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How credit crises lunched ?what is Emergency Economic Stabilization Act 2008

Structure and Change in Economic History

By: Gholamhossein Davani

IACPA,NYSSCPA,IMA,AIA,CFE

Jan.2009



Dayarayan Auditing & FinancialServices Firm

2

What it all comes down to is this : my opponent's view

of the world sees a long slow decline

for our country, an inevitable fall mandated byimpersonal historic forces. But America is not in

decline. America is a rising nation. I see America as the

leader, a unique nation with a special role

in the world. This has been called the American century

because in it we were the dominant force

for good in the world. We saved Europe, cured polio,

went to the moon and lit the world with ourculture. Now we are on the verge of a new century. I

say it will be another American century.

GW. Bush Aug.1988 Elect Lecture New Orleans




3

Blaming fair-value accounting for the credit

crisis is a lot like going to a doctor for a diagnosis

and then blaming him for telling you that you

are sick.''

Dane Mott , JPMorgan Chase & Co.




4

The Dow Jones Industrial Average (DJIA) doubled in just a

decade from 7,022 on 13 February 1997 to a peak of 14,164on 9 October 2007. It was a Golden Decade of continuousgrowth in share values and economic prosperity. But, in the13 months since last October, virtually all this growth hasevaporated & we are almost back to where we started in1997. Truly a decade of Boom to Bust!

Update 20 November, 2008: The second new low this week. Ithought we were near the bottom but, not after today. Themarket reached a new low of 7552, a fall of 46.7 %, from its alltime peak on 9 October 2007. This crash entered the charts afew weeks ago but, as the market continues to dive, thismillennium crash today reached NUMBER 5 in the all timeworst crashes!




5

Calculate loss

If you had $1000 on 3 September 1929, it wouldhave been worth only $108.14 (89.2% loss) byJuly 8th, 1932. Full recovery of this loss didnt

occur until 1954, 22 years later!Date Started: 4/17/1930Date Ended: 7/8/1932Total Days: 813

Starting DJIA: 294.07Ending DJIA: 41.22Total Loss: -86.0%




6

Three days that shook the world(12-

14 Sep.2008)

On Sunday, September 14, it was announced

that Lehman Brothers would file forbankruptcy after the Federal Reserve Bank

declined to participate in creating a financial

support facility for Lehman Brothers




7

The amoral Elephant

The March Of Folly

From 1929 To 2008




8

1nd Worst Stock Market Crash

1930-1932

This is the grand daddy of them all. Investorslost 86% of their money over this 813 day beast.This market crash combined with the 1929

crash, makes up the Great Depression. In justtwo months, September and October, the stockmarket had lost 40 percent of its value. BlackTuesday usually marks the point where theRoaring 20s ended and the Great Depressionstarted. The stock market continued to fall untilbottoming out in July of 1932.






10

3rd Worst Stock Market Crash

1906-1907

Key events: The Panic of 1907 due to a credit

crunch in New York, as well as gloom due to

President Roosevelts antitrust drive

Date Started: 1/19/1906Date Ended: 11/15/1907

Total Days: 665

Starting DJIA: 75.45

Ending DJIA: 38.83Total Loss: -48.5%




11

4th Worst Stock Market Crash 1929

Key events: End of the roaring twenties, and

kicked off the Great Depression

Date Started: 9/3/1929

Date Ended: 11/13/1929

Total Days: 71

Starting DJIA: 381.17





12

5th Worst Stock Market Crash 1919 -

1921

Key events: Followed a post war boom, bursting of the first big tech bubble- the automobile sector (butafter bottoming, this decade saw tremendous

growth in the stock market and the economy, oftencalled the roaring twenties)Date Started: 11/3/1919Date Ended: 8/24/1921Total Days: 660

Starting DJIA: 119.62Ending DJIA: 63.9Total Loss: -46.6%




13


1903

Key events: Assassination of President William

McKinley; a severe drought causing alarm about US

food suppliesDate Started: 6/17/1901

Date Ended: 11/9/1903

Total Days: 875

Starting DJIA: 57.33Ending DJIA: 30.88

Total Loss: -46.1%




14

7th Worst Stock Market Crash 1973-

1974

Key events: Vietnam war, Watergate scandalDate Started: 1/11/1973

Date Ended: 12/06/1974Total Days: 694Starting DJIA: 1051.70Ending DJIA: 577.60

Total Loss: -45.1%




15


1942

Key events: World War 2, attack on PearlHarbour

Date Started: 9/12/1939Date Ended: 4/28/1942Total Days: 959Starting DJIA: 155.92





16


1917

Key events: US being drawn into World War 1Date Started: 11/21/1916Date Ended: 12/19/1917

Total Days: 393Starting DJIA: 110.15Ending DJIA: 65.95Total Loss: -40.1%




17

10th Worst Stock Market Crash

2000 - 2002

Key events: Tech bubble bursting, September11th terrorist attack

Date Started: 1/15/2000Date Ended: 10/9/2002Total Days: 999Starting DJIA: 11,792.98

Ending DJIA: 7,286.27Total Loss: -37.8%




18

Breaking the buck

Money market funds seek a stable $1.00 net asset value (NAV): they aimnever to lose money. If a fund's NAV drops below $1.00, one says that thefund "broke the buck".

This has rarely happened: as of September 16, 2008, two money fundshave broken the buck (in the 37 year history of money funds), and from

1971 to September 15, 2008, there was only one failure. The Community Bankers US Government Fund broke the buck in 1994,paying investors 96 cents per share. This was the first failure in the then 23year history of money funds, and there were no further failures for 14years. The fund had invested a large percentage of its assets intoadjustable rate securities. As interest rates increased, these floating ratesecurities lost value. This fund was an institutional money fund, not a

retail money fund, thus individuals were not directly affected. No further failures occurred until September 2008, a month that saw

tumultuous events for money funds.




19

The worlds largest companies in

detail (Top 10)

Rank Company Country Business Turnover in USD Million

1 Wal-Mart USA Commerce 348650

2 Exxon Mobil USA Energy 335086

3 Shell NL Energy 318845

4 BP UK Energy 2622855 GM USA Car 207349

6 Toyota Japan Car 204773

7 Chevron USA Energy 195341

8 Daimler Germany Car 190200

9 ConocoPhillips USA Energy 16757810 Total France Energy 166486



Dayarayan Auditing & FinancialServices Firm 20

The worlds most valuable companies

in detail (Top 10)Rank Company Country Business Market capitalization in USD Million

1 Petro china China Energy 723794

2 Exxon USA Energy 511887

3 GE USA Conglomerate 374637

4 China Mobile China Telco 3540255 I&C of China China Bank 338412

6 Microsoft USA Software 333054

7 Gas prom Russia Energy 331825

8 Shell Netherlands Energy 264330

9 AT & T USA Telco 25205110 China P & CH China Energy 249608

(Data Source: FAZ: America varlet Führungsrolle, in FAZ, No 4, January 5th, 2008, page 11)




Citigroup ranked as the leading book runner for global securities in the first quarter 2006 withUS$178.8 billion in underwriting proceeds, compared to a US$152 billion in underwriting a yearago when the firm also took first place. In terms of global underwriting fees, based uponinformation calculated by Freeman & Company, imputed fees in the opening period of 2006 jumped to over US$8.9 billion from US$7.78 billion a year ago. Citigroup generated the mostunderwriting fees in the current quarter with US$788.5 million.

Global Debt, Equity and Equity related Q1 2006 ($US m)

1. Citigroup $178,7802. JP Morgan $130,3073. Morgan Stanley $121,4454. Deutsche Bank AG $118,7635. Goldman Sachs $102,1606. Merrill Lynch $101,5347. Credit Suisse $97,448

8. RBS $74,5529. Barclays $72,083unranked:Macquarie Bank $722

Equity and Debt Capital Markets






Much of the current crisis has been caused by the banks' unwillingness to lend toeach other, so the UK government has come up with a plan to inject billions of pounds in capital and to guarantee loans in the hope that lending will resume.

UK RESCUE PLANS




The government has also nationalized or part-nationalised some leading UK banks struggling to survive the crisis.




Governments have spent billions of dollars on rescue packages, led by the US

with its $700bn rescue package.

BILLION-DOLLAR BAIL-OUTS




FINANCIAL CRISIS: HOW IT HAPPENED









Most analysts link the current credit crisis to the sub-prime mortgagebusiness, in which US banks give high-risk loans to people with poor credithistories.These and other loans, bonds or assets are bundled into portfolios - orCollateralized Debt Obligations (CDOs) - and sold on to investors globally.










Seeking a long-term solution, the US government agrees a $700bn bail-outthat will buy up Wall Street's bad debts in return for stake in the banks. TheUS government plans to borrow the money from world financial marketsand hopes it can sell the distressed assets back once the housing markethas stabilized.









Lehman worse than Enron, say PricewaterhouseCoopers

After a closed-doors creditors meeting at the 02 Dome, Lehmans administratorsPwC told reporters that the collapse of the financial services firm was ten timesbigger and more complicated than Enron.

Tony Lomas, lead administrator, said PwC had identified more than a trilliondollars worth of assets and liabilities that were yet to be accounted for. Sincethe biggest Big Four firm was appointed on 15 September, it has recovered $5billion out of a potential $550 billions worth of outstanding obligations. Clientassets of $22.3 billion have been also identified.

Amongst the 400 trade creditors identified so far is PricewaterhouseCoopersitself, the Bank of England, and the Financial Services Authority.





The following is a list of the top 10 bank failures since 1934, based on the sizeof their assets, as reported by the Federal Deposit Insurance Corp.1. Washington Mutual of Henderson, Nevada and Park City, Utah; seized Sept.25, 2008 with $307 billion in assets as of June 30, 20082. Continental Illinois of Chicago, collapsed in 1984 with $40.0 billion in assets3. First Republic Bank Corp of Dallas, failed in 1988 with $32.5 billion in assets

4. Indy Mac Bank FSB of Pasadena, California, collapsed in July 2008 withassets of $32 billion5. The American Savings & Loan Assoc. of Stockton, California, failed in 1988with assets of $30.2 billion6. Bank of New England Corp collapsed in 1991 with assets of $21.7 billion7. MCorp of Dallas, failed in 1989 with assets of $15.6 billion8. Gilbraltar Savings of Simi Valley, California, collapsed in 1989 with assets of

$15.1 billion9. First City Bancorp of Houston, failed in 1988 with assets of $13.0 billion10. Homefed Bank FA of San Diego, failed in 1992 with assets of $12.2 billion

History of bankruptcy in USA




BANKS AFFECTED BY THE GLOBAL CRISIS - 2008

Giants of the business world, such as Lehman

Brothers and Merrill Lynch, have crumbled orbeen bought out.

Source: BBC news. Finance crisis: In graphics

Bank Date Status Website

Fannie Mae 07 Sep Nationalized Fannie Mae

Freddie Mac 07 Sep Nationalized Freddie Mac

Lehman Bros 15 Sep Collapsed Lehman Bros

Merrill Lynch 15 Sep Taken over Merrill Lynch

AIG 16 Sep Part-nationalised AIG

HBOS 17 Sep Taken over HBOS

WaMu 25 Sep Collapsed and sold WaMu

Fortis 28 Sep Nationalized Fortis

Bradford & Bingley 29 Sep Nationalized Bradford & Bingley

Wachovia 29 Sep Taken over Wachovia

Glitnir 29 Sep Nationalized Glitnir

Hypo Real Estate 06 Oct Rescue package Hypo Real Estate

RBS 13 Oct Part-nationalised RBS

Lloyds TSB 13 Oct Part-nationalised Lloyds TSB




Who were Bankrupt in credit crises

Washington Mutual WaMu

Bear Streamrn

American International Group (AIG AmaranthAdvisors

Lehman Brothers Bank

Fanni Mae

Freddie Mac

Merrill Lynch

UBS and

Next ??




Who were investor of Fannie Mae &

Freddie Mac !!

China 359.9 BL.$

Japan 228.2

Russian 75.3

South Korea 63 Taiwan 54.9

Source: The Fannie/Freddie bailout: What next

Business week, New York 22,Sep.2008




Stock Market Crash Time Line

The most famous crash happened on October

29, 1929.

The second Crash was happened on October1987

The third Crash was happened on 2001

Enron,Worldcom,Parmalat,.

And now biggest world crisis in globalization

age ! 2008




Washington, DC, November 25, 2008 - The combined assets of thenation's mutual funds decreased by $1.087 trillion, or 10.2 percent, to$9.600 trillion in October, according to the Investment Company Institute'sofficial survey of the mutual fund industry. In the survey, mutual fundcompanies report actual assets, sales, and redemptions to ICI.

Total Net Assets of Mutual Funds(billions of dollars)

Oct 08Sept 08% chg Dec 07 Stock Funds3,935.44,954.8R-20.66,521.4RHybrid Funds511.4600.8R-14.9713.4RTaxable Bond

Funds1,211.91,318.9R-8.11,305.1RMunicipal Bond Funds350.8370.7R-5.4373.8RTaxable Money Market Funds3,102.92,971.7R4.42,642.1RTax-Free Money Market Funds487.2469.8R3.7465.1RTotal9,599.610,686.7R-10.212,020.9RR=Rev ised data

Trends In Mutual Fund Investing

October 2008




What are Fannie Mae and Freddie

Mac?

The Federal National Mortgage Association

(Fannie Mae ) and

Federal Home Loan Mortgage Corporation

(Freddie Mac)

are the largest purchasers and insurers of

mortgages in the country.




Why were they created?

Fannie Mae was founded - in 1938 - during the Great Depression with a simplepurpose in mind: to give lower- and middle-income Americans more access to theGreat American Dream of home ownership with a reasonable interest rate. It did itby guaranteeing if a homeowner defaulted on a loan the bank would get paid.

The money they provide to banks to lend to people also is supposed to helpstabilize the mortgage market in times of stress by ensuring sufficient resources for

loans. First established as a government agency, Fannie Mae in 1968 became a private,

shareholder-owned company with a charter from Congress requiring the companyto support the housing finance system.

Freddie Mac was established in 1970 to expand the secondary market formortgages in the U.S.

Today Fannie and Freddie hold a pivotal place in the home loan market - one that

has grown to include special advantages, such as guaranteed lines of credits fromthe U.S. Treasury, exemption from state and local taxes and limited governmentoversight.




So they are owned by the

government?

No ! !

Both Fannie (FNM/NYSE) and Freddie(FRE/NYSE) are now publicly owned and their

stock is traded on the open market.






The Emergency Economic Stabilization Act of

2008 , Div. A, enacted October 3, 2008),commonly referred to as a bailout of the U.S.financial system, is a law authorizing theUnited States Secretary of the Treasury to

spend up to US$700 billion to purchasedistressed assets, especially mortgage-backedsecurities, from the nation's banks. The Actwas proposed by U.S. President George W.

Bush and Treasury Secretary Henry Paulsonduring the global financial crisis of SeptemberOctober 2008.




What happens in a government

bailout?In a bailout scenario, called a conservator ship,

Fannie and Freddie's regulator - the Office of

Federal Housing Enterprise Oversight - wouldtake control of the companies and oversee their

operations. Treasury Secretary Henry Paulson

says the government wants to keep the

companies operating in their current form

without a government takeover.






U.S. Treasury Secretary Henry Paulson proposed a plan underwhich the U.S. Treasury would acquire up to $700 billion

worth of mortgage-backed securities. The plan wasimmediately backed by President George W. Bush andnegotiations began with leaders in the U.S. Congress to draftappropriate legislation.

President Bush meets with Congressional members, includingpresidential candidates John McCain and Barack Obama, atthe White House to discuss the bailout, September 25, 2008

Consultations among Treasury Secretary Henry Paulson,Chairman of the Federal Reserve Ben Bernanke, U.S.Securities and Exchange




Can they fail?

If they did, says Brad Neigel, a senior analyst atAite Group, a financial services research firm, "Itwould be the collapse of the entire mortgage

industry as we know it.A government takeover would be the last optionof choice, Neigel added.




How do Fannie and Freddie's current

problems affect

If the government were to step in to help the pair, it

would likely lead to lower interest rates on mortgages

because investors would be assured of repayment, saidDan Green, a certified mortgage planning specialist and

author of the mortgage reports. COM. But those

declines in rates would probably be offset by an

increase in fees, Green added.




Lehman History

18401859The history of Lehman Brothers parallels the growth of the United States and its energetic drive towardprosperity and international prominence. What would

evolve into a global financial entity began as a generalstore in the American South. Henry Lehman, animmigrant from Germany, opened his small shop in thecity of Montgomery, Alabama in 1844. Six years later,he was joined by brothers Emanuel and Mayer, and

they named the business Lehman Brothers. 1850

Henry, Emanuel and Mayer Lehman founded the Firmin Montgomery, Alabama




Where were auditors ?!

Ernst & Young gave Lehman a clean bill of healthin a July 10 report to the SEC for the quarterended May 31. Despite the growing financial

crisis, auditors expressed no reservations aboutthe value of the company's derivatives or anyscenarios under which the company might beunable to meet its obligations.

Two months later, Lehman collapsed !!




Lehman auditor's report 2007:

"Our audit included obtaining an understanding

of internal control over financial reporting,

assessing the risk that a material weakness

exists, testing and evaluating the design and

operating effectiveness of internal control based

on the assessed risk, and performing such other

procedures as we considered necessary in thecircumstances."




What was Deloittes Opinion

In our opinion, the Company maintained, in all material respects, effectiveinternal control over financial reporting as of December 31, 2007, based onthe criteria established in Internal ControlIntegrated Framework issued bythe Committee of Sponsoring Organizations of the Tread way Commission.

We have also audited, in accordance with the standards of the Public

Company Accounting Oversight Board United States), the consolidatedfinancial statements as of and for the year ended December 31, 2007 of theCompany and our report dated February 26, 2008 expressed an unqualifiedopinion on those financial statements.

Deloitte & Touche LLP

Washington, DC .February 26, 2008




Stability of Freddie MAC 2007

Freddie Mac plays a vital role by moderating

cyclical

swings in the housing sector, equalizing the

flow of mortgage

funds regionally throughout the United States

and making

mortgage funds available in a variety of

economic conditions.




Board Directors report

it is important to note that the accounting change from theprevious model results in an increase in our guarantee obligationbalance for PCs held by us and a decrease in our guaranteeobligation balance because

our guarantee obligation is not re-measured at fair value when

PCs previously purchased by us are subsequently sold. As such,the change in the income on guarantee obligation line item is notdistinguished between no longer extinguishing our guaranteeobligation and our guarantee obligation amortization change, asdoing so is not operationally feasible given activity levels in the

various periods presented. This diaÇculty highlights the fact thatthe change will provide financial statement users with improvedtransparency of operating results under the new method, in thatit presents results using a single model.




I, Richard F. Syron, certify that:

I have reviewed this Information Statement of the Federal HomeLoan Mortgage Corporation, or Freddie Mac; Based on myknowledge, this Information Statement does not contain anyuntrue statement of a material fact or omit to state a material factnecessary to make the statements made, in light of the

circumstances under which suchstatements were made, not misleading with respect to the periodcovered by this Information Statement; and . Based on myknowledge, the consolidated financial statements, and otherfinancial information included in this Information Statement, fairly

present in all material respects the financial condition, results of operations and cash flows of Freddie Mac as of, and for, theperiods presented in this Information Statement.

Date: February 28, 2008 Richard




AIGs Social Responsibility

AIG recognizes that its investments in support of our

customers, employees and the communities in which

we operate are critical to our success. AIGs ongoing

efforts to be an outstanding corporate citizen andpromote responsible and sustainable business practices

are essential to our long-term business objective of

creating value for our shareholders and serving the

interests of our clients.






outstanding claims against the biggest

six Auditors under fire ! BDO Seidman last August a jury ordered BDO Seiman to pay $521m indamages for its negligence in a Portuguese bank audit, almost as much asthe firms estimated revenue for that year.

KPMG A US Justice Department report concluded that KPMG eitherhelped perpetrate the fraud at New Century or deliberately ignored it.Class action lawsuits are also pending. KPMG also faces a lawsuit byFannie Mae, which is trying to reclaim more than $2 billion from its oldauditors. KPMG already paid $400 million to settle the SECs case against itrelated to Fannie Mae.

Ernst and Young will likely face lawsuits related to the bankruptcy of itsaudit client, Lehman Brothers.

PwC lawsuits are likely for its audit of what was once the worlds

largest insurance company, AIG. Deloitte-Washington Mutual fund

Madoff scandal- Friehling & Horowitz Auditing firm has not peer reviewmore than 15 years !!!.



Dayarayan Auditing & Financial

Services Firm 59

Emergency Economic Stabilization

plan was expected to be announced for the Treasury to

buy equity stakes in 9 American Banks, and potentially

thousands of smaller banks, using the first $250 billion

dollars allotted to the program. The banks receivingmoney would include Goldman Sachs Group Inc.,

Morgan Stanley, J.P. Morgan Chase & Co., Bank of

America Corp. (including Merrill Lynch), Citigroup Inc.,

Wells Fargo & Co., Bank of New York Mellon and StateStreet Corp.




Services Firm 60

Action Plan !!

The law which created the fund gives the

Treasury $250 billion immediately, then

requires the President to certify that an

additional $100 billion in funds are needed,and finally $350 billion are subject to

Congressional approval




Services Firm 61

What will the housing bill do? (1)

Provisions of the housing bill that President Bush signed intolaw on Wednesday, July 30, 2008:

Gives the Federal Housing Administration $300 billion in newlending authority and relaxes standards to provide affordable,

fixed-rate mortgages to an estimated 400,000 debt-riddenhomeowners. Any losses will be covered by an affordablehousing fund financed by Fannie Mae and Freddie Mac, thegovernment-sponsored companies that finance mortgages.

Allows the Treasury Department temporary authority to lend

money to Fannie and Freddie or buy their stock to avert acollapse of one or both of the mortgage giants. The authorityexpires on Dec. 31, 2009.




Services Firm 62

Creates a new regulator and tighten controls on Fannieand Freddie, including power for the regulator toapprove pay packages for company executives. Createsa new affordable housing fund drawn from their

profits. Permanently raises the limit on the loans theymay buy to $625,000 in the highest-cost areas. Allowsthem to buy loans 15 percent higher than the medianhome price in certain cities.

Provides $3.9 billion in grants to the hardest-hit

communities for buying and fixing up foreclosedproperty

What will the housing bill do? (2)

i l ff




Services Firm 63

Potential effects

The maximum cost of a $700 billion bailout would be $2,295 estimated costper American (based on an estimate of 305 million Americans), or $4,635 perworking American (based on an estimate of 151 million in the work force). It

should be noted however, that it makes little sense to merely divide thenumber 700 billion by the number of Americans or even by the number of American families, as the debt would not be paid in this fashion even if itwere all entirely used and squandered. America pays the interest on its debt,and many Americans do not make a significant contribution to this payment

or to taxes in general. The bulk of this money would be spent to purchasemortgage backed securities, ultimately backed by American homeowners,

which possibly could be sold later at a profit, by the government. EconomistMichael Hudson predicts that the bailout would cause hyperinflation anddollar collapse. However, there is no persuasive evidence of prices rising andthe U.S. Dollar. has actually risen to higher levels than before the plan'sannouncement Indeed, during the week before and after the EESA wasagreed, investment bank UBS was continually flatly rejecting that bailoutssuch as these were inflationary, emphasizing instead that they were anti-

deflationary, not inflationary.The 2008 federal budget submitted by the president is $2,900 billion,meaning a $700 billion bailout would constitute a 24% increase to $3,600billion, which would in fact far exceed the $3,100 billion 2009 budget. Thetotal government commitment and proposed commitments so far in itscurrent and proposed bailouts is reportedly $1 trillion compared to the $14trillion United States economy.




Services Firm 64

Henry Paulson

U.S. Treasury Secretary

There is much more volatility and uncertainty in the market. We will see a big change in

trading habits over the next few years,"

Economic Hit Man

I didnt want to have to do that !




Services Firm 65

Manager on side shareholders inside

Remarkably, Mr. Viniar was able to do all of theabove, and for that he earned $58.5 million in totalcompensation in 2007, including a $22.6 million

bonus and $21.1 million in stock. All told, his paywas at least 21/2 times richer than that of any other CFO on Wall Street . Mr. Viniar's comp was alsomore than 23 times the average $2.5 million raked

in by the finance chiefs on FW 's list of 1,000 CFOsat publicly traded companies.




Services Firm 66

Who were main Planner !!

The original proposal was three pages, as

submitted to the United States House of

Representatives .The purpose of the plan was to

purchase bad assets, reduce uncertaintyregarding the worth of the remaining assets,

and restore confidence in the credit markets.

The text of the proposed law was expanded to110 pages




Services Firm 67

What is Socialism for the rich and

capitalism for the poor

Socialism for the rich and capitalism for the poor is a

classical political-economic argument, formulated

around 1970, stating that in the advanced capitalist

societies, what actually happens is that the stategives much more resources to help the rich than the

poor. The argument has different formulations, one

of the most common is, the capitalist political

economy toward big corporations is "privatizingprofits and socializing losses."




Services Firm 68

New Ways of Making Money



Dayarayan Auditing & Financial Services Firm 69

What Are Derivatives?

A derivative is a financial contract whose value is

linked to the price of an underlying commodity,

asset, rate, index or the occurrence or

magnitude of an event. The term derivativerefers to how the price of these contracts is

derived from the price the underlying item. It

was like riding a tiger, not knowing how to getoff without being eaten !?




Services Firm 70

Warren Buffett

Chairmans Letter to shares holders of Berkshire Hathaway

Financial instruments are time bombs and "financial weapons of mass

destruction their buyers and sellers, but the whole economic system.

Large amounts of risk have become concentrated in the hands of relatively

few derivatives dealers ... which can trigger serious systemic problems .

During the past 37 years, the company has delivered an average annual

return of 22.6%. Since 1965 the company's book value has gone up by

194,936%.

BBC News-Tuesday, 4 March, 2003




Services Firm 71

Some Figures and Statistics

Global equity capital $51.2 trillion (Wikipedia: Reuters March

2007) $165 trillion "total traded securities" (Economist,

19/01/2008)

Global physical trade

Daily ForEx trade volume $3.2 Trillion (BIS 2007)

Total Derivatives Nominal $516 trillion (BIS 2007)

Total Derivatives Value $11.1 trillion (BIS 2007)

Total Swaps Nominal $408 trillion, 79% of all derivatives% Interest Rate Swaps 75 (BIS 2007)




Services Firm 72

Free market ideology comes down to socialism

for the rich, capitalism for everybody else.

Market watch reminds us that the U.S. gross domestic product

(GDP) is about $15 trillion. The GDP of all nations combined is

approximately $50 trillion. The total value of all the real estate in

the world is estimated at $75 trillion and the total value of all the

world's stocks and bonds is about $100 trillion. But there's a$500 trillion market in derivatives!

(Source: By Gonsalves, AlterNet. Posted September 22, 2008.

Sean)

h bl d h l




Services Firm 73

What problems do they currently

face? Over the past year, mortgages have defaulted at a faster rate,

and companies have had to take billions of dollars in losses.Fannie and Freddie are required by their governmentregulator to have a financial cushion - cash or securities to fallback on. With losses rising, that cushion has been dwindling.

That has forced them to raise new money during a timewhere it has been expensive and difficult to do so.

Most of the mortgages Fannie and Freddie insure or own aretraditional, prime mortgages that are among the safest in themarket. The pair backed very few of the exotic sub primemortgages that have caused the most problems over the pastyear.




Services Firm 74

Some recent cases of market

manipulation using derivatives:

Avista Energy, electricity, in 1998.

Enron, electricity, 1998.

Enron, etal, electricity and gas, 2000 and 2001.

Arcadia, crude oil, in 2001.

Salomon Brothers, U.S. Treasury securities, 1991.Individual traders, U.S. Treasury securities, 1992.

Fenchurch, U.S. Treasury securities, 1993.

Ferruzzi, soybeans, 1989.

Sumitomo, copper, 1995 through 1996.

Source: Backgrounder Derivatives By :Randall Dodd

http://www2.gsb.columbia.edu/ipd/j_derivatives.html




Services Firm 75

A mortgage-backed security (MBS) is an asset-backed security whose cash flows are backed by theprincipal and interest payments of a set of mortgageloans. Payments are typically made monthly over the

lifetime of the underlying loans. However not allsecurities backed by mortgages are consideredmortgage-backed security (MBS). Housing Bonds(Mortgage Revenue Bonds) are backed by the

mortgages which they fund, but aren't classified asmortgage-backed security (MBS).




Services Firm 76

The secondary mortgage market is the market for the sale of securities or bonds collateralized by the value of mortgageloans. The mortgage lender, commercial banks, or specializedfirm will group together many loans and sell grouped loans assecurities called collateralized mortgage obligations (CMOs).

The risk of the individual loans is reduced by that aggregationprocess. citation need ed ] These securities are collateralizeddebt obligations (CDOs). The CDOs are sometimes furthergrouped in other CDOs. Mortgage delinquencies, clarify] defaults, and decreased real estate values can make theseCDOs difficult to evaluate. This happened to BNP Paribas in

August, 2007, causing the central banks to intervene withliquidity.




Services Firm 77

The bond market (also known as the debt, credit, or fixed

income market) is a financial market where participants buyand sell debt securities, usually in the form of bonds. As of 2006, the size of the international bond market is anestimated $45 trillion, of which the size of the outstandingU.S. bond market debt was $25.2 trillion.

Nearly all of the $923 billion average daily trading volume (as

of early 2007) in the U.S. bond market takes place betweenbroker-dealers and large institutions in a decentralized, over-the-counter (OTC) market. However, a small number of bonds,primarily corporate, are listed on exchanges.

References to the "bond market" usually refer to the

government bond market, because of its size, liquidity, lack of credit risk and, therefore, sensitivity to interestrates. Becauseof the inverse relationship between bond valuation andinterest rates, the bond market is often used to indicatechanges in interest rates or the shape of the yield curve.




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Bond market volatility

For market participants who own a bond, collect the coupon and hold it tomaturity, market volatility is irrelevant; principal and interest are received

according to a pre-determined schedule.But participants who buy and sell bonds before maturity are exposed to manyrisks, most importantly changes in interest rates. When interest ratesincrease, the value of existing bonds fall, since new issues pay a higher yield.Likewise, when interest rates decrease, the value of existing bonds rise, sincenew issues pay a lower yield. This is the fundamental concept of bond marketvolatility: changes in bond prices are inverse to changes in interest rates.Fluctuating interest rates are part of a country's monetary policy and bondmarket volatility is a response to expected monetary policy and economicchanges.

Economists' views of economic indicators versus actual released datacontribute to market volatility. A tight consensus is generally reflected in bondprices and there is little price movement in the market after the release of

"in-line" data. If the economic release differs from the consensus view themarket usually undergoes rapid price movement as participants interpret thedata. Uncertainty (as measured by a wide consensus) generally brings morevolatility before and after an economic release. Economic releases vary inimportance and impact depending on where the economy is in the businesscycle.




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Bond investments

Investment companies allow individual investorsthe ability to participate in the bond marketsthrough bond funds, closed-end funds and unit-investment trusts. In 2006 total bond fund net

inflows increased 97% from $30.8 billion in 2005to $60.8 billion in 2006. Exchange-traded funds(ETFs) are another alternative to trading orinvesting directly in a bond issue. These

securities allow individual investors the ability toovercome large initial and incremental tradingsizes.




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Bond market

Bond · Debenture · Fixed incomeTypes of bonds by issuer Agency bond · Corporate bond (Seniordebt, Subordinated debt) · Distressed debt · Emerging marketdebt · Government bond· Municipal bond· Sovereign bond

Types of bonds by payout Accrual bond · Auction rate security ·Callable bond · Commercial paper · Convertible bond ·Exchangeable bond · Fixed rate bond · Floating rate note · High-yield debt · Inflation-indexed bond · Inverse floating rate note ·Perpetual bond · Puttable bond · Reverse convertible · Zero-coupon bond

Securitized Products Asset-backed security · Collateralized debtobligation · Collateralized mortgage obligation · Commercialmortgage-backed security · Mortgage-backed security

Derivatives




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Derivatives

Bond option · Credit derivative · Credit default swap · CLN

Pricing

Accrued interest · Bond valuation · Clean price · Coupon · Day count convention · Dirtyprice · Maturity · Par value

Yield analysis

Nominal yield · Current yield · Yield to maturity · Yield curve · Bond duration · Bondconvexity · TED spread

Credit and spread analysis

Credit analysis · Credit risk · Credit spread· Yield spread· Z-spread · Option adjustedspread

Interest rate models

Short rate models · Rendleman-Bartter · Vasicek · Ho-Lee · Hull-White · Cox-Ingersoll-

Ross · Chen · Heath-Jarrow-Morton · Black-Derman-Toy · Brace-Gatarek-Musiela

Organizations

Commercial Mortgage Securities Association (CMSA)

International Capital Market Association (ICMA)

(Securities Industry and Financial Markets Association (SIFMA)




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All CDS positions (CDS = credit default swaps) have to be cleared and

processed. Their sum has been estimated about 1400 to 1600 billion USD.

(The total market size is 62000 billion USD).The total of mortgage based securities (e.g. mortgage backed securities)

that have been issued from Freddie Mac and Fannie Mae counts for 5500

billion USD. This is nearly 50 % of the US market, which counts for 12000

billion USD.

The US government is ready to invest 200 billion USD in preferred shares.

The sum of all public spending was 2700 billion USD in 2007.

The month the US government will spend 5 billion USD for bond issues of

Freddie and Fannie.

Two month ago the Congressional Budget Office estimated the financial

burden resulting to rescue Freddie Mac and Fannie Mae. The forecast was

25 billion USD.Indeed the cost of this rescue measure will account for 300 billion USD

(outcome of a new forecast). This amount would nearly twice the number

in terms of US net raising of credit in 2007.

(Source:http://www.eddielogic.com/)




Services Firm83

FASB Adopts Guidance to Ease Crisis

"fair value" accounting where there is no market for a

security. Fair value accounting, also known as "mark-

to-market" accounting, requires banks to value their

mortgage-related assets at current market prices.

Devastated by the write-downs they have taken on

mortgage assets since the collapse of the housing

market, banks - with the backing of congressional

Republicans - have been pushing hard for the Securities

and Exchange Commission to suspend the requirement

Storm in Accounting profession (1)




Services Firm84

But critical says

That suspending the fair value rule would

muddy the validity of financial statements andencourage exactly the kind of dodgy accounting

that defined the Enron era of corporate scandals

earlier in the decade.





Services Firm85

Recent professional guidance, such as SAS 99,Consideration of Fraud in a Financial StatementAudit, and Public Company Accounting Oversight

Board (PCAOB) Auditing Standard 2, has broughtmore attention to the auditor's responsibility touncover the warning signs of fraud, but there isstill some ambiguity about where the auditor's

responsibility ends and the fraud examiner'sbegins.





Services Firm86

New accounting Standard (FASB)

Under the change, when an active market for a

security doesn't exist, companies will be allowed

to use their managers' estimates of value, taking

into account expected future cash flows and risk

discount rates.





Services Firm87

Noteworthy language in the relief regarding

market transparency, oversight and audit, and

mark-to-market (MTM) FAS157 treatment:Section 114. Market Transparency. 48-hour

Reporting Requirement: The Secretary is

required, within 2 business days of exercising

authority...





Services Firm

88

The FRC Guidance on Audit Committees

(formerly known as the Smith Guidance) was

first published in 2003 and updated in 2005. It is

intended to assist company boards whenimplementing the sections of the Combined

Code on Corporate Governance dealing with

audit committees and to assist directors servingon audit committees in carrying out their role.




Services Firm

89

A new edition of the guidance was issued in October2008. A limited number of changes have been madeto implement some of the recommendations of theMarket Participants Group (MPG), which was

established to provide advice to the FinancialReporting Council on market-led actions to mitigatethe risk that could arise in the event of one of moreof the Big Four audit firms leaving the market. The

Groups final report, containing 15 recommendationsto enhance the efficiency of the UK audit market,was published in October 2007




Services Firm90

Helpless standardsThe amendments arise as a consequence of the amendments to

IAS 39 and IFRS 7 published by the International AccountingStandards Board (IASB) on 13 October 2008. The amendmentsissued by the IASB address the desire expressed in a number of quarters, including EU leaders and finance ministers, to reducethe differences between IFRS and US Generally AcceptedAccounting Principles.

In moving to issue the amendments, the ASB like the IASB has not followed its normal due process, given the need to takeurgent action to address the rare circumstances of the currentcredit crisis. The ASB wants to ensure that entities applying FRS

26 and FRS 29 have the same ability to be able to makereclassifications as those applying IFRS.

Entities may use the reclassification amendments, if they sowish, from 1 July 2008.

In September 2008 the IASB and FASB issued a progress report and a




Services Firm91

In September 2008, the IASB and FASB issued a progress report and a

timetable for completion for the projects initially discussed in their 2002

Memorandum of Understanding. Both Boards are clearly working hard to

bring the standards more in line with one another. In addition, the SECrecently removed the reconciliation requirement for foreign issuers to

reconcile their financial statements from IFRS to U.S. GAAP; and certain U.S.

companies may file their financial statements under IFRS starting for years

ending December 15, 2009. In addition, the SEC has recently issued a release

with a proposed roadmap for the potential mandatory adoption of IFRS in the

U.S.

With the fast pace of the convergence project, understanding the differences

between IFRS and U.S. GAAP is becoming more important for businesses of all

sizes. This course outlines the major differences between IFRS and U.S. GAAP.

Objectives:

Recognize the significant differences and similarities between U.S. GAAP andIFRS

Analyze financial statements prepared in accordance with IFRS

Standardize reporting in an international environment




Services Firm92

ACCA's written evidence to the Committee contains eight recommendations to help frame

the final report from the Committee:

There is a need to separate the activities of retail (i.e. taking deposits and making loans) from

all other forms of banking. We welcome the Government's moves to ring-fence depositoraccounts, as this is key.

ACCA recommends that remuneration design needs to be carefully thought through with a

clear eye to any unintended consequences as far as humanly possible.

Remuneration design should be linked to cash flow and clear performance measure, rather

than profitability and less well-defined measures of performance.

Banks are already heavily regulated, but the regulations are not supervised very effectively.

ACCA recommends that existing regulation for banking institutions is more effectively

supervised.

Ethical behavior and professionalism has to be at the heart of any solution.

There is a role for regulators, credit rating agencies, institutional investors and analysts in

understanding and better explaining to the wider world what the banks are doing. This has

implications for the training of these professions and the effectiveness of their

communications. There is a continuing need for convergence to international reporting standards.

The principles outlined in the OFR should be considered, and organizations should think

about how these can be injected into their reporting. ACCA is doing this and the principles

are proving useful.




Services Firm93

Into account market capitalization Chinese and European companies have gainedmore importance. Opposite to this development the importance of NorthAmerican companies as well as Japanese Companies declined. Among the top 100most valuable companies firms from China were able to more than double theirmarket value (+123 per cent). American companies had to face a decline of 10 percent.

Within the list of top 100 worlds largest companies three countries head the list:

United States, UK, and China. This list represents an example of the increasingimportance of emerging markets (countries), in particular China. (Note: Anotherexample for the importance of emerging market countries were recent measuresby sovereign wealth funds. Of course, it cannot be for granted that the enormousmarket capitalization of Chinese companies will be stable for the future. But itillustrates very well that the importance of US companies have been declined. Inaddition the weak USD, the sub prime crisis and the weak economic development

did influence the position of US companies in that list. Due to the stronger EUROcompanies from Europe were able to achieve a better position.

But see for yourself in the following to tables. Table A contains the worlds largestcompanies in terms of their turnover; table B contains the worlds most valuablecompanies in terms of market capitalization.



Sources

http://www.cbsnews.com/elements/2008/07/

16/in_depth_business/whoswho4265160.sht

ml

American Banker- October 15. 2008, where

were auditors Fannie Mae report spotlight,

Accounting errors. Bloomberg.com. Feb. 24,

2006

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