Presented By:

Pankaj Agarwal (President)

Mohit Almal (Secretary)

Kaushambi Ghosh ( Co- Secretary)

Manish Madhukar (Member)

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Agenda

Subprime•Traditional Model Vs Subprime Model

•Players in the Game

Bubble•Housing BubbleWhy it burst?

Global Crisis

Impact

Events

Bailouts

What Next?3

Subprime

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Traditional Model Vs Subprime Model

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Players in the GAME

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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

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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).

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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

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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%

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Bubble

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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)

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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)

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Population Dynamics in the Course of a Bubble

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Housing Bubble

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Why housing bubble burst????

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Process of Securitization

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Recap: Causes

Boom and bust in the housing market

High-risk mortgage loans and lending practices

Securitization practices

Speculation

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Contd..

Inaccurate credit ratings

Government policies

Policies of central banks

Financial institution debt levels and incentives

Credit default swaps

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How bubble burst led to crisis???

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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

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Ripple Effect-Suck Everything

The housing bubble

Defaults & write

A hole in the bubble

Banks go belly-up

Banks get sucked in30

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How it Unfolded???

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Impact

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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 reserve36

Crashing Stock Indices

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5000

10000

15000

20000

25000

30000

Val

ue

Indices

17th Jan' 2008

25th Nov' 2008

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List of events

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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

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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; aprivate 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 MorganStanley

14th October Mitsubishi UFJ finalizes $9B equity investment in MorganStanley

Treasury announces TARP Capital Purchase Program

21st October Fed announces Money Market Investor Funding Facility(MMIFF) 40

Loss in crisis

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200

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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)

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IMF raises the loss amount to 1.4 trillion dollars

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Country wise ActionUnited kingdomHas 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

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Contd..

BelgiumThe 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)

IcelandThe government has nationalised three of Iceland's biggest banks

Accounts in these banks stand frozen44

Contd..

United statesMay 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

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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

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Contd..

SpainWill spend 50 billion Euros ($68 billion) to buy bank assets, almost a third of the proposed 2009 central government budget

JapanYamato 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

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Bailout Ben

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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

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When the music stops in terms of liquidity, things will

get complicated. But as long as the music is playing,

you've got to get up and dance. We're still dancing. -

Chuck Prince, Citigroup

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Now What???

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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%.

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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)

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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

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Is Depression Imminent:

During the Great DepressionCombined 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

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