SUBPRIME CRISIS – ITS IMPACT

ON GLOBAL ECONOMY

Presented

By

Zaid Baig

MBLA 16

III Sem. l

Content History of global financial crisis. Subprime crisis Why and how it happened Who is responsible What could have been done to avoid the

crisis Effects of crisis on global economy Aftermaths of subprime crisis What we can learn from the crisis Conclusion

List of (recent) recessions (and depressions) that have affected the world

1919-21 Depression, cause-The end of World War I

Great Depression 1930, cause-US Reducing demand for European exports, also high interest rate defending the gold standard.

Mid 1970s recession, cause- oil crisis Early 1990s recession, cause- US savings and

loan crisis leading to the Early 1990s recession. Late-2000s recession, cause- dot com bubble

burst.

Subprime Mortgage Crisis

Sharp rise in home foreclosures in late 2006 Only 9% in 1996, 13% in 1999, 20% in 2006 $1.3 Trillion subprime mortgage as of March 2007 The delinquency rate had risen to 21% by 2008

Subprime Borrowers For poor credit history Limited income

Subprime Lenders Greater risks High returns

New Model of Mortgage Lending

Source: BBC News

Causes of the Crisis

The Housing Downturn Excess supply of home inventory Sales volume of new homes dropped Reduced market prices (10.4% 12/06-12/07)

Borrowers Difficulties in re-financing Begin to default on loans Walk away from properties Fraudulent misrepresentations

Causes of the Crisis

Financial Institutions Attraction from high returns Offered high-risk loan and incentives Believes that will pass on the risk to others

Securitization Mortgage backed securities Risk readily transferred to other investors From 54% in 2001 to 75% in 2006

Causes of the Crisis

Government and Regulators Community Reinvestment Act, encourages the

development of the subprime debacle Glass-Steagall Act contributes to the subprime crisis

(FDIC back up)

Central banks Less concerned with avoiding asset bubbles React after bubbles burst to minimize the impact No determination on monetary policy Institutions risk more because of Fed’s rescue

Direct Impacts of the Crisis

Stock Market

08/15/07 Dow Jones had dropped below 13,000 from July’s 14000

First 3 weeks of 08, the Dow Jones Industrial Average fell 9%

1/18/08 Dow Jones/0.5%, S&P 500/0.6%, and NASDAQ/0.3%

01/21/08 (black Monday) the world’s biggest falls since Sept. 11, 2001

Direct Impacts of the Crisis

Financial Institutions – Bankruptcy

New Century Financial (USA)– Apr. 2, 2007 American Home Mortgage (USA) – Aug. 6, 2007 Sentinel management Group (USA) – Aug. 17, 2007 Ameriquest (USA) – Aug. 31, 2007 NetBank (USA) – Sept. 30, 2007 Terra Securities (Norway) – Nov. 28, 2007 American Freedom Mortgage Inc. (USA) – Jan. 30, 2007

Direct Impacts of the Crisis

Financial Institutions – Write-Downs

Citigroup (USA) - $24.1 bln Merrill Lynch (USA) - $22.5 bln UBS AG (Switzerland) - $16.7 bln Morgan Stanley (USA) - $10.3 Credit Agricole (France) - $4.8 bln HSBC (United Kingdom) - $3.4 bln Bank of America (USA) - $5.28 bln CIBC (Canada) – 3.2 bln Deutsche Bank (Germany) - $3.1 bln

By 02/19/08 losses or write-downs > U.S. $150 blnBe expected exceeding $200 - $400 bln

Domestic Impacts of the Crisis

Home Owners Housing prices down 10.4% in Dec. 07 vs. year-ago Sales of new homes dropped by 26.4% in 07 vs. 06 By Jan. 2008, the inventory of unsold new homes

stood at 9.8 months, the highest level since 1981. Two million families will be evicted from their homes

Minorities Disproportionate level of foreclosures in minority 46% Hispanics, 55% blacks got higher cost loans

Domestic Impacts of the Crisis

Economy Condition Recession Low GDP growth rate Business close out or lose money (banks, builders etc.) Weak financial market Low consumer spending Lose jobs

Other credit markets Credit card Car loan

Global Impacts of the Crisis

Investors will be very cautious to act Lack confidence in stock/bound market

Consumer spending will slowdown Lack of cash or unwilling to spend

World economy may slip into recession U.S. economy condition will affect global economy

GDP growth will be low Lose businesses Lose jobs Economy slow down

Global Impacts of the Crisis

Financial market May take long time to recover

Unemployment rate may be high Slow economy increase unemployment rate

Exports will decrease in China, Korea, Taiwan GDP growth heavily depends on export

Impact on India

Little effect because there was quite a lot of liquidity in domestic markets in countries like India. Lack of exposure to U.S. mortgage securities; and the possibility of lower

capital inflows Public Sector Banks, viz State Bank Of India, Bank Of India, Bank Of

Baroda, Canara Bank, Punjab National Bank etc do not have major exposure to credit derivatives market due to their limited overseas operations.

The first Indian Organization affected by this Crisis was ICICI Bank Ltd. ICICI Bank's profit took a hit of more than Rs 1,050 crores ($264 million) in the year 2007-08. This was an indirect effect. ICICI lost money due to depreciation in the value of securities it bought in the international markets. Due to a rise in global interest rates after the sub prime loan crisis, the value of these securities fell, forcing the bank to provide for the difference from its profits.

Aftermaths There was a total of 2.2 million foreclosures in 2007, up 75% from the roughly

1.26 million RealtyTrac reported in 2006. RealtyTrac said 1% of all US households were in 'some stage of foreclosure' in 2007, up from 0.58% in 2006.

By the end of 2008, home prices had dropped 20% from their 2006 peak.

Many programs have been enacted and legislation passed to help those who have been hit the hardest by the crisis. Some examples include the Emergency Economic Stabilization Act of 2008 and the Homeowners Affordability and Stability Plan.

Former President Bill Clinton and former Federal Reserve Chairman Alan Greenspan indicated they did not properly regulate derivatives, including credit default swaps. A bill called the Derivatives Markets Transparency and Accountability Act of 2009 has been proposed to further regulate the CDS market. This bill would provide the authority to suspend CDS trading under certain conditions.

Government and Central Banks’ Actions

08/2007, President Bush announced – Hope New Alliance 02/13/08, President signed a tax rebates of $168 bln 09/18/07, the Fed dropped rate ½ point 10/31/07, ¼ point cut by Fed 12/11/07, ¼ point cut by Fed 01/22/08 the Fed slashed the rate by 3/4 points to 3.5% 01/30/08 another cut of 1/2 points to 3% Central Banks have pumped billions of dollars to banks Central Banks of the world have done the same thing

Conclusion Can you see that? Everybody wins! Borrowers,

banks and financial institutions are eating the same cheese happily and the cheese is “property appreciation”. Yummy, yummy!

We have learned almost nothing from our past experiences.

Human Greed Regulation Involvement of govt.

Thank You!