Economy & Recession-bhdruka 200309

8/14/2019 Economy & Recession-bhdruka 200309

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ECONOMY &RECESSION

S.L. Narasimha RaoCEO, Hema Sri Power Projects Ltd,

Visiting Prof. IPE, IIIF, CIRE,

Bhadruka Group of Institutions,

(former MD, IFCI Financial Services Ltd) March 20, 2009


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Economic Cycle

The four stages of an Economic Cycle are:

Recession Recovery

Boom

Depression


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Economy & Money supply

The economy and its growth are affected by the following

factors of money supply: Sources of Money supply (External):

Foreign Exchange Reserves : FE inflows through

FII & FDI investments,

NRI remittances

Export Revenues (Business Goods & Services),

ECBs raised by Corporates

External debt raised by Govt World Bank/IFC/ ADB aided projects

Spending by foreign Embassies and tourists (Business &Leisure)


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Economy & Money supply.. .Contd..

Sources of Money supply (Internal):

Insurance & Pension funds, Personal savings,

GNP & GDP

Monsoons & Agriculture growth

Manufacturing Growth (Index of Industrial Production)

Services Growth


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Factors Economy.. .Contd..

Internal:

Policies of the Government - Industrial sectors allowed,Investment limits

Legal environment: Tax, Duties, Labour, Employment,Ownership etc.

Infrastructure available (Roads, Ports, Power, Telecometc)

Investment avenues and quantum of investment

Knowledge & Skill levels (Human Resources)

GNP/GDP, Monsoons & Agriculture growth


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Economy & Money supply.. .Contd..

Major Factors: Foreign Exchange rate & FE Risk

Balance of Trade/ Balance of Payments

Inflation and Interest rates

Taxation

Budgetary deficit (Fiscal deficit)


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Growth of Global Economy

A Few Facts:

Post dotcom bust (2000) and 9/11 in 2001, the governmentsacross the world opted for monetary expansion to stimulategrowth and economy.

As a consequence of increased liquidity (of high magnitude) theinterest rates dropped and consumer spending increased.

The risk premiums have dropped and investors opted for riskierassets to increase their returns.

In fact, a global tide has lifted the whole world economyincluding that of India.

Now that the global tide is ebbing, India will fall with all others.

Given our strengths, we may not suffer as badly as others.


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The Effects

The core cause of the world wide economic boom was hugeoverspending by Americans in the last decade, based on a

long housing boom. Overspending led to a record US trade deficit of $700

billion/year.

To feed the above demand, while China & India have

supplied the manufactured goods & services, other countrieshave supplied the commodities, because of which the pricesof commodities shot through the roof.

China, averaging a double digit growth for the last so manyyears, has been the biggest beneficiary of the overspendingby Americans.

In turn, India has averaged a growth rate of slightly less than9% during the last 4 years.


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Effect on Indian Economy

The easy money supply in the US and other global markets

has caused the investors to look for investments in emerging

markets, to earn a higher rate of return.

The excess money supply found its way into the BRIC

economies, whose stock markets witnessed anunprecedented boom.

As Indian Govt and RBI gave importance to control of

inflation and kept the interest rates high, it has createdproblem of more capital inflows because of interest arbitrage.


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Effect Economy.. .Contd..

The rupee appreciated vis-a-vis US dollar, due to more

capital inflows.

The export industries such as IT & Textiles suffered.

There is an all round price increase and the prices of real

estate shot through the roof, threatening to create a housing

asset bubble.

INFLATIONhit an all time high (7.00%)


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The Sub Prime Mess


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The Mess - Overview

Economies worldwide were at risk of a deep recessionafter the dotcom bubble burst in early 2000 and by the

9/11 terrorist attacks in 2001.

In response, Central Banks around the world createdcapital liquidity by a reduction in interest rates, to stimulatethe economies .

Investors sought higher returns through riskierinvestments.

Lenders took on greater risks too, and approved subprimemortgage loans to borrowers with poor credit.

Consumer demand drove the housing boom to all-timehighs in the summer of 2005, which ultimately collapsed inAugust of 2006.

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Biggest Culprits- The Lenders Blame should squarely rest on the lenders (mortgage Originators) who

lent funds to people with poor credit record and a high risk of default.

Central Banks - capital liquidity lower interest rates depressed riskpremiums.

Investors for higher returns - riskier investments.

Lenders ample money to lend. Higher risks for higher returns.

Interest rates dropped substantially - increased demand for mortgages

- housing prices increased due to higher demand.

Economy was healthy and people made their payments.

Lenders saw subprime mortgages as less of a risk than they reallywere and the risk of credit default was not adequately priced in.

Subprime mortgage originations grew from $173 billion in 2001 to arecord level of $665 billion in 2005, which represented an increase ofnearly 400% (See Figure-1).

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Partners In Crime: Home buyers

Home buyers played an extremely risky game by buying houses

they could barely afford with non-traditional mortgages (NTM),

without understanding the risks and assessing their paying

capacity.

NTM offered low introductory rates and minimal initial costs

such as "no down payment, which depended on future rise in

incomes.Hoped for price appreciation, refinance at lower rates and take

the equity out of the home for use in other spending.

Property developers continued to develop house properties and

increased the supply of housing stock.

However, instead of continued appreciation, the housing bubble

burst, and prices dropped rapidly.

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Buyers.. .Contd..

As a result, when their mortgages reset, many homeowners were

unable to refinance their mortgages to lower rates, as there was

no equity being created due to fall in housing prices.

Buyers were, therefore, forced to reset their mortgage at higher

rates, which many could not afford.

Many homeowners were simply forced to default on their

mortgages. Foreclosures continued to increase through 2006 and

2007.

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Investment Banks Worsen the Situation

Securitisation played havoc.

Lenders increased the use of the secondary mortgage marketto sell off the mortgages, collect the originating fees and

increase the liquidity freeing more capital for more lending.

The number of subprime loans that lenders could originate

increased building up the momentum.

A lot of the demand for these mortgages came from the creation

of assets that pooled mortgages together into a security

(Securitisation), such as a collateralised debt obligation (CDO).

In this process, investment banks would buy the mortgages from

lenders and securitise these mortgages into bonds, which were

sold to investors through CDOs.

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Sub-Prime Losses.. .Contd..

These CDOs were sold throughout the globe to various banks,

FIs and HNIsThe chart overleaf demonstrates the incredible increase in

global CDOs issues in 2006.

Indian Experience:

Though not having direct exposure to Sub Primemortgage, due to credit crunch and increase in interestrates on Corporate ECBs, ICICI Bank had to provide for aloss of about $263 mn in its books for FY 2007-08, for itscredit swap transactions.

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Rating Agencies: Conflict of Interest

Rating agencies should have foreseen the high default rates for

subprime borrowers and should have given these CDOs much

lower ratings than the AAA rating given to the higher quality

tranches.

If the ratings had been more accurate and realistic, fewer

investors would have bought into these securities, and the losses

may not have been as bad.

Conflict of Interest:

There is an inherent conflict of interest between rating agencies,

who receive fees from a security's creator and their ability to

give an unbiased assessment of risk.

The rating agencies were enticed to give better ratings in order

to continue receiving service fees.

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Fuel to Fire: Investor Behaviour

Much of the blame also must be placed on those who invested

in CDOs.

Investors were the ones willing to purchase these CDOs at

ridiculously low premiums over Treasury Bonds and did not

understand the risks involved.

These enticingly low rates are what ultimately led to such huge

demand for subprime loans.

Much of the blame here lies with individual investors because it

is up to them to perform due diligence on their investments and

make appropriate expectations. Investors failed in this by taking

the 'AAA' CDO ratings at face value.

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Final Culprit: Hedge Funds

Another party that added to the mess was the hedge fund

industry. It aggravated the problem not only by pushing rates

lower, but also by fueling the market volatility that caused

investor losses. The failures of a few investment managers also

contributed to the problem.

There is a hedge fund strategy that is known as credit

arbitrage. It involves purchasing subprime bonds on credit and

hedging these positions with credit default swaps.

This amplified the demand for CDOs: By using leverage, a fund

could purchase a lot more CDOs and bonds than it could with

existing capital alone, pushing subprime interest rates lower andfurther fueling the problem.

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Hedge Funds.. .Contd..

Moreover, because leverage was involved, this set the stage for

a spike in volatility, which is exactly what happened as soon as

investors realized the true, lesser quality of subprime CDOs.

Because hedge funds used a significant amount of leverage,

losses were amplified and many hedge funds shut down

operations as they ran out of money in the face of margin calls.

loans.

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Final Blame - Regulators

Finally, the Regulators have to take their share of blame.

The whole episode was being enacted under the very nose of theUS Regulators The FED & the SEC.

Neither the SEC looked at the structure and rating of the CDOs.

Nor the FED cautioned the commercial banks about the risks

involved in dispensing loans to the sub prime borrowers.The home owners were not adequately educated about the

clauses regarding the interest rate reset, the balloon payments

and the foreclosure criteria etc.

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SUBPRIME LOSSES (as on 12th Aug 2008)

Firm Write down & Loss (bn USD) Capital Raised (bn USD)

Citigroup 55.10 49.10

Merrill Lynch 51.80 29.90

UBS 44.20 28.30

HSBC 27.40 3.90

Wachovia 22.50 11.00

Bank of America 21.20 20.70

IKB Deutsche 15.30 12.60

Royal Bank of Scotland 14.90 24.30

Washington Mutual 14.80 12.10

Morgan Stanley 14.40 5.60

JPMorgan Chase 14.30 7.90

Deutsche Bank 10.80 3.20

Credit Suisse 10.50 2.70

Wells Fargo 10.00 4.10

Barclays 9.10 18.60Lehman Brothers 8.20 13.90

Credit Agricole 8.00 8.80

Fortis 7.40 7.20

HBOS 7.10 7.60

Societe Generale 6.80 9.80

Bayerische Landesbank 6.40 -

Fi W it d & L (b USD) C it l R i d (b USD)


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Canadian Imperial (CIBC) 6.30 2.80

Mizuho Financial Group 5.90 -

ING Groep 5.80 4.80

National City 5.40 8.90

Lloyds TSB 5.00 4.90

IndyMac 4.90 -

WestLB 4.70 7.50

Dresdner 4.10 -

BNP Paribas 4.00 -

LB Baden-Wuerttemberg 3.80 -

Goldman Sachs 3.80 0.60

E*Trade 3.60 2.40

Nomura Holdings 3.30 1.10

Natixis 3.30 6.70

Bear Stearns 3.20 -

HSH Nordbank 2.80 1.90

Landesbank Sachsen 2.60 -

UniCredit 2.60 -

Commerzbank 2.40 -

ABN Amro 2.30 -

DZ Bank 2.00



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Bank Hapoalim 1.70 2.40

Mitsubishi UFJ 1.60 1.50

Royal Bank of Canada 1.50 -

Marshall & Ilsley 1.40 -

Alliance & Leicester 1.40 -

U.S. Bancorp 1.30 -

Dexia 1.20 -

Caisse d'Epargne 1.20 -

Keycorp 1.20 1.70

Sovereign Bancorp 1.00 1.90

Hypo Real Estate 1.00 -

Gulf International 1.00 1.00

Sumitomo Mitsui 0.90 4.90

Sumitomo Trust 0.70 1.00

DBS Group 0.20 1.10

Other European banks* 7.20 2.30

Other Asian banks* 4.60 7.80

Other U.S. banks* 2.90 1.90

Other Canadian banks* 1.80 -

Total 501.40 353.00

Source: Bloomberg


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IMFs Assessment of Subprime Losses

August 04, 2008

The IMF said in its bi-annual assesment of globalfinancial markets, that market turmoil related to the

credit crisis could result in potential aggregate lossesof $945 billion;

The IMF projects losses on mortgages and mortgagerelated securities could equal $565 billion. If loansand securities related to commercial real estate,consumer credit and corporations are included thenthe aggregate loss estimate rises to $945 billion.

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Moody's Estimate for Subprime Losses

Friday, February 27, 2009

Moody's Investors Service on Thursday raised its lossestimates to $680 billion in U.S. subprime residential mortgage-backed securities (RMBS) issued from 2005 to 2007 and putthem on risk for possible downgrade.

It said an additional 22% of current non-delinquent loans woulddefault after this year. When added to the defaults expectedfrom existing delinquencies and those expected by year's end,

Moody's expects a total default rate on existing subprime loansto reach 72% for 2006-vintage loans.

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EFFECT onGlobal & Indian Economy


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Forecasts Growth & Economy

Findings are:

Still there are some more toxic assets in the US financiallandscape to the tune of around $450 bn.

All the economies of the G-8 countries including that ofJapan are officially in recession.

The US economy is in deep recession, and would take 2 to 3years for the economy to stasbilise.

The economies of the BRICcountries (Brazil, Russia, India &China) are slowing down significantly.

Further, the US Government has introduced 2 stimuluspackages involving US $ 1.5 trillion in the aggregate.

E F t C td


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Eco Forecast.. .Contd..

The increased uncertainty and the large scale losses, haveincreased risk aversion among the investors banks &

individuals.

Most of the US & European banks are having a tight liquiditysituation.

Would reduce the flows into developing countries. The Indian economy has already slowed down the latest

growth estimate being around 6.5%.

The silver lining: However, US recession may actually

increase the outsourcing of business processes by UScompanies, in order to cut costs to stay competitive andbenefit Indian service providers.

G th P ibiliti


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Growth - Possibilities

Less US spending - a big drop in US imports from Asia - Reductionin demand for commodities from Africa, Latin America and CentralAsia.

The same countries that benefited from US overspending will nowsuffer as US spending declines.

In a very likely scenario, the US will suffer a prolonged slowdown-

cum-recession for 18 months or more. That will translate into hugeglobal pain.

In the above scenario, India's GDP growth will come down to 5-6%. That is no higher than in the 1990s!

This does not mean that all recent progress has been illusory. India

has raised its savings rate to 34%, and built up strong skills that arehere to stay.

But our sustainable long-term growth rate, in less-than-booming global conditions, may be only 7-8%.

US ECONOMY PREDICTION


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US ECONOMY PREDICTION

GEORGE CELENTE

Gerald Celente, the CEO of Trends Research Institute, isrenowned for his accuracy in predicting future world andeconomic events.

He predicted the 1987 stock market crash and the fall of the

Soviet Union.Celente also, successfully predicted the 1997 Asian Currency

Crisis, the subprime mortgage collapse and the massive

devaluation of the U.S. dollar

He is now forecasting revolution in America, food riots and taxrebellions - all within 4 years. Caution: putting food on the table

will be a more pressing concern than buying Christmas gifts by

2012.

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ECONOMY PREDICTION.. .Contd

Celente says that by 2012 America will become an undevelopednation, that there will be a revolution marked by food riots,

squatter rebellions, tax revolts and job marches.

It's going to be very bleak. Very sad. And there is going to be a lot

of homeless, the likes of which we have never seen before.

Tent cities are already sprouting up around the country and we're

going to see many more.

"We're going to start seeing huge areas of vacant real estate and

squatters living in them as well.

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THANK YOU

Economy & Recession-bhdruka 200309

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