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8/6/2019 The Bubble That Burst -Usa
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An Anecdote ³ When your neighbor loses his job , it
is economic slow down .
When you lose your job , it is arecession.
But, when an economist loses his
job, it becomes a depression .
8/6/2019 The Bubble That Burst -Usa
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The Great Depression of 1929
Bank failures
Men in threadbare clothes
Shoe stuffed with newspaper to plugholes in the sole
Unemployment
Poverty
8/6/2019 The Bubble That Burst -Usa
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The theor y of a free mar ket The economic system of US A believes
the less gover nment intervention ; thebetter
The mantra is that mar kets know best!!
8/6/2019 The Bubble That Burst -Usa
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Flash back ± US A , The Super Power
Growth in the financial sector
Profits in millions
Shareholders and senior executives atan enviable position
A strong nation, world superpower
8/6/2019 The Bubble That Burst -Usa
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The Asian financial crisis of
1997 Arose due to the de- linking of the baht
from the dollar
The crisis spread to South ± East Asia,Russia , Latin America and finallyto US A .
This led to the failure of the hedgefund , LTCM
8/6/2019 The Bubble That Burst -Usa
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The Crisis of September, 2008
Fall of Bear Stear ns and take over by
JP Morgan
Nationalizing of two failing mortgagere-financing institutions ,Freddie Macand Fannie Mae
Lehman Brothers filed for bankruptcyand sold part of its shares to Barclay¶s
8/6/2019 The Bubble That Burst -Usa
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September 2008
Merrill Lynch filed for bankruptcy andwas taken over by Bank of America
Gover nment bailed out AIG , the giantinsurance company as it involved thetrust of a large number of people
Long standing companies are re-
defining themselves by tr ying to merge.
8/6/2019 The Bubble That Burst -Usa
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Where did it all begin ??
Problem with sub prime mortgages
Mortgaged backed securities landed in
trouble This spread to asset±backed
commercial paper and auction ± rate
securities The problem spread like a virus and
started swallowing whole firms
8/6/2019 The Bubble That Burst -Usa
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The no of defaulters began to rise There was a feeling that the home prices
would increase
Rather , the prices fell sharply and themar kets crashed The parties blamed each other ± The borrower contended that he did not
understand the complicated mortgageprocess
The lenders vehemently denied about theignorance of the borrower
8/6/2019 The Bubble That Burst -Usa
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The Saviour The Federal Reserve has stepped in to
save the firms, to help the financial
mar kets as they were linked across theworld .
Bad financial practices created the
bubble that led to the origin of the newcrisis of 2008.
8/6/2019 The Bubble That Burst -Usa
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The lessons not lear nt
The US gover nment failed to understandthat the system of taking deposits andissuing mortgages has failed .
In the late1980¶s and early 1990¶s they hadto use 100 billion dollars of tax payer ¶smoney to rescue the financial mar kets.
The financial institutions were dabbling insecurities and derivatives that ver y fewpeople understood
8/6/2019 The Bubble That Burst -Usa
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The accounting systems were µshady¶as it allowed the firms to keep some
items off their balance sheets . Rating agencies were µdodgy¶ as they
were accepting the ratings that thebundlers gave them without verif yingthem independently.
8/6/2019 The Bubble That Burst -Usa
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The debate continued« The gover nment in US convinced the nation
that the social security in the countr y shouldbe privatized
In the year 1999 , they went ahead andgave up all the safeguards that the Glass-Steagall Act had put together lear ninglessons from the Depression of 1929 toseparate investment banks and commercialbanks .
8/6/2019 The Bubble That Burst -Usa
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Soon the bankers realized thoughquite late that they had over-borrowedand they had no reserves to fall backon
Growing credit losses anddelinquencies have caused the banks
to tighten credit standards The businessmen found that it was
becoming difficult to get loans
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The bail out plan ± Is it the
right move ?? The moral hazard ± The gover nment µs
support in such a situation will remove
limitations on future risk takings It will look like a free -for -all and make
the risk look like child¶s play
The philosophical role ± Raise questions about the functioning
of a free enterprise
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The Priority ±The Question of Moral Hazard
or Preservation of the Society
and the System
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The decisive force What if the gover nment always comes
to the rescue when the chips are down
What does it matter if one puts thesystem over the edge ---
So long as ¶ UNCLE S AM µ will take
care Could any individual pass up those
kind of opportunities???
8/6/2019 The Bubble That Burst -Usa
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Then what next ? The conflict of interests can be
avoided by refusing to bail out the risk
± takers Let the financial miscreants squirm in
their own juice «.
This can provide satisfaction to themoralists
But , is life so simple ??
8/6/2019 The Bubble That Burst -Usa
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The Bail Out The bail out costs $700 billion
It contemplates the creation of aspecial entity
It will acquire all the distressed assets
It will recover the costs when theassets are finally sold out atappropriate occasions
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The Ripple Effect on the Indian
Economy
8/6/2019 The Bubble That Burst -Usa
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Bail Out and the Indian Economy
The Impact Low liquidity in the US will reduce the
capital inflow in India
Reduce access to foreign credit sourcefor the corporates¶
As capital inflow dries up , whether FDI
or F
II , the rupee will drop as dollar supply decreases
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The Impact
Import will become costlier and the burden
on the gover nment to maintain subsidies will
increase Tight liquidity position in the Indian mar ket
may require the RBI to ease the constraintson CRR
Decline in the crude oil price does notmitigate the situation as the price that theconsumer pays has not shown any change
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Should reforms be eased in India ??
Should the RBI ease up on financialreforms ?
Should further liberalization of FDI norms be considered for the insurer ?
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The well placed regulator y system in India
NP A¶s a t an appropriately low level
Commercial banks with distinctcharacteristics
The regulation laid by the RBI reposesfaith and confidence
This is necessar y for social andfinancial inclusion in the countr yside
8/6/2019 The Bubble That Burst -Usa
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Message to take away
Mar kets have a tendency to µfall¶ since timeschange and behavior changes too
When the mar kets show signs of weakness ,gover nments must be ready to intervene
A wise gover nment must have the disciplineto leave the mar kets alone when they are
wor king fine and vice versa . Innovation for the sake of innovation should
definitely be avoided
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Names to remember in the USCrisis
Alan Greenspan ± Head of the US centralbank form 1987-2006
Henr y Paulson-Current Secretar y of the USTreasur y ( the head of Goldman Sachs for many years )
Mr Warren Buffet head of Ber kshire
Hathway, who said ,´I told you so long ago ³The war ning about the slide of the dollar and serious consequences for the economy