SUBPRIME CRISIS 2008Housing Bubble: USA

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Monil Shah A027Rohan Negi A035

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Meaning of Subprime :

The word means subordinate to primary It is the loan given to people with a bad credit

rating who are not eligible for Prime loan ( normal loans )

Characterized by higher interest rates, poor quality collateral, and less favorable terms in order to compensate for higher credit risk

Sub-prime lending may be utilized for sub-prime mortgages, sub-prime car loans, sub-prime credit cards etc.

Why are Subprime loans issued ?

For banks to earn more money by tapping the defaulting customers

For young people who do not have enough money for down payment

For people having financial problems

For people who are discriminated against

The US subprime mortgage crisis was a set of events and conditions that led to a financial crisis and subsequent recession that began in 2008

Characterized by a rise in the inability to pay housing mortgages resulting in the decline of securities backed by mortgages

These mortgage-backed securities (MBS) initially offered attractive rates of return

However, the lower credit quality ultimately caused massive defaults

The money was sucked out of several banks, financial institutions and the economy as a whole in September 2008

Several European and developing countries had invested heavily in American banks

The subsequent loss of funds resulted in the Global Recession of 2008

Subprime Crisis in Brief

2000-2005 :

Very low interest rates, property prices were on a rising trend and the sub prime borrowers were able to meet their obligations by selling the properties or getting the properties refinanced

This created what is called ‘The Housing Bubble’

2005-2006 :

The housing bubble burst during this time, triggering the crisis

There was a steep fall in housing prices The interest rates on subprime loans however

were high and were rising The subprime borrowers were not able to meet

their liabilities leading to meltdown of the US subprime industry

2006-2008 :

More subprime borrowers failed to pay their debts Securities held by mortgages lost value globally Global investors also drastically reduced

purchases of mortgage-backed debt and other securities

The global recession of 2008-2009 :

Concerns about the soundness of U.S. credit and financial markets led to tightening credit around the world and slowing economic growth in the U.S. and Europe

The U.S. entered a deep recession, with nearly 9 million jobs lost during 2008 and 2009

This recession was second to only ‘The Great Depression of the 1920’s’ resulting in huge losses

WHEN DID IT ALL START?

Owning a home is part of the 'American Dream'. It allows people to take pride in a property and engage in a community for the long term.

However, homes are expensive and most people need to borrow money to get one.

The conditions were right for people to achieve that dream. In the early 2000s, mortgage interest rates were low, which allow you to borrow more money with a lower monthly payment. In addition, home prices increased dramatically, so buying a home seemed like a sure bet.

Lenders understood that homes make good collateral so they were willing to participate.

The mortgage crisis was triggered as this situation built momentum.

The American Dream

DOT COM COLLAPSE – 2000

SEPTEMBER 11 TERRORIST ATTACK

Low interest rates

Increase in loan incentives

Easy credit conditions

•Principle of demand and Supply

2001 2004

1994 - 5 % 1996 - 9 % 1999 – 13% 2006 – 20%

Increase in Sub prime borrowers

The housing bubble began to burst in late 2005

Since the end of 2005, default rates on subprime mortgages have soared from 6.5% to 17%, while foreclosure rates have jumped from 2.5% to 9%.

2005

When house prices ceased rising in mid 2006 and then started falling, subprime mortgage defaults began accelerating.

Effects Sub prime borrowers Financial institutions Banks

2006

On December 1, 2008, the National Bureau of Economic Research announced that the economy had entered into a recession in December of 2007. Real GDP increased by only 0.4 percent for the year 2008, and it decreased at annual rates of 5.4 percent in the 4th quarter of 2008 and 6.4 percent in the 1st quarter of 2009. The unemployment rate increased from 4.9 percent in December of 2007 to 9.5 percent in June of 2009.

The total real estate equity in The United States was valued at $13 trillion during the 2006 peak, had fallen to $8.8 trillion by mid 2008.

2008

The Main PlayersThe people who contributed to the deadly chain of events that sent the entire world

economy into recession.

Continued Reduction in Fed Rates

Sudden increase in Money supply

Rates remained low till 2005

High Liquidity

The Federal Reserve

Lowered to lending rates to increase loan off take

As the prime market was nearing saturation, began lending to subprime borrowers

Aggressively sold MBS, CDO Additional funds raised by securitization was

re-deployed in the same manner

Commercial Banks

Non-traditional mortgages MBS ratings influenced using parental

linkages as well as rating shopping

Buying property well beyond their means Buying for price arbitrage Non-traditional mortgages leveraged their

borrowing capacity further 2yrs fixed rate, then floating rates: EMIs

rose exuberantly, house value fell Thus making foreclosure a viable option Accelerated downward spiral

Homebuyer

Increased use of Secondary mortgage market

Lenders sold their mortgages in the secondary market

Pooled mortgages into securities like CDOs and MBS

Investment Banks

Investors: Investors were the ones willing to purchase

these CDOs at ridiculously low premiums over Treasury bonds.

These enticingly low rates are what ultimately led to such huge demand for subprime loans.

Source: Hammond Associates

Fuelled volatility through credit arbitrage Credit Default Swaps Influenced banks to bring out more MBS &

CDOs as it was a good avenue to invest in

Hedge Funds

The worst hit economies

Source: Wikipedia

Denotes the real GDP Growth during 2009.(Countries in brown represent those in recession)

Subprime Crisis and India

Year Growth (US$ Bn)

2006-07 22.6

2007-08 29.0

2008-09 13.7

2009-10 -3.62010-11 29.5

India’s export growth rate

15 per cent of total export in 2006-07 was directed toward USA.

Official statistics released on the first day of the New Year, showed that exports had dropped to $1.5 billion in November 2008, (Sivaraman, 2008) from $12.7 billion a year ago.

Manufacturing sectors like leather, textile, gems and jewellery got hit hard.

India’s GDP growth rate

Year Growth Rate

2005-06 9.5

2006-07 9.6

2007-08 9.3

2008-09 6.8

2009-10 8.0

2010-11 8.6

Source: http://planningcommission.nic.in/data/datatable/1705/final_1.pdf

Impact on Indian Stock Market

BSE ‘SENSEX’ PERFORMANCE IN 2008

Month Open High Low Close

January 20325.27 21,206.77 15,332.42 17468.71

February 17820.67 18,895.34 16,457.74 17578.72

March 17227.56 17,227.56 14,677.24 15644.44

April 15771.72 17,480.74 15,297.96 17287.31

May 17560.15 17,735.70 16,196.02 16415.57

June 16591.46 16,632.72 13,405.54 13461.60

July 13480.02 15,130.09 12,514.02 14355.75

August 14064.26 15,579.78 14,002.43 14564.53

September 14412.99 15,107.01 12,153.55 12860.43

October 13006.72 13,203.86 7,697.39 9788.06

November 10209.37 10,945.41 8,316.39 9092.72

December 9162.94 10,188.54 8,467.43 9647.31

Source: http://www.bseindia.com/indices/indexarchivedata.aspx

Against a net inflow of US$20.3 billion in FY2007–2008, there was a net outflow of US$15 billion from Indian markets during FY2008–2009 as foreign portfolio investors sought safety and mobilized resources to strengthen the balance sheet of their parent companies.

With Indian stocks melting under the heat of a global crisis, overseas investors pulled out three dollars in 2008 from every four pumped in the previous year.

A major chunk of FII of over $3 billion had taken place in October 2008 alone, which saw the Sensex going to its lowest level in the last three years.

Reason for fall in index

Primary Market (IPO-NSE)Year No. of

IPOsAmt Raised (in Rs. Cr)

Issue Succeeded

Issue Failed

2007 108 33,946.22

104 04

2008 39 18,339.92

36 03

2009 22 19,306.58

21 01

2010 66 36,362.18

64 02

IPO Report - Year Vs. Money raised through IPOs

only US$18 billion raised in FY2008–2009 as commercial credit from the overseas market=41% less than the amount raised in the previous year.

ECB approvals declined from US$3 billion in September 2008 to less than US$0.5 billion in February 2009.

For the first time in last six years, FDI inflows witnessed a negative growth of 2% in FY2008–2009.

Year Inflow

FDI 2004-05 US$6Bn

2007-08 US$34.3Bn

ECBs 2004-05 US$9Bn

2007-08 US$30.3Bn

FDI & ECBs

Fall of INRDec 30th : 1USD =48INR

Jan 1st : 1USD =39INR Dec 1st : 1USD=50INR

WHERE AND HOW IT DID NOT HURT INDIA ON A LARGE SCALE ??

India’s Real estate market was very similar to that of the U.S in 2008.

Housing developments were sprouting up everywhere.

Plenty of money flowing into India, mainly from private equity and hedge funds, to fuel the commercial real estate bubble in particular.

Carlyle, Blackstone, Citibank — they were all here, throwing money at developers

WHY THIS DIFFERENCE!!

70% of the banking system in India is nationalized, so RBI’s role as a strong regulator is critical.

Indian banks were not levered like American banks.

Capital ratios here are 12% and 13%, instead of 7% or 8% of the Americans.

Banking Sector

Banks Capital Adequacy Ratio during2007-08

Federal Bank Oriental Bank of Commerce Barclays Bank Corporation bank Kotak Mahindra Bank Allahabad Bank Bank of India ICICI bank Citi Bank Axis Bank Indian Overseas BankHFDC bank

22.5%12.1%21.1%12.1%18.7%12.0%12.0%14.0%12.0%13.7%12.0%13.6%

Indian banks don’t do interest-only or subprime loans.

Never gave more money to a borrower because the value of the house had gone up.

Non performing loans are less than 1 %. Mortgage loans tend to have down payments

in India that are 1/3rd of the purchase price. Lets not talk about those prevailing in the

United states!

Positives of the Indian Banking sector

He started sensing that real estate, in particular, had entered bubble territory before the crisis.

One of the first moves he made was to ban the use of bank loans for the purchase of raw land.

Only when the developer was about to commence building could the bank get involved — and then only to make construction loans.

ONE MAN ARMY of Dr. Y.V. Reddy!

Reddy pushed interest rates up to more than 20 percent, which of course dampened the housing frenzy.

He made banks put aside extra capital for every loan they made.

In effect, Mr. Reddy was creating liquidity even before there was a global liquidity crisis.

India's trade theory is changing a lot as it is turning out to be more of a manufacturing export oriented country.

The net trade of services done by India accounts to about just 22% .

The trade practices of India with US has decreased .

BUT on the other hand has relatively increased with China reflecting out that the risk of US recession has been deflected.

INDIAN IT SECTOR

However on a short term it will have its effect on the IT companies and also on its revenues in their future quarter results.

The growth in the employment in the IT sector in the year 2008 was 44 % up till August 08 which will drop to about 28% net growth for this financial year. 

For both commercial and residential real-estate, the proportion of black to white money may vary from 20 to 40 % depending on various factors.

However, the borrowing from banks is based only on the white portion as it should be.

Thus the value of the asset is substantially higher than what is shown in the book due to financing of the asset partly by black income.

BLACK MONEY

The presence of black money or what one may call the hidden net worth of India has tremendous advantages in times of asset based lending and borrowing since only a part of the price of asset is seen, like the tip of the iceberg.

The other portion of the asset finance by the borrower from black fund makes it imperative for him to protect his position by meeting the obligations.

The amounts in the form of black money are large and mostly invested in real-estate and gold, two major areas of passion for the Indian middle-class. As long as a good portion of our economy and asset financing is by black income we need not worry about sub-prime

THANK YOU!