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8/8/2019 Economic Recession 2
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US LOANSUS LOANS
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Once Upon a TimeOnce Upon a Time Banks made loans with the money from depositors
The 5 Cs of credit
Majority of mortgages were at fixed interest rates
Bad news: Bankers did not lend more than the deposits on banks
Good news: Depositors trusted bankers to watch and take care loans
Character
Character Capacity
Capacity Capital
Capital Conditions
Conditions Collateral
Collateral
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2121stst
Century BankingCentury Banking Banks made loans
House prices were always increasing bankers decided collateral was
sufficient for loan
Price the loan expecting refinance
Sell the loan to somebody else
Securitize: create securities that are sold in the markets and whose
payments are backed by the payments of the loans, i.e. mortgages
Good news: Selling loans raises capital and allows banks to make more loans
Set initial price so borrowers can pay, such as teaserlow interest rate
When rates change, refinance the loan
If borrower cant pay, then sell the higher pricedhouse
If house prices increase, banks cannot lose
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Causes of the economic crisisCauses of the economic crisis Boom and burst in the housing market
Consumerism
Supply more than demand Decline in prices of houses leading to defaults.
Defaults further increased the supply vicious cycle
Speculation Houses were purchased as an investment
High-risk mortgage loans and lending practices
"No Income, No Job and no Assets" loans
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Causes(contd)Causes(contd)
Inaccurate credit ratings
Credit rating agencies gave investment-grade ratings to MBSs
High ratings encouraged investors to buy securities backed by subprime
mortgages, helping finance the housing boom
Government policies
Increasing home ownership was a goal of the Clinton and Bush
administrations.
Policies of central banks
Central banks have generally chosen to react after such bubbles burst
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How did IHow did I -- Banks got involved ?Banks got involved ?
Interest rate cut to 1% post 9/11 and dot-com bust.
Collaterized Debt Obligations (CDO) returns of 4-6 %
riskier
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Opportunities for BanksOpportunities for Banks
Retain significantRetain significantportion of the interestportion of the interest
collected from borrowerscollected from borrowers
Get an upfront premiumGet an upfront premiumfrom I banksfrom I banks
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How did Insurance comps gotHow did Insurance comps got
involved ?involved ?
C
redit Default Swaps
Opportunities for AIG
the property could be confiscated if default occurs
property prices doubled over the last three years
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Chain of eventsChain of events
US housing market goes into speculative bubble
high demand increases prices
demand further increased as homes began to be seen asinvestments
Interest rates increased from in 2004-06
Defaults began to happen Property prices began to decrease starting a reverse chainreaction
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Chain of eventsChain of events
AIG goes into crisisBanks start selling
investments to make up
for losses
World markets plunge
Federal Reserve Banksannounce bailout plan tobuy $700 billion worth
of mortgage backedsecurities
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Financial sector downturnFinancial sector downturn
The crisis began to affect the financial sector in February 2007.
HSBC, the world's largest (2008) bank, wrote down its holdings of subprime-relatedMBS by $10.5 billion, the first major subprime related loss to be reported.
During 2007, at least 100 mortgage companies either shut down, suspended operations orwere sold.
Top management has not escaped unscathed.
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Market downturns and impactsMarket downturns and impacts
Crisis encouraged investors to take their money out of risky mortgage bonds
and shaky equities and put it into commodities as "stores of value.
Bankruptcy of investment bank Lehman Brothers.
Merrill Lynch joined with Bank of America in a forced merger worth $50
billion.
Insurer American International Group saved by US government frombankruptcy.
Crisis in stock indices in the United States (the Dow Jones Industrial Average,
NASDAQ, and the S&P 500).
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Indirect economic effectsIndirect economic effects
Declining house prices have reduced household wealth and the collateral
for home equity loans.
House-related crimes such as arson have increased.
Significant job losses in the financial sector.
major decline in the sale of motor vehicles.
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Impact on IndiaImpact on India
PharmaceuticalsOil & GasFMCGMedia & Entertainment
Power equipments &ServicesAutoRetailLogisticsHospitality and tourism
BanksFinancial ServicesReal EstateInfrastructureInformationTechnology
LeastLeast
ImpactedImpacted
MildlyMildly
ImpactedImpacted
MostMost
ImpactedImpacted
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Indian Financial ServicesIndian Financial Services
ICICI bank :- Rs 1056 crores Loss
Low Cash Reserve Ratio by RBI
SBI, BOB ,PNB, BOI were major banks having an exposure to the
instruments issued by Lehman Brothers and Merrill Lynch.
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Real EstateReal Estate
Lehmans real estate investments at project levels
including the big ones like
DLF,
Unitech
Future Capital
have been disbursed.Stocks to get affected: Anant Raj Industries, Orbit Corporation,
Ganesh Housing, DSK Kulkarni Dev, Ajmera Reality, AnsalHousing, Ansal Properties, Purvankara Projects
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Infrastru
cture
Infrastru
cture
Adverse impact on the infrastructure companies as it disturbs the
financial atmosphere for the companies which are in the growthstage.
If there is no change in the scenario, fund raising byinfrastructure companies could become a problem.
Stocks to get affected: Reliance Infra, Prajay Engg , Triveni Engg,Unity Infra, BSEL Infra, Nagarjuna Construction, Sujana Tower,
Jyoti Structures, Action Construction.
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Information TechnologyInformation Technology
USA is most critical region for top IT companies.
% Revenue Share TCS Infosys Wipro
Americas 50.77 62 63
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