Date post: | 10-May-2015 |
Category: |
Economy & Finance |
Upload: | kaushambi-ghosh |
View: | 9,233 times |
Download: | 0 times |
Presented By:
Kaushambi Ghosh
Manish Madhukar
Mohit Almal
Pankaj Agarwal
Agenda
�Subprime•Traditional Model Vs Subprime Model
•Players in the Game
�Bubble•Housing Bubble
�Why it burst?
�Global Crisis
�Impact�Events
�Indian story
�Bailouts
�What Next?
Subprime
Traditional Model Vs Subprime
Model
Players in the GAME
Players
Player 1: Fed-- Fed kept the interest rate low during much of 1990s
and particularly 2001-2005 (low oil prices, and lowinflation prompted the policy), fueling the market
-- During the 2001-2005, FFR was in the 1% to 3% range, and mostly in the 1% range
-- Fed encouraged more risky ARM lending (Greenspan)
Player 2: Mortgage Salespersons-- Worked on commission based on the number of
arms successfully twisted
Contd..
Player 3: Primary Lenders-- No incentives for judicious lending
Banks no longer needed to hold on to the mortgage,as use of mortgage-backed securities made risktaking more appealing
-- Use of ARMs with low teaser rates (below marketrates for a while, followed by much higher ratestied to index, LIBOR + some %). Teaser rates are popular when long-term interest rates are at historical lows (like much of this period), as they help lenders benefit from ARMs as rates rise
-- Net Effect: Many loans were made to NINJA’s (people with No Income, No Jobs or Assets).
Contd..
Player 4: Other Financial Institutions
-- Freddie Mac and Fannie Mae issued many
Mortgage Backed Securities
-- Other financial institutions that traded in
these as well as derivatives based on real
estate assets. Many of these were global
institutions
Contd..
Player 5: Credit rating Agencies and Analysts-- Lack of market for many of these securities, so
models were used to price them-- Inflated ratings, mostly in A range (similar to T-Bills)-- Conflict of Interest: Investment bankers’ analysts
were rating investment bankers’ clients (scandal)-- For example, 3 months prior to its demise, AIG was
rated strong buy (8 analysts), buy(3), hold (10))!!!
Player 6: Home Buyers (Taking Excessive Risk)-- Home buyers were enjoying the ride-- New ones were joining the ride, even if unqualified-- Home ownership up from 60% in 1990s to 70%
Bubble
Historic Bubbles
�Dutch Tulip Mania (1630s)
�South Sea Bubble (1710s)
�British Railway Bubble (1840s)
�US Railway Bubble (1880s)
�Roaring Twenties (1920s)
�Multi Bubble (1960s)
�Internet Bubble (1990s)
�Housing Bubble (2000s)
Structure of a Bubble
� Displacement (diffusion of new technology starts)
� Take off (stock prices show abnormal increase)
� Exuberance (stock prices grow at very high rate)
� Critical Stage (stock price growth slows down)
� Crash (stock prices start tumbling)
Population Dynamics in the Course of
a Bubble
Housing Bubble
fafafafjafkajfajfabf
afbabfabfabfabfaf
bajfbajabfabfabfa
bfabbafbafabfbafb
afbafbababfbafbaf
babfabfbafbababf
bafbabfabfbafbab
ababfbafbabababf
ababfabfabfbabfa
bfbafbafbabfbafba
fbabffabfbafbafba
bfbafbabfabfabfab
fbabfabfbafbfabfa
afaaafafafafaffafaa
a
Why housing bubble
burst????
Process of Securitization
Recap: Causes
�Boom and bust in the housing market
�High-risk mortgage loans and lending practices
�Securitization practices
�Speculation
Contd..
�Inaccurate credit ratings
�Government policies
�Policies of central banks
�Financial institution debt levels and incentives
�Credit default swaps
How bubble burst led to
crisis???
How did this turn into a crisis ?
Step 1 - The housing boom in the US started fading out in 2007
Step 2 - Boom had led to massive increase in supply of housing
Step 3 - Thus House prices started falling
Step 4 - This increased the default rate among sub-prime borrowers
Step 5 - These borrowers were no longer able/willing to pay high price for a house
that was declining in value
Step 6 – Security/Guarantee being the house being bought , this increased the
supply of houses for sale while lowering the demand, thereby lowering prices
even further and setting off a vicious cycle
Ripple Effect-Suck Everything
The housing bubble
Defaults & write
A hole in the bubble
Banks go belly-up
Banks get sucked in
How it Unfolded???
Impact
Banks Writedown($ billion) Actions
Citigroup 55.1 Bailout by Fed Reserve($326 billion)
Merrill Lynch 51.8 Taken over by Bank of America
UBS 44.2 $5.3 billion Swiss government bailout
HSBC 27.4
Wachovia 22.5 Wells Fargo
Bank of America 21.2
Royal Bank of Scotland 14.9
Morgan Stanley 14.4 bank holding companies
JP Morgan chase 14.3
Lehman Brothers 8.2 Files for Bankruptcy
AIG 18.5 bailed out by Federal reserve
Crashing Stock Indices
0
5000
10000
15000
20000
25000
30000
Va
lue
Indices
17th Jan' 2008
25th Nov' 2008
List of events
Date Events
8th September Fannie Mae/Freddie Mac placed into conservatorship by U.S.
Government
14th September Bank of America agrees to purchase Merrill Lynch for $35B
15th September Lehman Brothers declares bankruptcy
16th September Reserve Primary Fund “breaks the buck” U.S. government seizes
control of AIG in $85B bailout
18th September Treasury Secretary Paulson announces bailout plan
19th September Governments worldwide announce short selling restrictions
Treasury establishes Temporary Guarantee Program for money
market funds
21st September Fed allows investment banks Goldman Sachs and Morgan Stanley to
become bank holding companies
23rd September Warren Buffett announces $5B investment in Goldman Sachs
Date Events
25th September Washington Mutual is seized by FDIC; assets sold to JPMorgan for
$1.9B
29th September Citigroup agrees to acquire Wachovia with FDIC guarantee; a
private transaction with Wells Fargo is later announced
First bailout bill is rejected by U.S. House of Representatives
3rd October - Congress passes TARP legislation
FDIC temporarily increases deposit insurance to $250,000
7th October Fed announces Commercial Paper Funding Facility (CPFF)
8th October Coordinated rate cut by central banks around the globe
13th October Mitsubishi UFJ finalizes $9B equity investment in Morgan
Stanley
14th October Mitsubishi UFJ finalizes $9B equity investment in Morgan
Stanley
Treasury announces TARP Capital Purchase Program
21st October Fed announces Money Market Investor Funding Facility
(MMIFF)
Loss in crisis
0
100
200
300
400
500
600
700
800
900
1000
savings and loan crisis(1986-
95)
Banking crisis(1990-99) Banking Crisis(98-99) Subprime crisis(2007-present)
Expon. (Series1)
IMF raises the estimated loss
amount to 1.4 trillion dollars
Country wise ActionUnited kingdom�Has lined up a $850-billion rescue plan, May nationalise Royal Bank of Scotland
�Will recapitalise banks by up to $88 billion. Abbey, Barclays, HSBC, Llyods, Standard Chartered, HBOS and Nationwide Building Society can draw from an aggregate of $44 billion to boost their Tier 1 capital
�Bank of England will infuse liquidity of $351 billion through loans
�The government will guarantee $439 billion worth of short-and-medium term debt
�Britain has seized control of mortgage lender Bradford & Bingley
�Earlier this year nationalised Northern Rock
�Alarm: The total liabilities of Barclays of £1,300 billion (leverage ratio of over 60), surpass Britain's GDP
Contd..
Belgium�The government took partial control of the struggling Fortis Bank
�France, Belgium and Luxembourg stumped up $93 billion to recapitalise Dexia, a French-Belgian lender that ran up huge losses in its US operations
Alarm: Fortis Bank's liabilities are several times larger than the GDP of Belgium (leverage ratio of 33)
Iceland�The government has nationalised three of Iceland's biggest banks
�Accounts in these banks stand frozen
Contd..
United states�May pick up ownership in failing US banks (Morgan Stanley is reported to be one)
�Fed ready to lend directly to stressed companies
Germany
�Has guaranteed all bank deposits
�Has organised a credit lifeline of euros 35 billion for blue-chip commercial real estate lender Hypo Real Estate Holding
�Alarm: The total liabilities of Deutsche Bank (leveraging ratio of over 50) amount to 2,000-billion euro, which is more than 80 per cent of the GDP of Germany
Contd..
Singapore
� Eased monetary policy for the first time since 2003 after sinking into its first
recession in six years, hit by the meltdown in financial markets
� The government revised its 2008 growth forecast to around 3 per cent from an
earlier estimate of 4 to 5
Italy
� UniCredit Bank has announced plans to raise its capital ratio by spinning of
property assets
Ireland
� Has guaranteed all bank deposits
Contd..
Spain�Will spend 50 billion Euros ($68 billion) to buy bank assets, almost a third of the proposed 2009 central government budget
Japan�Yamato Life Insurance failed with $2.7 billion in debt
�The government may revive a bank-rescue law of the 1990s banking crisis
�Tokyo may set up a $100-billion fund to prop up smaller lenders
�Alarm: Real estate companies are folding up, forcing regional banks to raise reserves against bad loans
Indian Story
Impact of Subprime Crisis in India
No direct impact:
Structured finance undeveloped
No deleveraging
On the contrary India and China were seen as saviors of a ‘decoupling’ global economy
Result:
Capital influx, currency appreciation, stock market boom
Impact on India-Second Round
The second round effect of Sub Prime + spike in oil prices was devastating for Asian countries, including India
But for the macroeconomic cushion of low external debt
Ratio and fiscal deficits and comfortable reserves this had
the ingredients of a classic currency crisis
The Devastation
�Oil shock – worsening current account balance�India’s merchandise trade deficit in April-July 2008 increased by 50%
�BRIC may split – prospects of Brazil/Russia brightened& that of India/China darkened
�Sharp increase in inflation – food & oil the culprits�Governments could no longer fully insulate consumers from increase in retail oil prices
�Spike in food prices through biofuels link
�Higher weightage of food and oil in the consumption basket of developing world
�July 2008- CPI at 9.41% and WPI at 12%+
�Increase in fiscal deficit�Government absorbed part of the increase in oil and food prices – lower savings
�EAC’s estimate of off balance sheet deficit on account of rising food and oil prices – 4.5% of GDP
�Threat of credit downgrade
�Decline in Capital flows�Sharp decline in stock market capitalization and bearish markets
�Rupee under pressure – feeds inflation
�Decline in Growth [EAC’s estimate for 2007-08 : 7.7%] �Rising interest rates hurt consumption and investment
�Rise in fiscal deficit and decline in corporate profits result in fall in savings
Th
e D
eva
sta
tin
g e
ffe
ct
0246810121416
Thailand
India
China
South Korea
Germany
U.K.
Brazil
Russia
Soudi Arabia
U.S
Cons
umer
pri
ce in
flat
ion
M…
Co
ntd
..
-40
00
.00
-30
00
.00
-20
00
.00
-10
00
.00
0.0
0
10
00
.00
20
00
.00
30
00
.00
40
00
.00
50
00
.00
60
00
.00
70
00
.00
10
00
0
11
00
0
12
00
0
13
00
0
14
00
0
15
00
0
16
00
0
17
00
0
18
00
0
19
00
0
20
00
0
21
00
0
January 2007
February 2007
March 2007
April 2007
May 2007
June 2007
July 2007
August 2007
September 2007
October 2007
November 2007
December 2007
January 2008
February 2008
March 2008
April 2008
May 2008
June 2008
July 2008
August 2008
BS
E S
en
sex
an
d F
II Eq
uity
Se
nse
x C
lose
FII E
qu
ity $
M
Co
ntd
..
39
40
41
42
43
44
45
46
January 2007
February 2007
March 2007
April 2007
May 2007
June 2007
July 2007
August 2007
September 2007
October 2007
November 2007
December 2007
January 2008
February 2008
March 2008
April 2008
May 2008
June 2008
July 1 2008
August 1 2008
September 10 2008
US D
olla
r -In
dia
n R
up
ee
Exch
an
ge R
ate
(RB
I)
Emerging economies adversely
impacted by demand destruction in
‘global consumer of the last resort’:
US major trading partner for India
(15% of exports), Brazil and China
(20% of exports)
Can India and China rescue the world?
Emerging markets have borne the brunt of the second round impact and are themselves
bearish
Lessons of the sub prime crisis for India
�You cannot decouple from the world’s biggest economy in a fast integrating world
�Sophisticated structured finance products canbecome ‘weapons of mass destruction’
�Moral hazard and financial sector liberalization
�RBI must rethink the concept of Universal Banking
�Focus on ‘Credit Discipline’ as a corrective to financial inclusion
�Reconsider basing monetary policy entirely on movements in consumer prices alone
Bailout Ben
Rationale for the Bailout
Stabilise the Economy
Improve Liquidity
Comprehensive Strategy
Immediate and Significant
Broad Impact
Investor Confidence
Impact on Economy and GDP
Second
Bailout of
$800 billion
announced
yesterday
by FED
When the music stops in terms of liquidity, things will When the music stops in terms of liquidity, things will When the music stops in terms of liquidity, things will When the music stops in terms of liquidity, things will
get complicated. But as long as the music is playing, get complicated. But as long as the music is playing, get complicated. But as long as the music is playing, get complicated. But as long as the music is playing,
you've got to get up and dance. We're still dancing. you've got to get up and dance. We're still dancing. you've got to get up and dance. We're still dancing. you've got to get up and dance. We're still dancing. ----
Chuck Prince, CitigroupChuck Prince, CitigroupChuck Prince, CitigroupChuck Prince, Citigroup
Now What???
Liquidity Crunch
The reduced availability of liquidity
Interest rate premiums
U.S.: Banks not lending to each other
ROW: London Interbank Offered Rate (Libor)
Libor is used to set rates on the $360
trillion of financial products worldwide.
Three month Libor set an all time high last
week at 5.34%.
Amount Outstanding Estimated Losses
Residential Credit:
Depository Institution Loans $2,889 $308
Non-Agency Securities $2,531 $523
GSE Exposures $4,807 $76
Subtotal $10,227 $907
Non Residential Credit:
Loans $7,670 $195
Non-Agency Securities $5,440 $475
Subtotal $13,110 $670
Total $23,337 $1,577
Overview of Credit Exposures and Estimated Losses(September 2008; billions of US dollars)
Estimated Costs of Banking Crisis
U.S.A. 2007-2010 $700 billion = 5.0 %
$1600 billion = 11.4 %
$3200 billion = 22.8 %
Country Period Estimated Cost as % of
GDP
United States 1980 2.5 %
Japan 1990 20.0 % est.
Norway 1987-89 4.0 %
Korea 1997 60.0 % p
Indonesia 1997 80.0 % p
Is Depression Imminent:
�During the Great Depression�Combined GDP of 7 largest economies dropped by
20%during 1929-1932
�There were no deposit insurance, so people withdrew money from banks and many banks failed
�Fed increased interest rate (!!) and reduced liquidity
� U.S. imposed heavy tariffs and other countries reciprocated lowering world trade by 70%
The situation is much different as a lot is learned from experiences of the Great Depression