Economic Recession 2

8/8/2019 Economic Recession 2

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US LOANSUS LOANS


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Once Upon a TimeOnce Upon a Time Banks made loans with the money from depositors

The 5 Cs of credit

Majority of mortgages were at fixed interest rates

Bad news: Bankers did not lend more than the deposits on banks

Good news: Depositors trusted bankers to watch and take care loans

Character

Character Capacity

Capacity Capital

Capital Conditions

Conditions Collateral

Collateral


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2121stst

Century BankingCentury Banking Banks made loans

House prices were always increasing bankers decided collateral was

sufficient for loan

Price the loan expecting refinance

Sell the loan to somebody else

Securitize: create securities that are sold in the markets and whose

payments are backed by the payments of the loans, i.e. mortgages

Good news: Selling loans raises capital and allows banks to make more loans

Set initial price so borrowers can pay, such as teaserlow interest rate

When rates change, refinance the loan

If borrower cant pay, then sell the higher pricedhouse

If house prices increase, banks cannot lose


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Causes of the economic crisisCauses of the economic crisis Boom and burst in the housing market

Consumerism

Supply more than demand Decline in prices of houses leading to defaults.

Defaults further increased the supply vicious cycle

Speculation Houses were purchased as an investment

High-risk mortgage loans and lending practices

"No Income, No Job and no Assets" loans


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Causes(contd)Causes(contd)

Inaccurate credit ratings

Credit rating agencies gave investment-grade ratings to MBSs

High ratings encouraged investors to buy securities backed by subprime

mortgages, helping finance the housing boom

Government policies

Increasing home ownership was a goal of the Clinton and Bush

administrations.

Policies of central banks

Central banks have generally chosen to react after such bubbles burst


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How did IHow did I -- Banks got involved ?Banks got involved ?

Interest rate cut to 1% post 9/11 and dot-com bust.

Collaterized Debt Obligations (CDO) returns of 4-6 %

riskier


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Opportunities for BanksOpportunities for Banks

Retain significantRetain significantportion of the interestportion of the interest

collected from borrowerscollected from borrowers

Get an upfront premiumGet an upfront premiumfrom I banksfrom I banks


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How did Insurance comps gotHow did Insurance comps got

involved ?involved ?

C

redit Default Swaps

Opportunities for AIG

the property could be confiscated if default occurs

property prices doubled over the last three years


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Chain of eventsChain of events

US housing market goes into speculative bubble

high demand increases prices

demand further increased as homes began to be seen asinvestments

Interest rates increased from in 2004-06

Defaults began to happen Property prices began to decrease starting a reverse chainreaction


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Chain of eventsChain of events

AIG goes into crisisBanks start selling

investments to make up

for losses

World markets plunge

Federal Reserve Banksannounce bailout plan tobuy $700 billion worth

of mortgage backedsecurities


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Financial sector downturnFinancial sector downturn

The crisis began to affect the financial sector in February 2007.

HSBC, the world's largest (2008) bank, wrote down its holdings of subprime-relatedMBS by $10.5 billion, the first major subprime related loss to be reported.

During 2007, at least 100 mortgage companies either shut down, suspended operations orwere sold.

Top management has not escaped unscathed.


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Market downturns and impactsMarket downturns and impacts

Crisis encouraged investors to take their money out of risky mortgage bonds

and shaky equities and put it into commodities as "stores of value.

Bankruptcy of investment bank Lehman Brothers.

Merrill Lynch joined with Bank of America in a forced merger worth $50

billion.

Insurer American International Group saved by US government frombankruptcy.

Crisis in stock indices in the United States (the Dow Jones Industrial Average,

NASDAQ, and the S&P 500).


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Indirect economic effectsIndirect economic effects

Declining house prices have reduced household wealth and the collateral

for home equity loans.

House-related crimes such as arson have increased.

Significant job losses in the financial sector.

major decline in the sale of motor vehicles.


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Impact on IndiaImpact on India

PharmaceuticalsOil & GasFMCGMedia & Entertainment

Power equipments &ServicesAutoRetailLogisticsHospitality and tourism

BanksFinancial ServicesReal EstateInfrastructureInformationTechnology

LeastLeast

ImpactedImpacted

MildlyMildly

ImpactedImpacted

MostMost

ImpactedImpacted


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Indian Financial ServicesIndian Financial Services

ICICI bank :- Rs 1056 crores Loss

Low Cash Reserve Ratio by RBI

SBI, BOB ,PNB, BOI were major banks having an exposure to the

instruments issued by Lehman Brothers and Merrill Lynch.


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Real EstateReal Estate

Lehmans real estate investments at project levels

including the big ones like

DLF,

Unitech

Future Capital

have been disbursed.Stocks to get affected: Anant Raj Industries, Orbit Corporation,

Ganesh Housing, DSK Kulkarni Dev, Ajmera Reality, AnsalHousing, Ansal Properties, Purvankara Projects


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Infrastru

cture

Infrastru

cture

Adverse impact on the infrastructure companies as it disturbs the

financial atmosphere for the companies which are in the growthstage.

If there is no change in the scenario, fund raising byinfrastructure companies could become a problem.

Stocks to get affected: Reliance Infra, Prajay Engg , Triveni Engg,Unity Infra, BSEL Infra, Nagarjuna Construction, Sujana Tower,

Jyoti Structures, Action Construction.


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Information TechnologyInformation Technology

USA is most critical region for top IT companies.

% Revenue Share TCS Infosys Wipro

Americas 50.77 62 63


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Economic Recession 2

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Transcript of Economic Recession 2