INTELLIGENT DIALOGUE UPDATE

BEYOND PRIME ANGST

JUST MONTHS after we published our “Prime Angst” Intelligent Dialogue paper in May 2008, the tremors of the U.S. subprime crisis
gave way to a full-blown earthquake, shaking the global financial system to its core. And as we all see, aftershocks are spreading fast
into the everyday global economy of jobs and purchases and family finances.

In keeping with our principles of Intelligent Dialogue, just as we raised questions back in May, we continue to examine the
constantly shifting environment and encourage discussion. In this follow-up, we explore the landscape by revisiting questions we asked
then, and by looking ahead.

WHAT HAPPEN S WH EN BORROWERS CAN’T REPAY TH EI R

LOAN S, AN D HOW DOES TH I S AFFECT EVERYON E ELS E?

UPDATE: Events since May have
provided dramatic answers to that
question, reaching an absolute
crisis point in September.
On September 7, as subprime borrowers
were defaulting on loans in ever larger
numbers, the U.S. government took
control of mortgage corporations Fannie
Mae and Freddie Mac, which between
them accounted for almost half the U.S.
home-loan market. Financial services
companies that had bought packets of
subprime loans bundled into CDOs
(collateralized debt obligations) saw the
market value of their CDO portfolios
plummet, dragging them toward
insolvency. The U.S. authorities allowed
investment bank Lehman Brothers to go
bankrupt on September 15. On the same
day, Bank of America acquired troubled
investment bank Merrill Lynch. On
September 16, vast insurance corporation
AIG faced a liquidity crisis and accepted
up to $85 billion of Federal Reserve credit
in exchange for 79.9% equity in the group.
All around the world, big-name banks
faced collapse. As we wrote in May, the
tiny nation of Iceland was in trouble after
its aggressively expanded banks could no
longer fund themselves on the money
markets; Iceland effectively went bankrupt
October 9. The list of woes has grown
longer by the day as consumer and
business confidence declines.
The answer to the question is that when
too many people and institutions can’t
repay their loans, governments themselves
become the only entities strong enough to
step in—individually or collectively (through
the International Monetary Fund)—with
bailouts, cash injections and liquidity
guarantees. The U.S. financial system was
saved from collapse by a $700 billion
Federal bailout plan passed October 3. The
U.K. government rescued the British
banking system October 8 with a £400
billion package for eight of the country’s
biggest banks and mortgage lenders. Other
countries such as France, Germany and
Switzerland followed suit. The IMF bailed
out Ukraine to the tune of $16.5 billion on
October 26 and stepped in with $25 billion
to rescue Hungary on October 29.
The focus so far has been on managing
the fallout from mortgage-related debt. But
mortgages are only one of the ways
households get money on loan. The next
household loan crisis brewing is consumer
credit, which has been the top-up fuel
that’s turbo-charged the booming economy
in recent years. At the end of 2007, U.S.
consumers alone owed $961 billion in
credit card debt. Now that home equity
withdrawal has become more difficult or
impossible (with house prices falling and
equity turning negative) consumers have
turned to credit cards to pay for everyday
purchases. But with bad home loans
mounting, card issuers are anticipating a
spike in credit card defaults. They’re
becoming much choosier about who they
lend to, how much credit they extend and
how quickly they expect payment.
Consumers are finding that fees and rates
can land them deeper in trouble.
It’s now increasingly clear that high
levels of debt have determined the
headlong dynamics of whole markets,
national economies and the whole global
economy.

How long will it take for more manageable forms of debt and more sustainable dynamics to emerge? Can finance
lead the way, or will governments force the issue through intervention and regulation?

1 INTELLIGENT DIALOGUE UPDATE: BEYOND PRIME ANGST

 IS TODAY’S CRISIS A PRELUDE TO EVEN BIGGER DISASTERS
IN OTHER SECTORS SUCH AS EDUCATION AND RETIREMENT?

UPDATE: We said in May that
all around the world, some of the
most profound effects of the crisis
will be felt at the beginning and
end of adulthood, and this is
certainly proving to be the case.
On the education front, expectations of
ever-increasing prosperity have pushed up
demand for education as well as costs.
According to the U.K.’s Daily Telegraph,
between 2001 and 2006, average British
school fees rose by 39 percent. Parents
have squeezed their budgets and taken out
loans to give kids a running start in life
with private education aimed at getting
them into top universities. However, now
that credit is drying up and incomes are
threatened, many parents are pulling their
children out of private education and
looking for ways to reduce educational
costs. A recent New York magazine article
reports that 45 families have informed the
300-year-old competitive-enrollment
Trinity School in New York City that their
kids will not be returning next year, a huge
drop considering the school’s enrollment
of only 1,000 for its entire K-12 program.
Students are finding it harder to get loans
and grants as banks become tighter. This
is bad news for private educational
institutions because it’s reducing
enrollment income at the same time that
investments are being hit by falling stock
markets. Inevitably some schools won’t
make it through the economic crisis.
Publicly funded school systems are less
directly vulnerable to students’ ability to
pay fees, but they too are facing funding
problems. Falling tax revenues and rising
demands on public funds mean that
schools will increasingly struggle with
tighter budgets.
This raises serious questions about
investment in the education of future
problem-solvers and wealth-generators:
Will economic strain result in a relatively
short-term dip in educational provision
and output? Or will it inflict longer-term
damage that harms nations’ capacity to
educate and results in a “lost generation”?
No matter what, young people have the
expanse of their whole adult life to get back
on track. People approaching retirement
have no such prospects. Those who made
provisions for retirement in pension plans
are seeing the value of plans decline as stock
markets have fallen. Those who thought
their home would fund their pension must
think again, realizing home equity won’t be
an option unless housing markets pick up,
and that could take a long time.
Younger people have the consolation of
knowing there’s a fair chance that the
economy will pick up sooner or later, allowing
them to get back to work with a reasonable
chance that stock markets and property
will gradually start to recoup lost value.
But for older people, working beyond their
planned retirement may not be an option
in a recessionary or stagnant economy.

Will the crisis prove to be a wake-up call for consumers and governments to make more robust provisions for the
huge numbers of baby boomers moving toward retirement age? Or is it the early phase of a chronic problem of
senior short-funding?

DOES TH E S U BPRI M E CRI S I S HAVE H EALTH I M PLICATION S?

UPDATE: In the short-term, the
impact of the crisis is expected to show
up in matters of mental health. The
World Health Organization warned
on October 9 that the global financial
crisis is likely to cause increased
mental health issues and even suicides
as people struggle to cope with the lack
of cash, the prospect of unemployment
and even losing their homes.
As we noted in May, 47 million American
adults were without health insurance
and each percentage-point rise in
unemployment will result in an additional
1.1 million people losing their coverage.
Inevitably, as the economic effects of the
crisis hit jobs and household finances,
more families will cut back on medical
costs and defer medical attention.
Compounding the emotional stress of an
economic crisis, this certainly has serious
longer-term implications for public health.
A major meta-analysis of 293
independent studies published by the
American Psychological Association found
that people’s immune systems suffer badly
from stress-inducing events that change
their identities or social roles, are beyond
their control and seem endless: “The
longer the stress, the more the immune
system shifted from potentially adaptive
changes … to potentially detrimental
changes, at first in cellular immunity and
then in broader immune function. Thus,
stressors that turn a person’s world upside
down and appear to offer no ‘light at the
end of the tunnel’ could have the greatest
psychological and physiological impact.”
People who lived through the Great
Depression of the 1930s and other major
hardships (war, internment, dictatorship)
are evidence that people have survived
worse traumas. But quality-of-life
expectations are much higher today. Not
only that, societies are more complex and
interconnected; as the economic crisis has
shown, events in one place can set off a
chain that travels far and wide.

Will the economic crisis lead to a longer-term problem of more stress-related illnesses? How can the economic crisis
be prevented from turning into a health crisis?

2 INTELLIGENT DIALOGUE UPDATE: BEYOND PRIME ANGST

 I F BAN KI NG AN D FI NANCE ARE TO BLAM E,
WHO WI LL PU N I S H TH EM AN D HOW?

UPDATE: Since we raised the
question in May, this has become a
very hot topic. In allowing Lehman
Brothers to go bankrupt, U.S.
authorities may have intended a
gesture of punishment; many
analysts now contend that the move
was a mistake that accelerated the
meltdown of the financial system.
In any event, Lehman was the exception;
authorities around the world quickly
concluded that banks could no longer be
allowed to fail, since that would put the global
financial system at risk. In fact, far from being
punished, other troubled banks have either
been rescued with bailouts or guided into the
arms of more solvent financial firms; for
example Merrill Lynch was bought/rescued
by Bank of America in September.
There was outrage and opposition to the
$700 billion bailout of the U.S. financial
system proposed by U.S. Treasury
Secretary Henry Paulson in September—a
move that prompted the phrase
“Capitalism on the way up, socialism on
the way down.” In fact the plan was voted
down by the House of Representatives on
September 29 before it was modified and
accepted October 3.
Rightly or wrongly, there is a
widespread public perception in many
countries that the banking and finance
industry is to blame. Since banks have
been bailed out with taxpayers’ money in
the U.S., U.K., France, Germany,
Switzerland and the Benelux countries, the
media and the public are on alert for any
signs that banks are abusing the largesse of
citizens by paying themselves too much or
by sitting on cash rather than extending
badly needed credit.
There are plenty of accounts of PR foul-
ups by bankers. On October 24, New York
Times journalist Joe Nocera wrote of a
conference call with JP Morgan Chase
employees, during which the bank
reportedly planned to use bailout money
to buy weaker banks and grow, rather
than to ease the consumer credit crunch.
In the U.K., Chancellor of the Exchequer
(finance minister) Alistair Darling
summoned big bank chiefs to “persuade”
them to pass on the benefits of the Bank of
England’s historic 1.5 percent point cut in
base rates. The banks were reluctant to
pass on the cuts. This prompted the
chairman of Parliament’s Treasury Select
Committee to comment, “They are being
short-sighted. Given that they have had
copious amounts of money from the
taxpayer and are fully guaranteed, it must
dawn on them that they have a social
responsibility as well. The pressure on
them will be maintained until they
acknowledge that responsibility.”
The net result appears to be a standoff.
The financial system is absolutely reliant
upon government willingness to step in
with bailouts, yet governments are
absolutely reliant on banks and financial-
services firms to keep money moving
through the economy.
In May, we asked whether the financial
crisis would mean a return to stricter
regulation for the banking industry. As of
November, there is certainly talk, but the
G20 summit of world leaders in
Washington resulted in no definitive step
forward. A follow-up meeting has been
scheduled for April 30, 2009, 101 days after
Barack Obama takes office as U.S. President.

Is it possible to design and enforce a global financial system that is more stable than the current one? Will banks
cooperate to foster greater stability, or are the interests of global financial institutions now decoupled from the
interests of the global economy?

WHO WI LL BEN EFIT FROM TH E CREDIT CRU NCH?

UPDATE: It’s very early to talk
about benefits from a crisis that’s a
long way from finished. However,
history will likely say that the crisis
definitively tipped the 2008 U.S.
presidential election in favor of
Barack Obama. The more the crisis
spiraled, the more commanding
Obama’s lead in the polls became.
In May we noted a comment from Roger
Martin-Fagg of Henley Business School at
the University of Reading in the U.K.:
“Power and ownership are shifting
eastward.” As developed-world economies
of the United States and the European
Union struggle to find cash for bailouts, all
eyes turn to countries with big cash piles.
China and the Gulf States have trillions of
dollars in reserves that could enable the
IMF to help smaller countries withstand
the present turmoil. British Prime Minister
Gordon Brown, one of the most proactive
world leaders in this crisis, toured the Gulf
States in early November to bolster
funding for the IMF. At the very least,
Gulf economies and China are likely to
wield much more authority in global trade
and finance talks.
In the meantime, down on Main Street
it’s hard to see who will benefit from the
crisis in the short term, apart from
insolvency practitioners and bargain
hunters short on debt and long on cash.
Still, with auto sales falling dramatically,
consumers driving less and economic
activity slowing, the environment may be
one unintentional beneficiary.

In the meantime the questions on everybody’s mind are: How much worse will it get before it gets better, and how
long will that take? And how will we know when the crisis is over?

3 INTELLIGENT DIALOGUE UPDATE: BEYOND PRIME ANGST

 LOOKING “BEYOND PRIME ANGST”

DURING THE YEARS of economic boom, everyone came to expect high rates of growth, especially in business. Many businesses were
expected by analysts and investors to deliver double-digit growth year in, year out. In many cases, 10 percent annual growth was seen
as disappointing, even though that means doubling in size every 10 years. It’s now clear that much of that growth was dependent
upon credit, which has now become drastically less available.

As long as the downturn continues, it’s highly unlikely that many businesses will be able to achieve even minimal growth. In fact,
maintaining business at previous levels will be a major achievement for many. And once economies emerge from the crisis, consumers
will need time to regain their confidence. Who will be quick to risk the sort of credit-fueled spending that delivered the big growth in
the boom years?

This begs the question: Will consumer-focused industries lead the way out of the recession? Which industries will drive future
economic growth? U.S. President-elect Barack Obama has a clear view on this issue: “The engine of economic growth for the past 20
years is not going to be there for the next 20. That was consumer spending. … There is no better potential driver that pervades all
aspects of our economy than a new energy economy.”

In the economies that emerge from the recession, where there is no easy credit to fuel business, what rates of growth will be
regarded as reasonable and sustainable? Will the business culture become more prudent and cautious, or will it revert to the hard-
driving pre-crisis attitudes?

And finally, how will the crisis shape the attitudes of Millennials and the generation behind them? They have never experienced a
serious economic downturn, let alone one that has generated such widespread fear and angst. Will the experience traumatize them into
being cautious and avoiding risk, or will they shrug it off and get back to the future?

The Porter Novelli INTELLIGENTDIALOGUE Principle

WHAT PORTER NOVELLI UNIQUELY OFFERS can be summed up in two words: Intelligent Influence. The basis for
Intelligent Influence is Intelligent Dialogue. As yesterday’s mass media morph into today’s interactive media, people
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sound-bite answers are seductive; they give a comforting but illusory sense of resolution. Instead, we need to cultivate
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4 INTELLIGENT DIALOGUE UPDATE: BEYOND PRIME ANGST