Economic Crisis of 2008 and Its Continuing Effects_guest Lecture

8/3/2019 Economic Crisis of 2008 and Its Continuing Effects_guest Lecture

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ECONOMIC CRISIS OF 2008 AND ITSCONTINUING EFFECTS ON GLOBAL

ECONOMY


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A noble cause

Post WWII era US dream of a house for

everyone Government Sponsored Entities

Establishment of Freddy Mac & Fannie Mae in1960s

Help lenders with funding the loans Generate funds from issuing debts in domestic

and international capital markets

Started guaranteeing the risky loans since 1990


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Efforts paid off


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Slippery ground

Credit score

Prime and SubprimeLoans

Loan to Value ratio


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The Bubble & Roots of crisis

Fast Growth of Mortgages to 84% of GDP in US

compared to say 9% in India Process of Securitization

Complex derivative products like ABS/MBS/CDOs

(tranches) - Higher the risk higher the return

Multiple layers of these products and exposure to allcountries creating risk for global economy with a fall

of one institution in US


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Securitization process


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Growth in Securitization Market in adecade


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Role of Rating agencies in the process

Nexus between Rating agencies and Financial Institutions

Rating determined the capital requirement. Higher the rating less

the capital adequacy and higher the demand for products of thatfinancial institution

Fee Income flowing from Financial institutions Contradiction ofBusiness model

The complexity of transactions and reliance on data provided bythe Fin Institutions

When Real Estate prices were on a upward trend noonequestioned the ratings (despite of the fact that almost 71% ofthe underlying loans were sub prime or Alt-A)


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The collapse

Housing bubble burst

Downgrades by rating

agencies

Upsurge in capital

requirements for maintaining

Capital adequacy ratio

Worries of Highly leveraged

Financial Institutions due to

Collateral calls

Upsurge in Overnight

lending/borrowing rates


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Gone with the wind


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Drop in sale prices of US houses


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Rating agencies in action


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Subprime Mortgage crisis


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Upswing in Leveraging


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Credit risk shot up dramatically during

September 2008


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Here comes the Sharks of economy

Hedge Funds

Modus Operandi Trigger of short selling and buying ofCDS

against these Institutions

Thin line between being ahead of markets

based on strong analysis vs Insider Trading


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End of economy is near

Impact on Financial

Markets Daily Panic/Rumors

Sell on every rally

Credit spreads rising to

the levels of 10% and up

MM funds trading belowface value

Global economy is

exposed


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End of economy is near (contd)

Impact on FinancialInstitutions and Industries

C

ollapse of LehmanBrothers

Winding up of SmallMortgage Businesses

Mass Layoffs

The effect also trickleddown to companies like

AIG, GE, GM resulting slowindustrial production

Deposit holders queuing upfor withdrawals

First signs of recession


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The Rescue Mission

Merger of Financial Institutions Bear Sterns taken over by JP Morgan Bank

Merill Lynch taken over by Bank Of America Wakhovia Bank taken over by Wells Fargo

Government Initiatives Banning the shorts

Saving the GSEs by nationalization

Opening credit lines for Financial Institutions

End of Broker Dealer era IBs to HBCs Deposit insurance raised from USD 100k to USD 300k

Big Bang Bailout Package

Protests by Oppositions for using tax-payers money


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Did it help?

Some respite from pain

Stabilization of Markets

Fuel for new problems High Liquidity

Rising commodity prices(Gina Rinehart, anAustralian woman whoinherited a debt-ridden

mining company from herfather 20 years ago is set tobecome the world's richestperson)

More Money in EmergingMarkets and high inflation


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Rising inflation and commodity prices


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Precious Metals A refuse in the

times of crisis

Gold backed money printing concept

Current version of Fiat economy What is the real worth of Gold?

According to World Gold Council Report, the

global gold demand in second quarter of

2011 came down by 11%


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Emergence of new problems

Huge debt levels of US &

PIGS with no supporting

growth

Relation of growth and

reduction in deficit

Data comparision between US and India as of July 2011

1514

2

9

0.251.8

0.9

8

46

024

68

10121416

GDP (USD T) Debt (USD T) Inflation (%) Deficit (%) Policy rate

(%)

US

India


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Reasons of high debt of US

Heavy expenditure on healthcare and

retirement benefits Warfare Highest under Bush Administration

Bailouts

Safe heaven for World economy with AAA

rating (Lowest interest rates) China and Japan the major holders of US

debt


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Effects on US economy

Unsustainable levels of Interest and principlepayouts

Near default by US escaped narrowly in August2011

The Dollar currencies reserve for world economy haslost charm and now down to 63% from 71%

Devaluation of US dollar vis a vis other free strong

currencies like Japan and Euro Downgrade of US debt for the first time by Rating

Agency

Fears of double dip recession


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Possible solution for US problem:

Proposals:

Raise taxes - Tax Foundation reports that between 1986 and

2009, the percentage of Americans who pay zero or negativefederal income taxes has risen to 51% from 18.5%. Tax receiptsdropped from 19% to 14% of GDP around same time.

Increase retirement age and cut spending - The Bureau ofEconomic Analysis tells that total US government spending hasrisen to 37% of GDP today from 27% in 1960.

Quantitative Easing methods

Is it possible?

Tax hike and increasing retirement age or reduction healthcarebenefits has social implications

Spending is in fact required to ensure a better growth


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The story is the same in Europe

Unsustainable Debt levels of PIGS

High Risk of default by PIGS resulting in highCDS and interest rates

Global exposure Struggle for

Italy/Swiss/Germany

Global recession


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Impact on India

Heavy reliance on Foreign Money

Strong growth momentum

Solid and stable banking system

Huge domestic demand (Export to GDP ratio is only 15%compared to 35% that of China)

World class Industries

Parallel economy and Governments efforts to bring the same in

tax net through different initiatives like Swiss treaty and GST Political Will to make things happen the right way by timely

policy changes

Economic Crisis of 2008 and Its Continuing Effects_guest Lecture

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