some bondholders but didnt require any FDIC assistance to cover insured deposits. Only days after that, Wachovia Bank, which was the fourth largest bank holding company in the US and had been on the verge of collapse itself due to a flight in its deposit base, was sold to Wells Fargo after being threatened with seizure by the FDIC. If the markets hadnt been in a state of turmoil already with the Lehman brothers filing, the AIG near-collapse, the seizure of Washington Mutual and forced sale of Wachovia turned up the panic several more notches. Immediately following the Lehman bankruptcy filing, an already distressed financial market began a period of extreme volatility, during which the Dow experienced its largest one day point loss ever, largest intra-day range (more than 1,000 points) and largest daily point gain. In addition, the money-markets witnessed the equivalent of an electronic bank run. Withdrawals from money markets were $144.5 billion during the one week following the Lehman filing, versus $7.1 billion the week prior. This interrupted the ability of corporations to rollover (replace) their short-term debt. The U.S. government responded by extending insurance for money market accounts analogous to bank deposit insurance via a temporary guarantee and with other Federal Reserve programs to purchase commercial paper which are effectively overnight loans made to investment grade companies such as GE - since investors were unwilling to buy the debt. What followed was what many have called the "perfect storm" of economic distress factors and eventually a $700bn bailout package (Troubled Asset Relief Program often referred to as TARP) prepared by Henry Paulson, Secretary of the Treasury, and approved by Congress and signed into law on October 3, 2008. Days afterwards, in an effort to get ahead of the series of bank runs which had already caused several large bank failures, the Federal Deposit Insurance Corporation (FDIC) established the Temporary Liquidity Guarantee Program on October 14, 2008, to strengthen confidence and to encourage liquidity in the banking system. The program had two parts: a Debt Guarantee Program (DGP), which allowed banks to issue government guaranteed debt, and a Transaction Account Guarantee (TAG) program, which essentially extended deposit insurance to depositors in unlimited amounts. In addition, on the same day, Secretary of the Treasury Henry Paulson and President Bush separately announced revisions to the TARP program. Through TARP, the Treasury announced their intention to buy $125 billion senior preferred stock and warrants from the nine largest American banks and would also end up buying preferred stock and warrants from hundreds of smaller banks, investing up to $250 billion (including the $125 billion invested in the largest firms). While the October 2008 measures did not break the back of the financial crisis altogether and there were certainly many more programs put in place to try to unfreeze the credit markets, it was clear that the US Government would use unprecedented and overwhelming measures to break the cycle of panic which had spiraled out of control. Nonetheless, despite their efforts clearly being seen as successful in retrospect, Federal Reserve Chairman Ben Bernanke, U.S. Treasury Secretary Henry Paulson and former Federal Reserve Bank of New York President Timothy Geithner faced incredible scrutiny, criticism and were second-guessed for each decision at the time and for years afterward. Saving Bear Stearns using government money was roundly criticized at the time and letting Lehman fail was called a disaster and more of a punishment for their polarizing CEO, Dick Fuld, than anything else (Treasury Secretary Hank Paulson and Dick Fuld were long-time Wall Street rivals and Fuld was known to have turned down opportunities to sell Lehman only months before). In addition, while saving AIG was widely seen as a necessary evil given the sheer size of the company, the fact that their trading counterparties, which included Goldman Sachs, received 100 cents on the dollar on amounts due to them under collateral calls as opposed to taking some sort of a haircut since everyone else was losing money- definitely struck the wrong chord with many and was seen by some as the elite taking care of their own.

We talked about the mechanics of the financial crisis, and how the deep market penetration of MBSs exposed all the biggest financial institutions to great risk. We discussed the down-spiral effect of the dislocation of the lending apparatus between financial institutions, and how lack of investor confidence in the biggest financial firms expanded this crisis into pandemic proportions. And- while most discourses on the financial crises from financial professionals focus on Wall Street- we paused to consider how Main Street contributed to the crisis as well, and why this made the scale of this crisis was so great. Hopefully I was able to put a face on the financial crisis and understood how it trickled down into becoming a personal crisis for so many people, myself included. In the end, like any storm, the darkest of thunderclouds seem to clear within a few months when it was obvious our society wasn't collapsing into an abyss worse than the great depression thanks to the quick action of folks like Bernanke, Paulson, Geithner and FDIC Chairman Sheila Bair who prevented the mother-of-all bank runs (by guaranteeing the money market funds in September of 2008 and by orchestrating the various bailouts that were so controversial). While these moves were widely condemned at the time and in retrospect, and many criticize them for not taking action earlier to prevent the debacle, our economy was literally on the precipice of total meltdown the likes of which has not been seen before, so I am grateful they took the actions they did. Have we all learned the lessons of that era? I don't know, but I have: Be optimistic about the future because things always get better when things seem darkest, but be ready for the worst case scenario. What does this mean? It means that companies need to be prepared to deal with unforeseen economic circumstances by not depending on short term funding to fund illiquid assets and by having an ample amount of liquidity on hand to manage through difficult circumstances such as market dislocations and recessions. For individuals, it means having sufficient liquidity to manage through potential periods of unemployment. As for the lessons that ought to have been learned by the financial services industry, I'm not so sure.